Private banking: Relationship therapy as families and private banks try to move on

With wealthy families increasingly trusting their own judgment when it comes to managing their investments, private banks are under pressure to raise their game. Paul Golden speaks to both sides to analyse where they stand. 

One of the most common criticisms of the private banking sector post-recession is that it didn't listen to its customers. When formulating investment strategies they preferred to focus on products that generated the maximum profit for the advisor – and the bank, as opposed to those that best suited the customer.

A survey of Swiss-based European private banks published by MyPrivateBanking.com last year suggests that little has changed. It found that one in four of those surveyed showed no interest in the views of a fictitious "client", more than half recommended an extremely bearish strategy despite indications that the client was looking for a long-term strategy with reasonable risk tolerance, and that around one-third had "significant hidden costs" in their proposal.

Prashant Jhawar, vice chairman of the India-based, family-owned Usha Martin Group, claims that private banks generally want to manage wealthy families' money on a discretionary basis. "We are very upfront in telling the bank that we don't want to see a suite of products. We go to them with our own ideas," he says.

Sandy Loder is particularly well placed to comment on the relationship between wealthy families and the private banking community, having recently left his family business (Fleming Family & Partners) to set up wealth management consultancy AH Loder Advisers.

He feels that families should always be wary of the bank's motives and whether what it is offering is truly independent with no conflict of interest. Loder is also convinced that high net worth families have become more financially savvy since the financial market crisis.

"They have woken up to the fact that what a bank's investment product says on the label doesn't necessarily represent accurately what it ends up doing. Therefore, they are much more cautious of what the bank is telling them and are demanding greater visibility and clarity. Private banking clients are increasingly knowledgeable and asking more searching questions – they want value for money and performance," Loder says.

Robert Taylor, private banking CEO at Kleinwort Benson says the biggest single issue for the wealthy families he deals with is accessing independent advice. However, he warns that multiple advisors don't always compliment each other. "The potential implication of this disparity is that important issues can be overlooked, such as how shareholdings are structured and whether they should be maintained. Families sometimes hold onto shareholdings for reasons of sentiment and the performance of their assets is affected as a result," he says.

More than half of the private clients surveyed for PwC's 2009 Global Private Banking and Wealth Management survey described their primary source of financial advice as their own independent research and knowledge. This trend is replicated in other surveys, including the Citi Private Bank/Knight Frank Wealth Report 2010, which found that only in South America were high net worth individuals more inclined to consult their bank.

According to Lanse Crane, former chairman and CEO of seventh-generation US papermaker Crane & Co, the needs and concerns of high net worth families have changed since the market crisis. It redefined the concept of risk and underscored the need to be realistic about returns, to understand and monitor investments and to return to the fundamentals of diversification.

"The lesson that Salomon Brothers should have taught everyone – that your financial advisors and managers should be at risk for their own products and advice – wasn't learned and the experience was repeated," says Crane. "One great way to differentiate a financial manager is to ask whether they are at risk for the negative consequences of their opinions and decisions. That tends to sharpen the focus and keep the risk taking to reasonable levels."

The MyPrivateBanking.com survey noted that only eight of the 20 private banks it questioned included a price list in their proposal. But it is not only the availability of fee information that is important – clients also want to see some correlation between what they are paying and the service they are receiving.

"I think the banks will need to be more innovative in how they charge for their services, as every client has different sizes of asset and different requirements," says Loder. "Do the banks actually work out the profitability of every client regardless of size? A bit of activity-based costing may be required and as a result, some smaller clients will be more profitable than some large ones."

Taylor agrees that charging on a time-cost basis might be a better option. "A lot of business is still done on a commission basis, which does not make sense for a wealth family. Why would you turn your business over to someone who only gets paid if you buy their product?" he asks.

The other big issue at the moment is that in this low interest rate environment, fees have to be met from capital, which is never a popular development. "I think there will be further pressure on fees," Taylor adds. "Some banks may start to bring in hourly charging, especially if clients are hardly changing their portfolios."

However, PwC's survey found that only 13% of respondents had reduced their fees since the downturn in the markets. Heinrich Adami, head of private banking at Pictet in London, says fees have only come under pressure where past performance has been below-par: "Our fees have not changed," he states, while Crane suggests they are more likely to have been frozen for the short term rather than reduced.

According to Gary Powell, head of UK private banking at Rothschild Private Banking & Trust, clients are increasingly alert to the total cost of a portfolio, particularly to layering of fees where a private bank recommends house funds or other hidden costs. "Where fees have changed across the industry, this is largely a consequence of reduced interests rates and changing product mix. As a consequence, those private banks who depend on traditional deposit-taking business or rely on the structured products or funds with heavy front-end loads have found their P&L hit very hard," he says.

Wilmington Trust's chief fiduciary officer and head of family wealth Kemp Stickney says his organisation, which deals with US-based clients, has long taken a different approach to how it charges its clients. "We decided at an early point to charge on letter agreements rather than assets under management so our fees are not tied to the whims of the market. We expect to see more companies in our industry doing this over the next few years," he says.

There are also signs of change at India-based Kotak Mahindra Bank, where head of wealth management services Jaideep Hansraj identifies a shift from transaction-orientated charging towards a fee-based model.

A 2009 report on private banking produced by Ole Heggtveit and David Clarkson of management consulting firm Oliver Wyman concluded that private bankers had lost the trust of their clients because of unsound incentive structures that were only exposed by the financial crisis. They suggested that only by making structural changes would private banks retain many of these clients over the long term.

Powell admits that the industry is still struggling to take account of the concerns of high net worth families. However, he believes there is a willingness to be more pragmatic and less theoretical around asset protection and to make bigger tactical calls on individual asset classes. "As far as yield is concerned, we have seen a much increased appetite for corporate credit and for relatively high-yielding, blue chip equities," he says.

Clients have realised the importance of a structured investment plan that seeks to diversify investments across asset classes. "They are demanding and getting regular reviews while being more amenable to pruning and rebalancing portfolios," says Hansraj.

Stickney refers to greater interest in due diligence among families, who are not only asking the right questions but are drilling down to much greater detail – even to the extent of expressing concerns about government-backed securities.

He also acknowledges that families want to do business with people who understand their specific requirements as well as the financial products they are selling: "You need people-oriented staff who can interact with multiple generations and display a diversity of thinking that the family cannot find in-house. Clients are also expecting a very candid assessment of what they can achieve from their portfolio."

Loder believes there are also gaps in private banks' knowledge of "soft issues" such as next generation education, succession planning, family governance and mentoring. "Wealth retention involves many other factors apart from a stable of investment products that promise attractive returns," he says. "I see demand from clients for a truly independent trusted advisor who can prepare the ground in these areas and then hold the client's hand as they approach the private bank, a practice that is already well established in the US."

Jhawar is keen to highlight the increasing role that family offices are playing in the private bank-family relationship. "Families with family offices tend to take a similar approach when it comes to telling banks what they want, but it is harder when you don't have a family office to act as your eyes and ears," he says.

But Powell dismisses the notion that growing interest in the family office model of wealth management represents a threat to his business. "In fact, we work with an increasing number of family offices that seek to outsource services such as investment management and structuring capability. The family office market seems to be evolving a more stable understanding of where – and at what levels of wealth – the model is helpful and where it is not," he explains.

Given that Wilimington Trust effectively started life as a family office it is hardly surprising that Stickney does not feel threatened by growing interest in this model of wealth management, while Pictet's Adami also sees the family office as a compliment to rather than an alternative to the private bank. "They are an additional knowledgeable layer between families and bankers," he says.

According to Jhawar, the key is to use the bank as a decision-making tool and transaction execution platform. He has also detected increased flexibility on wealth thresholds. "Minimum levels have become more flexible as the banks take a longer term view of the potential value of a client on the basis that a relatively small client can grow into a bigger business over a period of several years," he says.

Private banks are the natural partners for high net worth families – their biggest challenge is how to get access. "In a relationship driven world, I see them as trying to figure out how to establish the key relationships that will access the closed communities that typify high net worth families - and how to differentiate themselves from the noisy world of financial managers and advisors," concludes Crane.