If there was any need to highlight the regulatory challenge faced by wealth managers, the financial regulator’s ‘Dear CEO’ letters have made the issue strikingly clear. As the letters showed, the industry has yet to reach the required standards to capture, monitor and – just as important – prove suitability.
The wealth management community has plenty of forward-looking firms that recognise regulatory compliance can improve business practices and deliver enhanced outcomes for their high net worth investors. But no-one denies that the costs of compliance can undermine a firm’s long-term sustainability and destabilise expansion and growth strategies.
Much of the new regulation is intended to protect investors. But anecdotal evidence and ongoing discussions among professionals suggest that more aware and more demanding investors are taking proactive measures to look after themselves. Some are pursuing investment vehicles with perceived lower risks, and missing out on possible returns from upturns in the market. Others are looking at passive vehicles to keep their costs down.
Safety first
This focus on wealth protection at the expense of wealth creation has made it much harder for investment managers to generate impressive returns and, with them, fees.
What’s more, some clients are demanding greater transparency and control. Monthly reports and quarterly meetings are no longer enough – these investors are looking for better and more frequent access to portfolio data, including real-time access to performance and risk reports.
The administrative burden of producing more frequent and detailed reporting for diverse accounts is proving a heavy one for wealth managers and highlights some of the inherent inefficiencies of a highly bespoke, high-quality service.
Caught in this ever-tightening vice with clients on one side and regulators on the other, wealth managers are seeing their margins come under substantial downward pressure. Carving out a successful business model in this environment is a significant challenge, which is replicated across the breadth of the financial services sector.
In the high-end wealth management space, which is partially defined by the premium placed on personal relationships, bespoke advice and faultless customer service, that challenge has become acute.
The issue of suitability also illustrates the underlying problem. If all clients are invested in fully bespoke portfolios, then maintaining compliance with suitability requirements demands a level of attention that hinders both growth and the delivery of high-touch client services.
High-touch hesitation
Elsewhere, portfolio modelling has provided at least part of the solution. Certain IFAs have relied on model portfolios to manage standard accounts across multiple clients. However, modelling in high-end wealth management feels counter-intuitive precisely because of high-touch services. Modelling suggests a step back from a highly personalised level of service and its uncertain reception within this section of the wealth management community is understandable.
More specifically, the use of modelling has the potential to create a head-on collision between wealth managers looking for greater efficiencies and the FCA, which has made it very clear that investors should not be ‘shoe-horned’ into specific investment vehicles or funds for which they are unsuited.
Regulatory censure will follow if a wealth management firm offers only a limited range of models and attempts to fit the client to the model rather than the model to the client, or if the model does not take into account a client’s ability to sustain losses alongside attitude to risk.
However, where modelling is based on fully understanding the individual client, and ensuring that there is a sufficiently diverse range of models available, then it starts to look like an attractive option for wealth managers looking to improve investor outcomes while remaining compliant with regulations and coming to terms with an altered income base.
Knee-jerk rejection
In many ways, the reflex rejection of modelling has failed to take into account the new tools designed specifically for this area of the market. The right technology can enable wealth managers to develop models tailored appropriately to clients in support of the development of a bespoke service on several levels.
Some wealth managers are already embracing a model-based portfolio approach as part of their service. The idea that modelling places rigid constraints on a portfolio and prevents them from making allowances for individual preferences and tolerances is simply out of date.
Instead, a more accurate way of looking at modern portfolio modelling is to consider wealth management services as being positioned on a spectrum. At one end is the traditional, commoditised service that is applied equally to all portfolios; at the other is a highly bespoke and tailored service.
There is no reason why models cannot have multiple tiers, with a highly structured base, then bespoke modelling as a second layer, and the ratio between the two adjusted according to circumstance and individual.
When wealth management services are viewed as part of this more fluid continuum, the advantages of individual modelling become clearer and the traditional objections more easily overcome. One of the more obvious benefits is that automation of ordinarily manual processes frees up time and resource to focus on the high-touch aspects of wealth management. Clients still get the personal experience they look for, while wealth managers are better able to deliver it in a manner that is both compliant and efficient.
Of course, wealth managers should only embrace modelling after due consideration of the obligations it places on them, and the underlying tools they need to provide it. Modelling can be the solution to a wealth manager’s current dilemma only if there is sufficient breadth in the models themselves to ensure they are appropriate for most kinds of suitability groupings. Wealth management firms with a limited number of highly constrained portfolios are unlikely to meet the demands of either clients or regulators.
Models therefore should not be overly prescriptive or rigidly inflexible, which is to say that highly structured models should not be the only ones on offer.
This is the key success factor in their adoption by wealth managers. Instead, they should resemble investment strategy and guidelines, so that they can be used to ensure compliance with regulations and with client mandates. Modelling can be used as a tool to support the wealth manager’s investment decision-making rather than a tool to automate that decision-making.
The right model
Nor does modelling obviate the need for suitability assessments. Indeed, the regulations state that modelling techniques must include effective suitability tests to ensure that investors are put into the appropriate model. The reality of even the most bespoke of service offerings is that a number of clients will present very similar requirements and profiles. Treating them differently is as hard to justify to regulators as treating all clients exactly the same.
Understanding investors in terms of their attitude to risk and their ability to sustain losses is still the critical factor. But garnering that information and using it to make decisions about the broad style of portfolio to be developed will help firms ensure that the portfolio fits the particular client, and where similar treatments can reasonably be applied. Applying modelling appropriately should mean a firm can ensure they are providing improved customer outcomes while being fully compliant and able to prove that compliance while still improving efficiency.
For too long, modelling has taken a back seat to manual processing. But in the current climate, justifying the operational burdens involved in rebalancing portfolios by hand is becoming harder and harder. The chances of achieving and demonstrating compliance when dependent on manual processing are remarkably small.
Manual processing also introduces greater uncertainty into the decision-making process. It undermines confidence and, ultimately, reputation. The technology is available that enables personalised modelling, helps create a more streamlined and efficient service, and gives firms deeper foundations on which to build future growth. The changing investment climate suggests that wealth managers would do very well to investigate it further.
