Margins in private banking are fading. Increased regulatory costs and a low interest rate environment are not helping. But more prominently, the lack of client activity combined with fading trust cuts right into the heart of the private banking business model. Prominent players try to regain lost revenues by reinventing their advisory offerings. In this INSIGHT, we scrutinize fee-based advice solutions in the context of business model innovation and identify seven areas critical for success. It is our viewpoint that success requires taking a value based rather than an effort-based approach to advising clients.
Many private banks are strugling with pressure on revenues and fading margins. Increased costs, due to regulatory requirements combined with a low interest rate environment, are one of the reasons. Decreasing client transaction activity is is another one. In addition, trust in high margin discretionary mandates solutions is dwindling.
Different private banks try to counteract this trends by introducing fee based advisory solutions. But what does fee based advice (“FBA”) mean? FBA solutions provide clients with advice supporting their investment decision process through aggregating, filtering, and summarizing market intelligence. In addition, FBA solutions monitor the clients’ portfolio, alert them proactively of unindended risks, and provide ideas to adress them.
Is FBA a winning formula for the future or only a passing fad?
To gain insights into answering that questions, we reviewed the advisory services offered by eight of the largest banks in Switzerland based on publicly available information. We identified seven key criteria which we believe are critical for success.
FEE BASED ADVICE IS A PRODUCT ON ITS OWN
Observations. The advisory services offered by private banks can be classified into two categories:
- Advisory services are defined and marketed as distinct products. A dedicated fee is charged for the services provided. Innovative characteristics of the service offering are used as differentiating factor.
- Advisory services are a free door-opener and trust builder to sell related products.
Most innovative offerings were found in the first category. Traditional, and usually smaller private banks tend to position their advisory services along the lines of the second category.
Our viewpoint. Times are over where providing “free” advice, cross-financed through the sales of other products, is a sound business model. Increased pressure on cost transparency, an ongoing search in value for money, and the avoidance of conflicts of interests, will drive private banks towards having clients pay for the services they obtain, and ideally for the value they receive.
Observations. All providers of FBA define their solutions based on the labor incurred in delivering advice and related services to the clients. The most common efforts identified and used in defining client segments are
- contact frequency with the trusted advisor,
- access to dedicated investment specialists,
- frequency with which investment ideas are provided, risks monitored, and portfolio reports delivered, and
- inclusion of additional services, like tax reporting or online access to research.
Our viewpoint. Taking a labor-based approach to client segmentation is sub-optimal. Defining different FBA solutions based on actual client needs will lead to a better segmentation and increased benefits. Broadly speaking, there exist two categories of clients interested in FBA solutions:
- The first category of clients wants to minimize the time spent on managing their investments but doesn’t trust private banks enough to fully delegate their assets. Clients want to have the final say on any investments made but expect FBA to come up with investment proposals and monitor associated risks. Clients in this category are interested in transparency and want to avoid unnecessary hassles.
- The second category of clients are those clients that believe they are better in managing their investments than private banks are. They are looking for research, investment ideas, and a partner with whom to discuss financial markets whenever and wherever they feel for it.
The key for success is focusing on satisfying needs that clients see value in and are willing to pay for. Client value is achieved through offering FBA solutions based on identified client needs rather than internal efforts or costs.
Observations. Whether driven by regulators or asked for by clients, there exists a trend towards fee transparency. Two opposing approaches to providing that fee transparency can be observed:
- The line-item approach – Each component of the FBA service is charged separately. No hidden fees exist, and clients can relate the services received to the efforts of the private bank to deliver them.
- The all-in approach – Clients pay a fixed fee, known upfront, which covers all services provided. Unforeseen costs are avoided. The focus is put on value of the services rather than efforts to deliver them.
Our viewpoint. Private banks should offer all-in fee models related to the value created for their clients. Fees should be directly associated with the benefits clients gain from satisfied needs. Traditional fee models based on assets under advice do not meet that criteria. All-in fee models, if successfully implemented, offer high margins and are not perceived negatively by clients. They represent a win-win situation.
A MULTI-CHANNEL APPROACH
Observations. Most FBA providers implement a dual channel strategy: i) they offer a single point of contact for all interactions and ii) use existing channels for one-way delivery of information, like their e-banking platform. Private banks do not offer dedicated FBA platforms allowing clients to perfect their investment processes.
Our viewpoint. One-way information delivery should be technology driven. Human interaction should focus on two-way communication when emotional and/or judgmental factors play a key role. FBA solution should promote agility and just in time delivery. For example, when a risk starts to materialize, technology should be used to alert the client promptly and suggest options, which they could directly execute without additional human interaction. Only when the client needs additional information, should the interaction with a trusted advisor occur. Depending on the client’s needs either a single point of contact or a specialist channel approach should be implemented.
REGULAR AND AUTOMATED PORTFOLIO REVIEWS
Observations. A key value proposition of all FBA solutions reviewed is ensuring regular and automated monitoring and reporting of client portfolio risks. Different solutions differentiate themselves with respect to what is monitored, how often the monitoring process is performed, and the activities executed when an issue is identified.
Our viewpoint. Monitoring portfolio risks is critical to success. But, it is also important that clients don’t get the impression that monitoring risks means risks will never materialize. We believe that regular and automated portfolio reviews, as well as any reporting modules of a FBA solution, should support the advisory process rather than define it.
Observations. The investment process underlying the advice provided to the clients has not changed significantly over time. It is still based on defining a strategic asset allocation representing the client’s strategic financial goal, their risk tolerance, and risk preference. A top-down, usually region based, asset-only view is common. Research coverage is broad, and differentiation is missing. No clear concepts for integrating liabilities in the investment process are present.
In addition, none of the FBA solutions reviewed shows any performance track record. Performance generation is perceived to be fully delegated to the client. This may be because private banks rely on FBA to generate revenues ahead of delivering value to their clients.
Our viewpoint. Overhauling the investment process underlying FBA is mandatory to deliver investment performance in an environment where private banks advise, and clients decide. It should be liability driven and goal based, rather than an asset only, whereby the liabilities formalize the client’s goals and needs. A differentiated investment process, combined with a proven track record, will be critical for success.
UNIQUE VALUE PROPOSITION
Observations. FBA solutions distinguish themselves from traditional free advice through increased pro-active interaction with the clients. Private banks still have a tough time characterizing why their FBA solutions is different from and superior to the one of their competitors or to their “free” offerings. The biggest differentiators are found in the frequency of client contacts, portfolio reviews, and reports made available, in addition to the charged fees.
Our viewpoint. We believe that lasting success requires private banks to focus on stating why their specific FBA solution adds more value for the client and/or addresses the needs of the client in a better way than the one of their competitors or “free” offerings.
FBA solutions address a well-defined need of private banking clients. To be successful, FBA solution providers must focus on what is in for the clients, that is, delivering added-value by satisfying client needs rather than what is in for the private bank.
Private banks should increasingly show the added-value for the client in excess of costs of their FBA solutions. Being able to answer the question why a client will have more money with rather than without using FBA will be key to increased revenues and margins from FBA solutions.