When Bankers Win While Clients Lose

The assets under management of the 15 leading wealth management firms fell on average by 22% from 2007 to 2008. But in the same period the pre-tax profit margins of these firms, dropped only from 30% to 24.5%. This is a frequently overlooked result of the widely cited Wealth Report 2009, published by Merrill Lynch Global Wealth Management and Capgemini. The report further elaborates that the wealth management divisions of global firms “significantly outperformed” other business lines and were of high importance to balance out the huge losses of divisions such as investment banking in diversified firms.

The report does not provide data or explanations on this surprising finding that while clients had to face tremendous losses in their portfolios, the profit margins of their wealth manages, however, stayed high. This in spite of the fact that one of their main sources of income, the generated fees for the assets under management, should have dropped sharply due to the decrease in client assets.
One explanation could be a huge and swiftly executed reduction in costs. However, this is rather unlikely because the steep decline of the markets happened only in the second half of 2008. Large-scale downsizing usually generates additional costs in the short-term rather than quick savings (e.g. severance payments). The other explanation is that the surveyed wealth management firms could find other sources of income to make-up for the huge losses in management fees caused by the decrease in assets under management.

What other sources could these be? As analysed in our guide to wealth management costs, wealth managers have two main venues to make money from the clients` assets on top of the management fee. One venue, which is most expensive for the client, is the use of structured products and funds, which carry hidden costs (management-fees, front-loads, etc.) and also often result in kickbacks for the wealth manager. By increasing the share of these products in a client portfolio, the costs for the client and proportionally the income for the wealth manager will grow even if the official fee stays the same.

As we discovered in our report on European private banks, the use of expensive products is currently widespread. The second biggest way that additional money can generated is from clients who choose a pricing model based on the number of transactions. By simply increasing the rate of transactions in a client’s portfolio a lot of additional income can be generated.

No matter what the missing explanation is: A frenzied cost-cutting, leaving clients during the toughest time with less advisers to speak to or what seems more likely, an increase in income by the use of expensive products and by jacking up transaction volumes. The client ends up losing and surely does not feel much better by the fact that banks use the high profits made from wealth management to cross-subsidize their other ailing business lines during the crisis.