Twenty years ago, when the FT group launched PWM magazine, three sometimes complimentary, but often contradictory, trends – the ‘3Ds’ – underpinned growth of cross-border private banking: democratisation, diversification and distribution.
Democratisation of portfolio management – highlighted at the time by PwC research – involved a nascent ‘open architecture’ movement. This saw private banks starting to search for the market’s best products, often sourced from external providers, rather than purely pushing in-house chestnuts to clients.
This opening up was enhanced by successive incarnations of the EU’s cross-border Ucits directive, delivering sophisticated asset management, previously restricted to institutions, to a broader audience of high net worth (HNW) individuals across Europe. This was a winning story to sell to clients and private bankers, both keen to access big brand, ‘blockbuster’ funds, already available to customers of some rival banks.
Sales pitch
Diversification, similarly, led to a new class of ‘advisers’ blitzing the increasing constituency of wealth entrepreneurs looking to preserve and boost their assets. The broader palette of products also allowed salespeople to wax lyrical about new strategies investing in the bustling markets of Asia.
A definitive asset class was evolving, which the likes of Mark Mobius at Franklin Templeton had renamed “emerging markets” to move on from the pejorative label of “Third World” countries.
“The emerging market label carried with it an image of political success, particularly in the Tiger economies of south-east Asia,” recalls Sharmila Whelan, deputy chief economist of Aletheia Capital. Ms Whelan believes the Asian crisis of 1998 marked a huge turning point for the region’s standing.
“The biggest change was the emergence of multi-party democracies. Before that it was one-party states, so that’s a lasting impact. Plus, there were major reforms of restructuring and opening up for Asia,” she says.
Enjoying a similar period of early popularity were the capital markets products sourced from investment banks. The addition of hedge funds, managed by a combination of machines and colourful characters, promised returns well beyond the world of more traditional stocks
and bonds.
Distribution proved a thornier issue, however. While the forging of a broad range of alliances with private banks across Italy, Germany and Switzerland worked well for independent fund firms such as Schroders, it failed to find favour at ‘universal’ banks like Deutsche, BNP Paribas and the Swiss players. Private banking for them, at the turn of the millennium, was purely a distribution channel to boost sales of shiny products cooked up in investment banking or asset management kitchens.
“There was always a temptation just to dump this stuff on the wealth management side,” says Matthias Schulthess, managing partner at recruitment consultancy Schulthess Zimmermann & Jauch and former banker at UBS in Asia. This system worked by keeping costs and profits in-house, with no interest in sharing revenue with any partners.
By 2003, the ‘3Ds’ were gathering momentum. HNW individuals, turning to investment banks for derivative-based strategies, spurred competition between bourses in London, Frankfurt and Milan, battling to have their indices incorporated into products structured by the likes of Citigroup and Merrill Lynch.
Italy’s Unicredit even set up a subsidiary, TradingLab, specifically to sell derivatives to HNW investors. The undisputed kings of this asset class were the science graduates of the Parisian ‘grandes ecoles’, who plied their trade at Société Générale, headquartered among the glass and concrete towers of La Defense.
“Clients liked our structured products because they supplied a term sheet, that told you exactly what you got back in different scenarios,” says former senior SocGen banker Kim Cornwall, now a trainer for relationship managers in the Middle East. “Banks liked them, as margins were high. They work well as long as markets are trending.”
US fund houses such as JP Morgan Fleming, Pioneer and Morgan Stanley, keen to make a name for themselves in virgin European territory, also launched multiple products for their new market. Concepts such as high yield bond funds combatted the growing threat from passive franchises such as iShares, aiming to replicate the North American success of their index-trackers.
Distribution of these investment funds by private banks was also gaining momentum. Deutsche Bank caused shockwaves across Europe in 2004, promising to sell products from eight international fund providers across all client segments, in return for “marketing expenses” incurred by the fund groups.
Too much, too soon?
This led to consternation in Frankfurt, at the headquarters of DWS, Deutsche’s investment house. With Fidelity funds often preferred to the bank’s home-grown vehicles, unhappy insiders even talked about the bank having allowed “strangers into the bedroom”.
Liberalisation of wealth and asset management had moved too quickly for some. Distribution bosses at Goldman Sachs Asset Management sounded the alarm of an “unstable business mix” resulting if excessive amounts of funds were sold to investment banking units building opaque structured products.
By the mid 2000s, investment houses and private banks had begun to approach partnerships with more caution. The promiscuous, flag-planting days of the turn of the millennium were left behind, with a “less is more” principle triumphing. Fund houses such as Merrill Lynch Asset Management sought smaller numbers of ‘triple A’ clients to form cosier partnerships in key European markets.
But it was not all haymaking for the mutual fund houses, some of which fell foul of Bronx-born New York attorney general Eliot Spitzer’s vigorous attack on ‘late trading’ from 2003. This led to giant US pension schemes including California’s Calpers withdrawing mandates from fund groups being investigated. Similarly, many distributors started to avoid any investment houses connected with Mr Spitzer’s probes.
This marked the beginning of an era of greater responsibility for both the fund groups and the wealth managers that distributed them. A huge evolution of both clients and products has left the latter much more focused on client needs, confirm several practitioners.
“Investment banks are still launching certificates and other solutions. But today there is much more of a long-term perspective, as opposed to the short-termism of the past,” says Furio Pietribiasi, CEO of Mediolanum Asset Management.
The response
Private banks responded to these democratisation, diversification and distribution trends in several ways. Pictet, one of Geneva’s quintessential ‘white glove’ firms, signalled a path away from secrecy and tax-led management of wealth. Instead, it boosted its asset management arm, emphasising thematic investments.
Others launched a public relations offensive, aiming to convince clients in other European countries that the lakeside banks, which prided themselves on tradition, were no longer taking clandestine caches from dictators looking to bleed their countries and avoid taxes. Emissaries from Geneva were regularly dispatched to Milan and London, with spokespeople such as Pierre Mirabaud tasked by the Swiss Bankers Association to tell a new generation of entrepreneurs: “We are open and willing to share our experience in private banking.”
But the plan to gain mass acceptance was stillborn. In 2007, a crisis born in the asset management arm of BNP Paribas forced to freeze several funds which it could no longer value correctly due to endemic problems in US sub-prime mortgages, soon ravaged the financial system. Private banks, and the hedge funds they promoted in the same way as luxury goods, were caught in its wake.
In 2008, clients of Geneva’s UBP lost $700m in products invested in strategies exposed to fraudster Bernard Madoff’s fraudulent schemes. Following an outcry among clients, UBP partially compensated investors and paid $500m in 2010 to the trustee aiding the fraudster’s victims.
The image of both private banks and hedge funds plummeted during this almost cataclysmic serious of financial disasters. Hedge funds were ‘gated’ as clients queued to cash out, leading to what Paul Marshall, founder of the Marshall Wace group, called the “Hotel California moment” in a 2009 investor conference. Imposition of gates on investors meant you could now “check out any time you like, but you can never leave”, damaging the sector’s long-term reputation.
Most commentators believe the lessons of the global financial crisis have yet to be learned. “Today, you have those same banks investing client assets in late stage private equity, an illiquid investment, leveraged by the minute,” comments Mr Cornwall. “My nose tells me it’s late cycle and that a lot of stuff out there does not make any sense.”
Out of step
This crisis of 2008 also exposed a lack of communication between the central hubs of private banking operations in Zurich, New York and London, and their advisers in peripheral markets. Several did not approve funds, including those managed by Mr Madoff, for sale. Yet their relationship managers continued to offload them on unsuspecting clients. The whole problem of inappropriate product sales clearly ran deep across the banking sector.
Speaking at PWM’s annual private banking summit in Geneva at the end of 2008, Juerg Zeltner, then head of wealth management for north, east and central Europe for UBS, apologised on behalf of the entire industry to clients for excessive sale of structured products not suited to client needs, backed by “disappointing” advice. The industry had “over-promised and under-delivered”, he said, because this course of action was an attractive one for banks to take.
This brave and frank admission came from a remarkable leader, who sadly died, aged 52, in 2020, soon after he had taken over at the helm of Quintet group. Not only did Mr Zeltner steer the transformation of UBS, but he also negotiated a historic settlement with US authorities.
Reluctant to take any blame for poor economic stewardship leading to the GFC, politicians attacked bankers and investment managers, whose luxury lifestyles made them the perfect scapegoats in the eyes of voters. US president Barack Obama’s crusade against Swiss private banks, for their role in helping US citizens avoid paying tax, not only played out well back home, but demonstrated the potency of US power internationally.
While most Swiss banks initially decided to fight Washington, Mr Zeltner’s UBS struck a $780m deferred prosecution agreement with the US in 2009, also providing “administrative assistance” relating to the submission of 4,450 US client files by the Swiss federal authorities. This sounded the death knell for banking secrecy and the clandestine services provided by Swiss banks.
UBS used the crisis as an opportunity to rebuild, with a portfolio management-led structure eventually emerging. But the echoes of these episodes have resonated from the crisis, right into the 2020s.
Paradoxically, these debacles have empowered investors who have taken on their banks for selling them the wrong products. Following the 2008 crisis, several banks settled out of court, reluctant to take the reputational hit of legal proceedings. Similar settlements are expected at Credit Suisse, following fallout from the bank’s suspension of a $10bn range of funds linked to Greensill Capital.
But private banks have also enjoyed much success in portfolio management, especially in the demanding, post-crisis period when the nature of asset allocation techniques changed fundamentally. Bonds have particularly come under the microscope, as minimal or negative yields led most private banks to re-assess their traditional 60-40 equity-bond asset allocation models.
“Fixed income has always had an important role to play in preservation of capital and protecting income, but an ultra-low interest rate environment has been the catalyst for growing numbers of investors to chase riskier, higher yielding assets,” says Jamie MacLeod, chief executive of Bordier UK, a strategic alliance between the eponymous Swiss bank and boutique investment house Berry Asset Management.
With the “historical correlation” between equities and bonds having shifted decisively, a much deeper dialogue with clients has resulted, embracing a broader range of risk management tools and alternative assets in the diversification story.
These developments have led to increasing acceptance and influence of private banks in the investment ecosystem, many now differentiating themselves by offering regular updates from their chief investment officers, often based on identifying megatrends transforming business and society, which could be translated into effective investment strategies.
This thematic approach became particularly prevalent during the Covid era, when private banks and investment houses stepped up digital communication with housebound clients during lockdown, with the latter keen to engage in dialogue on major trends.
“Simplistically, from an asset management perspective, every trend can be translated into an investment opportunity,” says Alexandra Altinger, CEO of Europe, UK and Asia for JO Hambro Capital Management.
“But megatrends can also prove difficult from an investment perspective. The difficulty is not in understanding and defining the opportunity but often in the timing. You can see it is playing out, but you don’t know how long that will take to be reflected in financial asset prices. That is the biggest challenge.”
Many banks and investment houses can be too early with trends yet to reach their “tipping point”, when it is accepted by the business and scientific communities that their influence can help determine asset prices.
ESG era
Environmental, social and governance (ESG) investing typifies a trend which has passed its “tipping point” into mainstream finance, described by Ms Altinger as “our highest priority” and other commentators as the “number one challenge” to traditional asset management models.
With investors looking for a cleaner, greener overall sheen to their portfolio, banks and relationship managers, with limited experience and research relating to ESG criteria, are left “with a considerable challenge in identifying those funds who are truly walking, not simply talking, the talk,” believes Bordier’s Mr MacLeod.
Practitioners are all convinced that this trend, amplified by the Covid pandemic, will not only define investment processes for the foreseeable future, but also help reshape the structure of private banking businesses around a more ethical and equitable approach, focused on building a better society.
“The pandemic has put enormous focus on empathy and ability to manage stakeholders as well as define and navigate the ESG-related implementation steps,” says recruitment consultant Mr Schulthess. “This goes well beyond the product level and lies at the heart of corporate strategy for those who want to lead this business in a decade from now.”
