The financial crisis of 2008, when the S&P 500 lost 38.5% in value, and the ensuing market volatility in the three years since have served as a sobering wake-up call for the wealth management industry.
Which is dramatically changing the way it plans to do business in the years ahead.
This is according to a new report from Ernst & Young, titled "Investing in the Future: A Focus on Wealth Management Product and Client Trends.
Now, wealth managers very carefully review the performance and risk levels of their entire product lineups-annually. Some are even moving towards quarterly product reviews.
Before 2008, they would analyze the potential for a new product idea, launch it and revisit it only if it trailed it is benchmark over several years. With the focus on new rather than existing products, only in a small percentage of cases would a fund be closed or merged into another.
At the same time this diligent paring down is going on, a seemingly counterintuitive trend is happening: more open architecture. This is where asset managers partner with other wealth managers to offer their products alongside their own. Investment firms are doing this through jointly developed and managed funds, sub-advised funds that are run by an outside manager and, increasingly, separately managed or unified managed accounts that integrate various types of investment products, such as equity mutual funds and alternative investments, into one portfolio.
These were two of the key findings in the Ernst & Young report, based on a survey of 39 high-level investment professionals conducted by Greenwich Associates in April and May.
The executives were with companies with at least $1 billion in assets under management, and in some cases, more than $500 billion. Fifty-six percent of the firms target high-net-worth clients with more than $1 million in investable assets, 18% serve mass affluent individuals with $250,000 to $1 million in investable assets, and the remaining 26% are focused on the mass market, people with less than $250,000 in investable assets.
"The move to open architecture is being driven by client demand," said Anthony Caterino, a partner with Ernst & Young's Financial Services Office.
"While we didn't ask respondents if the increased demand for open architecture is being driven by the search for best-of-breed, competitive fees" or new types of investment approaches, such as tactical asset allocation or absolute-return funds, "those certainly could all be reasons," Caterino said.
Another reason firms could be casting a wider net through open architecture: asset managers are starting to segment their clients into more refined, sophisticated classifications, going beyond the traditional income, age and risk tolerance approach-to assess an investor's life stages and other, richer demographic classifications, such as their motivations and attitudes towards money and saving.
"For the next two to five years, the general consensus among investment management professionals was expanded open architecture, more investment product offerings and broader client coverage across multiple client segments with a unique service model for each," Caterino said.
In terms of the specific numbers, the survey showed that 79% are planning to expand their open architecture in the next two to five years. Sixty-eight percent are working on an expanded product offering across a wide range of products, and 71% are eyeing broader client coverage across multiple segments.
Eighty-four percent say their firm now has annual product reviews-but only 15% consider the process to be highly effective.
"This suggests clear opportunities to identify and develop best practices to ensure they are adding the right products to the platform," Caterino said.
Thus, this open architecture transformation is driving other changes, too-most notably the need for more robust software applications for financial advisers so that they can consolidate information on all of these additional products, Caterino said.
"Given their asset gathering mandate, it is critical that wealth managers reduce the servicing burden on the adviser-including online service capabilities-particularly in the area of client reporting for firms focused on high-net-worth and mass affluent clients," Caterino said.
"Firms offering unified managed accounts and other third-party products are looking for improved performance reporting on a regular, routine daily basis-as opposed to waiting for month-end reporting cycles," he added.
Risk management is another driver of technology investments, Caterino added. "As more advisers are using UMAs and managed accounts and setting up portfolios on a fee-basis as opposed to a commission-based transactions, this is making them more attuned to managing the risk in those portfolios."
Which means more technology investments.
The survey showed that 95% of the executives' firms are investing in or expect to invest in adviser desktop and support tools. This is followed by 82% planning to invest in client reporting, 69% in back-office executing systems, 67% on risk management platforms and 64% on data security.
The survey also indicated that risk management has become more top of mind. A majority of firms have taken multiple steps to mitigate risk, both through technology investments, people and enhanced compliance processes.
The biggest area of investment to control risk is through the monitoring of performance and risk in portfolios (42%), which the executives said is handled through a combination of technology and processes.
This is followed by client investment suitability (29%), which is principally handled through technology, and investment manager selection due diligence (29%), which is all about people and processes. Executives said their firms are beefing up their investment manager selection due diligence by investing in training, research and improved governance and oversight.
Looking to Equities
Ernst & Young also asked the investment executives what they expect will be the best-performing asset classes over the next two years. Sixty-two percent pointed to emerging market equities.
Perhaps more surprisingly, 54% pointed to U.S. equities and 38% cited international developed market equities. However, Caterino reminded that the survey was conducted in April and May, before the market turbulence started in August.
Yet, should the market return to more normal historical levels, perhaps the executives' bullish outlook for the U.S. will be prescient. If U.S. equities return to outsized performance, that would certainly be welcome news.