Private banking isn't always what you think.
"It was such a period as seldom occurs, and hardly
ever more than once in anyone's lifetime. The period between 1863 and
1871 was one in which it was easy to grow rich ... One had only to buy
anything and wait; to sell at a profit; sometimes, as in real estate,
for instance, at a very large profit in a very short time."
Move the dates forward about 130 years, and the mirror isn't so distant at all. In fact, those words were written by Thomas Mellon in 1888, years after he emigrated as a child from Northern Ireland and built one of America's largest family fortunes, often by purchasing equity stakes in promising companies that were clients of his Pittsburgh bank.
Today, Mellon Financial's private wealth management group manages $85 billion in client assets, making it one of the nation's largest private banking concerns. Yes, the bank's client list includes a lot of old money, with slightly over 1,000 families that have assets of more than $10 million a piece. Those families, with a total of more than $60 billion, represent the major chunk of the bank's assets. Of that amount, Mellon manages $30 billion for about 100 clients. The other $25 billion consists of portfolios in the $1 million to $10 million range.
Increasingly, however, banks like Mellon are raising the level of their game and competing in the same space as many independent financial advisors. With modest minimum account sizes of $1 million, many of the nation's ubiquitous millionaires-next-door are welcome at the tony private banking unit that is headquartered in Boston. "People think of private bankers as guys who smoke cigars and walk rich people's dogs," quips Dave Lamere, president of the private wealth management group. But if rivals want to underestimate the resources his unit brings to bear in a client engagement and dismiss its success to expensive marble and marketing, Lamere doesn't seem to mind.
The reality is that the average new client relationship at Mellon, which typically involves managing $3.0 million to $3.5 million for a family and acting as a fiduciary, isn't all that different from many advisors' new business development programs. Over the last five years, Mellon hasn't just competed against registered investment advisors for new clients; it's also gone out and acquired nine firms. Most of the firms purchased by Mellon tend to have between $300 million and $1 billion under management. "They tend to have their own investment management process and tend to have long-established relationships in their communities," Lamere says. "They are often limited by lack of capital."
Many acquirees tend to help the bank expand into regions where it lacks a significant presence. The private wealth management unit retains a group of three professionals dedicated solely to acquisitions. "Many deals don't work, " Lamere acknowledges, referring to the merger game in general. "People issues are key. It's a viable way to enter a new market. Every deal we've done we'd do again."
Adds vice chairman Craig Sutherland, "Someone who just wants to cash out isn't what we're looking for. Growth is the objective." So is making sure that both the acquirer and acquiree are on the same page.
The experience of some of the firms that Mellon has acquired serve as a reminder of everything that can go wrong with a big bank's trust department. In 1989, Jack Sawyer, an internal counsel, got together with two other professionals and left the trust department of a predecessor bank of SunTrust, and formed The Arden Group. Several clients, who were put off by the confining environment of a stodgy bank, had encouraged them to strike out on their own.
The 1990s were very kind to the firm. Within six months, The Arden Group raised its minimum account from $1 million to $4 million, a high minimum for that era. Its relatively small client list included several families who had participated in building Coca-Cola from the ground up. During the decade, it helped clients create about 70 charitable remainder trusts, as well as family foundations and other charitable/wealth transfer vehicles, were created, often with Coca-Cola stock. Until around the turn of the millennium, 80% of The Arden Group's clients came from inherited wealth.
Sawyer and his partners hadn't set out to build something they could sell. "I thought I was building a better life for myself and my clients," he recalls. Nonetheless, they started surfacing on the radar screens of some of the biggest wealth management concerns in the nation.
"Mellon was the sixth company that came to us," Sawyer recalls. "One was a big family office out of Atlanta. They had bought other companies and none of the principals had stayed very long. They wanted to put us in a slot and fit us into their mold."
By the time Chris Flanagan, Mellon's acquisition chief, called Sawyer, he was feeling like the pretty girl who, for whatever reason, didn't want a date to the prom and was getting tired of talking to guys and turning them down. "I let three or four calls go without returning them," he says. "I hardly ever do that."
At their first meeting, Sawyer was surprised-and impressed-at how much Mellon already knew about The Arden Group. "They had done a lot of work," he notes. "My greatest fear was that we were going back to a big bank environment. Some clients who had begged us to get out a big bank were very concerned about us going back to a bank environment."
The decision to sell the firm into 2003 proved very difficult for Sawyer and his partners. Though he didn't ask for it, he signed a five-year employment contract. Unlike the way other acquirers structure deals, Sawyer says most of the payment was up front without contingent earn-out provisions. Over the last three years, the business he runs has grown from 13 professionals and $750 million under management to 38 professionals and $2.3 billion. Many of his clients remain his best friends. "Investment performance is more of a commodity every day, but relationship management is not," he argues.
From Mellon's viewpoint, it would appear their executives know what they can buy when they purchase an advisory firm-and what they can't acquire. "We can't buy those trusted relationships," Sutherland acknowledges.
Most often, Mellon's competitors are other large wealth management institutions like Bessemer Trust, Northern Trust, Goldman Sachs & Co. and Sanford Bernstein, as well as regional players in California and Atlantic Trust in the southeast. When asked how Mellon typically attracts business, Sutherland cites many of the usual suspects: trusts and estates attorneys, Certified Public Accountants and client referrals. Much of their new business also comes from familiar sources: liquidity events such as an inheritance, a corporate executive retirement the sale of a private business or an IPO.
The top executives at Mellon's private wealth unit are acutely aware that the wealth management business has all sorts of positive megatrends driving its growth. "This is a fabulous business with huge growth opportunities," Lamere says. "What other business in the world has an embedded 3% or 4% growth rate. Put that in perspective. In most businesses, prices are falling."
Theoretically, the fragmentation of the business should lead to consolidation, but as long as profit margins remain as high as they are the industry probably will continue to attract new competitors, Sutherland believes. In what may signal intensified competitive pressures across the business, Mellon intends to hire as many 50 sales professionals over the next two years.
Even though it employs a full-time acquisitions staff, Mellon executives emphasize the importance of organic growth. The bank unit has separated the function of relationship management and sales. "If you combine sales and service into one person, then once you add clients something has to give," Sutherland explains. "The sales process can often take over one year. Clients also have direct relationships with portfolio managers. The sales person [can remain] involved, but they are not the point person on an ongoing basis."
Mellon's biggest source of growth, contributing from between 33% to 40% of the increase in its top line in recent years, comes from referrals and new assets from existing clients. The firm targets an 8% to 10% growth rate for its existing portfolios. "We look forward and try to estimate future rates of return for different asset classes. In the late 1990s, the investment team began to see limited upside for large-cap equities. We needed to take money off the table and look for new asset classes," Lamere says. "Fixed income is usually an anchor towards windward for our clients."
However, the bank has scored solild gains at several junctures in the last decade, buying high-yield bonds when they were selling at depressed levels. Significantly, though, it classified the junk bonds as part of clients' equity, nits fixed-income, allocation. Lately, high-yield bonds have been squeezed out of the portfolio. "Now we believe equities offer more potential," Lamere says. Currently, most portfolios favor large-cap stocks over small-cap stocks and international over domestic equities.
Mellon executives make it clear that from time to time clients' portfolios may experience periods of underperformance. But Sutherland points out that from 1995 to 2005, when the Standard & Poor's 500 Index returned about 9% on an annualized basis, the typical Mellon client would have earned that same return in a portfolio that held 40% of its assets in bonds. "Consistency and the importance of getting the big decisions right are [critical]," he says. "We're forward thinking about when valuations are out of whack. Many things happen because of happenstance and some people mistake happenstance for genius."
Above all, Mellon executives believe in managing assets in a tax-efficient manner with an eye toward wealth transfer. That means starting out determining an asset allocation policy. The bank tries not to embrace a particular thematic view of the world; instead, it aims for broad diversification and appropriate asset class weightings. "In a typical year, clients [may see] one or two weightings changes," Lamere says. "What we don't want to do is take huge unpaid-for risk."
Clients who, at the outset, ask to see the bank's hottest funds or managers send a signal that they could pose problems. "There's all kinds of rich people," Lamere notes. "Wild success doesn't equate to sophistication."
A client of Mellon can expect what Sutherland calls a centralized effort relying on the services of multiple specialized professionals within the firm. A number of its relationship managers are trusts and estates attorneys. "Specialists are there to support portfolio managers in areas like private banking, estate planning and alternative investments," Sutherland says.
One area where Mellon is bucking a trend that is increasingly prevalent in the wealth management business centers on proprietary products. With the exception of certain alternative investments, virtually all of its clients' money is managed in-house. It's a decision about which Mellon executives have no regrets and offer no apologies. "Our history has been about building, buying and owning all the capabilities" offered to clients, Sutherland maintains. "Few smaller firms have the capital base to have expertise in every area."
In the late 1990s, when tech stocks went into orbit and blue-chip companies like General Electric were selling at almost 40 times earnings, Mellon executives realized that clients would soon start eyeing hedge funds as a way to play both sides of an increasingly frothy market. So the bank purchased a 15% interest in Optima Funds Management, a New York-based hedge fund group. "There are instances in private equity where we've partnered with outside firms," Sutherland says. "But we like to control the things we offer. We can integrate our services like tax management much better."
For many clients, the bank tries to create what Sutherland calls "a large farm to harvest losses against gains across entities." Relationship can coordinate various issues and take it to the next level. Interestingly, Mellon has never used exchange funds to help clients diversify out of large positions. Until certain rules were tightened, shorting against the box was a superior alternative, Sutherland explains. Today, hedging with collars and prepaid forward contracts "leaves you with more options and liquidity than you can get with an exchange fund," he adds.
Getting clients to diversify isn't always easy. "Lower tax rates don't inspire people to take capital gains," Sutherland believes. "The prospect of higher capital gains taxes does make them focus."
The bank's fees for custody and record keeping start at 1%, though they are significantly lower if it's a fixed-income-only portfolio. The largest clients can pay as little as 30 to 40 basis points for custody and record keeping. Private equity, of course, costs significantly more. Total fees could amount to between 1.5% and 2.5%.
With hedge funds, the variance in costs and performance are even higher. So is the amount of research and due diligence required. "Find me a hedge fund you can get into for 50 basis points, and I'd tell you to turn around and walk out," Sutherland remarks. "Look at the universe of hedge fund managers and the range around average performance figures [and the standard deviation] is absolutely huge."
Mellon executives know very well that private banks that live up to their stereotypical image as stodgy, complacent institutions can experience rude awakenings. They monitor client retention rates closely. "We get upset when we lose a client," Lamere admits.
He also knows that blistering growth rates and mile-wide profit margins haven't guaranteed success for other businesses sporting similarly seductive financial characteristics. "Will we be successful?" asks Lamere. "Only if we deserve to be."