But because the outside manager is only providing the design function (rather than a fully integrated model of design, trading and packaging), many top decile active managers are willing to accept only 0.25 percent of assets for their services instead of their usual 0.65 to 0.85 percent. Thus, the UNHW firm’s clients can take advantage of very good active management at a price that makes more sense and do so in a much more tax efficient manner.
(To be sure, many brokerage firms also use this type of technology. However, they are brokerages and thus, pocket the savings rather than pass them onto their clients.)
At some point in the near future, this technology will migrate down from the UNHW sector to wealth managers that work with mid-sized and smaller clients. It will enable wealth managers to invest client assets at a much lower cost than clients can do on their own—so much so that the savings will offset a large portion of the wealth manager’s fees. (Does this sound a bit familiar to 30 years ago when there were no ETFs and this new thing called “institutional classes” of mutual funds allowed wealth managers to more cost effectively invest client assets than they could do on their own?)
Of course, at some point this technology ultimately will wind up on the desk of the consumer. But there will be a window of time in which wealth managers will have a new relative pricing power. However, these cost savings alone will not fully offset clients’ ability to rationally allocate and acceptably invest their assets for next to nothing.
Second, future successful wealth managers will therefore increase their value added in the investment function by providing access to investments that clients cannot source on their own.
One such area will involve investing in private companies. As noted earlier, most wealth management firm client portfolios today have little to no exposure to these kinds of investments. This is a bit absurd given that the private markets are often much less efficient than the public ones and that private companies constitute more than half of the economy.
However, to date it has been very hard for wealth managers to rationally invest their client assets into private transactions. The only current means for doing so is through funds of funds that invest in PE blind pools, an archaic method that is quickly headed toward the ash heap of financial history. Why? The pools’ core clients—sovereign funds and pensions—have figured out that this structure is expensive and often creates conflicting incentives between the client and the PE firm.
Consequently, both sovereigns and pensions are racing to disintermediate their PE managers by creating their own direct private equity investment capabilities. And although the PE industry is currently breast stroking its way through an ocean of $100 bills that it needs to find someplace to invest, over time it will have to find new sources of capital. One obvious one is the $5T wealth management industry that is growing at a very high rate and that needs to find investments that clients cannot source on their own.
That much said, it is unlikely that wealth managers will create their own private equity arms. It is not their core competency and the cost of developing these capabilities will be (at least in the near term) prohibitive for most firms. More importantly, the independent wealth management industry is premised on the idea that it provides unconflicted advice and offering products violates that pact.
Hence, it is more likely that future successful firms will directly invest their clients’ assets into individual private companies in the same manner as many family offices do today—i.e., by partnering with specialist private equity firms which will source, negotiate and manage transactions and structure individual investments to meet the unique needs and goals of their clients.