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."