OPINION OF THE WEEK: It's Getting Tough Out There – Margins Under Pressure

Tom Burroughes Group Editor 30 June 2023

OPINION OF THE WEEK: It's Getting Tough Out There – Margins Under Pressure

I take to my weekly pulpit to delve into the data recently provided by one of a cluster of annual wealth industry surveys, and reflect on figures about profit margins and what these mean for the sector.

Three years on from the pandemic year of 2020, the falls in global markets of 2022 and rising inflation mean that while private banks’ net interest margins got some uplift from rising interest rates, overall profitability is down. And the industry has a challenge on its hands to restore the situation.

Going through the fine print of the recent Boston Consulting Group report on global wealth trends was an eye-opener, even though some of the data points did not come as a huge surprise. Global equity and bond markets fell last year as central banks such as the US Federal Reserve, European Central Bank and Bank of England tightened monetary policy. The Russian invasion of Ukraine was also a blow. US-China trade and diplomatic tensions didn't help, either.

Almost 15 years of quantitative easing isn’t going to be easy to unwind, or quickly (see my thoughts on this here). We are, for the moment, in an inflation period, and wages and salaries face significant upward pressure. A friend of mine in the London wealth management sector told me this week that staffing costs, right along the seniority level, are a big issue. There’s still a talent shortage – which the arrival of thousands of former Credit Suisse and UBS employees into the workforce in Zurich and other centres is unlikely to dramatically change. 

This all stacks up to a period when profit margins are under pressure. BCG said that globally, pre-tax profit margins, in basis points, fell to 18.9 bps last year, down from 21.2 bps in 2021 and 21.5 bps in 2020. Return on client business volume (RoCBV) was 60.5 bps last year, down a touch from 2020 but up from 59.5 bps in 2021. (CBV is a measure that includes not only AuM but also loans.)

Overall, wealth managers globally faced an 11.7 per cent drop in CBV in 2022, mainly due to shrinking AuM (-10.5 per cent). The decline in AuM was driven by poor capital markets performance (-12.1 per cent), which was only partly offset by an increase in net new AuM (+1.6 per cent).

There’s quite a bit of regional variation inside the global figures, it should be noted. In Western Europe – not exactly known for being a cheap place in which to do business – pre-tax profit margins actually rose in 2022 to 20.7 bps, from 16.6 bps a year before. In the US, margins fell significantly, to 19.6 bps from 23.1 bps. In Asia-Pacific, a region that has been putting North America under pressure as the leading wealth region, margins have sunk, down to 14.9 bps from 22.3 bps. In this case, anecdotal and other evidence I hear about high salaries in places such as Singapore (and very high residential costs) suggests that Asia is not quite the cheap place to operate in that it might have been a few years ago. Falls in Asian markets were also a blow. The drop in Asia margins may be a wakeup call to firms operating in Singapore, Hong Kong and elsewhere that they need to sharpen up.

BCG also suggests that Western Europe’s financial sector did a “better job of weathering the storm” as markets fell. As European interest rates rise, and economies languish, we will see how well Europe manages.

Over the long term, as the report notes, profit margins have been eroding for years. It’s a reason why we hear the regular refrain that a “wave of consolidation” is coming. True, there’s been a fair amount of M&A activity that is driven by a need for economies of scale. We see that in the M&A carousel spinning rapidly in the US RIA market, for instance, or the consolidation in parts of the UK’s independent financial advisor world. Regulations are a part of the cost mix: the arrival of new rules in Switzerland this year are squeezing the population of external asset managers (EAMs). (The UBS/Credit Suisse combo, mind you, is more of a shotgun wedding/rescue rather than a straight consolidation play, although cost cuts, mostly on the payroll side, are likely to be severe.)

When markets rose in the decade after September 2008, aided by lumps of all that QE, banks’ margins were not initially as ruthlessly exposed as they would be in flatter, more difficult markets. As BCG notes: "Although profit margins have been eroding for years, players could generally count on seemingly ever-growing financial markets and subsequent rising client business volumes…But the rare combination of declining bond markets (owing to rising interest rates) and declining equity markets in 2022 has had a sizable impact on wealth managers’ performance.”

What all this amounts to is that firms have to work harder than ever before to prove their value proposition to clients. This also explains, in my view, much of the enthusiasm for forms of technology to make it easier for relationship managers to find new clients and keep them happy with top-notch client reporting. Expect to read more about how technology, including AI, as a big productivity enhancer.

Tight margins explain why certain services are outsourced. And I think it also means that whatever doubts there might be, ESG investing remains a big theme because firms think it is a popular with clients, especially younger ones, and gets the money in. And finally, margin pressure means the tension between complying with KYC and AML rules on one side, and not wanting to pass up onboarding lucrative clients, remains as difficult to handle as ever. The pressure to cross-sell, and encourage clients to go for sexier investments, remains big when margins are tight and one's bonus package is on the line.

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