From tailwinds to crosscurrents: Resilient growth in wealth management
A decade of favorable conditions for US wealth management has come to a close. Firms now need to urgently rethink operating models and focus on growth.
For US wealth management firms, the decade-long period of relatively easy growth fueled by favorable market conditions is likely over. The year 2022 brought a drumbeat of tough economic news, from slowing economic growth and high inflation to sagging equities and bond markets. The industry has held up relatively well thus far. Revenue growth and margins have proven resilient as rising interest rates more than offset sharp declines in client assets for most of the industry's delivery models. However, declaring victory would be premature. The macroeconomic uncertainty is not expected to subside in the near term, and indications are that the interest rate rises that propelled economic performance for many in the industry in 2022 are unlikely to continue at the same level. Worse, firms grew largely due to market performance rather than due to organic growth, so their cost bases have risen with the markets and have become less variable as firms became more complex and invested during a period of economic expansion. As wealth managers set their priorities for the next 12 to 18 months, history offers one clear lesson: those that make bold moves and invest in growth early emerge as winners. According to our analysis of how companies across industries performed during and after the global financial crisis of 2008, those that moved early to build resilience positioned themselves for outperformance during the crisis and even more in the recovery that followed. For example, firms that invested in businesses and pursued transformative M&A solidified market-leading positions for the decade to come. This is an especially pertinent lesson for the wealth management industry—a growth industry that is experiencing a set of accelerating disruptions and facing long-standing demographic shifts that will redistribute wealth among subsegments. Therefore, wealth managers need to develop a set of bold growth priorities that will enable their firms to thrive through and beyond the current macroenvironment. Specifically, they need to take several near-term measures to strengthen resilience, including proactively helping clients navigate the challenging environment (and, in turn, building loyalty), as well as addressing sometimes long-neglected structural cost issues. From that baseline, they need to deploy financial and managerial capacity into decisive measures that can boost organic growth. These measures include doubling down on the most promising growth initiatives already under way, creating a strong lead generation system, building new businesses, and pursuing capability-driven or transformative M&A. Years from now, the US wealth management industry will look back on the current period as a decisive one. Some firms will get through by hunkering down and staying cautious in the face of uncertainty. But true leaders will seize the opportunity to capitalize on the uncertainty by making bold strategic choices and positioning their organizations for long-term success. 2021: Culmination of an era of easy growth and (apparent) strength In the decade since the global financial crisis, the US wealth management industry experienced one of the longest periods of market growth and economic stability in recent history. Between 2012 and 2021, global markets rose by an average annual rate of 14 percent. Over this period, firms relied heavily on these rising tides to provide their growth: capital markets performance was responsible for 70 percent of industry-wide asset growth. The industry's decade-long bull market—in terms of economic performance and increased reach—culminated in 2021, as markets and clients rebounded from the COVID-19-related disruptions of 2020. In 2021, client assets grew $7.9 trillion (19 percent) to reach an all-time high of $50 trillion (roughly doubling 2016 industry asset volume), with 13 percentage points of that growth driven by market performance and a record-high six percentage points ($2.5 trillion) from net flows (Exhibit 1). Industry profits grew by 24 percent to reach $58 billion (also an all-time high) with margins reaching 24 percent, which represents a 1.4-percentage-point increase year over year. In addition, a growing number of US households sought wealth management services: in 2020 and 2021, record numbers of new self-directed and advised accounts were opened. Growth concentrated among top performers The decade-long bull run appears impressive, but a closer look at the industry's financial performance reveals a more nuanced picture. First, growth has not been distributed equally. In the five years leading up to 2021, most organic growth accrued to digital-direct wealth managers, which offer low-cost value propositions and digital-first client experiences. Digital-direct firms captured approximately 41 percent of total industry net flows for the period, growing their share of client assets from 21 percent to 27 percent. The other delivery model that achieved a disproportionate share of net flows was registered investment advisors (RIAs), which saw 22 percent of total net flows, above its 16 percent share of total client assets in 2021. The growth has been primarily driven by a sustained movement of advisors away from national full-service wealth managers. Regional and independent broker–dealers slightly outperformed the industry average (achieving 25 percent of total net flows, versus 24 percent of total client assets in 2021), also due to net-positive advisor recruiting away from national full-service wealth managers. In contrast, national full-service wealth managers and private banks punched below their weight. Between 2016 and 2021, they captured 9 percent and 4 percent of the industry's net flows, respectively, and as a result, they controlled 20 percent and 13 percent of total client assets in 2021. Within most delivery models, growth was distributed unevenly, with a subset of firms significantly outperforming their peers. The same holds true at the advisor level, with the best-performing advisors capturing a starkly disproportionate share of growth. The top quartile added 18 new households per year, 2.5 times more than the number for second quartile and 12 times that of the bottom quartile. Even within the top quartile, performance is highly concentrated at the top, with the top decile outperforming the next tier by a factor of 2.4 (28 and 12 new households per year, respectively). Therefore, even though the industry overall demonstrated remarkable growth during the decade-long favorable market conditions, wealth managers and advisors alike tend to find themselves in very different positions, requiring different playbooks for the period ahead. Flat operating leverage The second detail from our closer look at the industry's financial performance is that the industry's unprecedented growth in client assets and revenue has brought a similar increase in costs. In 2021, total costs for the US wealth management industry reached a new high of $186 billion, with $25 billion of cost growth occurring in 2021 alone (Exhibit 2). Although the increased cost base in 2021 came with positive operating leverage—a 15 percent cost increase with 17 percent revenue growth—the story preceding this banner year was more mixed. Despite being aided by market tailwinds from 2016 to 2020, the industry grew with flat operating leverage, experiencing annual revenue and cost growth of 5 percent. What is behind this? On one hand, clients have sought new digital value propositions, more digitally enabled engagement with their advisors, and more complex products, services, and solutions (including adjacencies like cash management, lending, and asset management). At the same time, advisors have sought better technology, support services, specialist support, and other home office support. As a result, wealth managers have responded by investing heavily in new propositions and capabilities, resulting in more complex—and perhaps rigid—operating models. In fact, over the last five years, rising frontline and technology-related costs contributed 82 percent and 9 percent of overall industry cost growth, respectively, and grew more than twice as fast as the industry's organic growth rate (a compound annual growth rate of 9 percent, compared with 4 percent average net flows in 2016–21). The growth in the size and complexity of the industry's cost base represents a vulnerability for wealth managers. As assets have grown over the past decade, some management teams have not focused on expense discipline—a common oversight when there is little urgency. During that time, operating models have become more complex, and cost structures have ossified. An expanding industry cost base is a natural—and perhaps inevitable—corollary to a steadily growing base of industry assets and revenues. But the volatility of the first three quarters of 2022 serves as a reminder that growth cannot be taken for granted. In a decade-long bull market, strong growth masked some underlying issues in the industry, and many firms have not capitalized on the opportunity to expand margins through more scalable infrastructure and new business models. 2022: Entering choppy waters with (temporary) wind in the sail for some The current macroeconomic volatility will undoubtedly pose challenges, yet the wealth management industry has proven resilient thus far. Our analysis of performance of public wealth management firms in the first three quarters of 2022 suggests client assets sharply declined by 16 percent and net flows moderated from 2021 highs (Exhibit 3). But revenue growth for the industry was 4 percent and margins have improved by 0.4 percent, driven by sustained interest rate increases throughout 2022. The different categories of wealth management providers had somewhat different experiences:
Private banks experienced the smallest decrease in client assets among all delivery models (down 10 percent through the third quarter of 2022), due to their relatively low exposure to public equity markets. At the same time, significant exposure to cash management and lending businesses helped generate annualized revenue growth of 10 percent, with increases in both volumes and yields. Margins declined five percentage points as the largest private banks sustained higher structural expense and investments in the business, largely talent.
Digital-direct wealth managers saw the steepest decline in assets (down 18 percent), driven by their significant exposure to public equity markets. Despite that, top- and bottom-line performance improved in 2022 due to higher interest rates on cash balances and increased volumes of cash as clients took a more conservative stance to investing. We estimate that revenues grew by 5 percent (on an annualized basis), with slight margin expansion to 47 percent (increasing one percentage point relative to 2021). Importantly, despite the worsening equity market conditions, the delivery model continued to generate relatively strong net flows of 4 percent in the first three quarters of 2022, albeit below this channel's average of 6 percent over the last decade.
National full-service wealth managers (also referred to as wirehouses) reported an average 17 percent decline in overall client assets. Despite that, the segment managed to maintain margins at 24 percent and achieved positive annualized revenue growth of 1 percent (aided by rising interest rates), though this was the lowest top-line growth among all delivery models analyzed. The segment experienced continuation of a long-standing trend of advisor departures, with more than 300 departures in aggregate during the first half of 2022. Firms are starting to reenergize their recruiting efforts, with some focusing on high-quality teams and experienced advisors, while others focus on new-advisor development. A subset of firms are starting to see the benefits; two of the four national full-service wealth managers reported growth in advisor head count during the third quarter.
Regional and independent broker–dealers also saw sharp declines of client assets (down 16 percent). Despite that, revenue growth was a robust annualized 6 percent, resulting in a margin expansion from 15 percent in 2021 to 16 percent in the third quarter of 2022. This segment benefited from continued strength in attracting and retaining advisors and from improvements in advisor productivity, with one firm reporting third-quarter year-over-year productivity gains as high as 7 percent, driven by inflows and rising interest rates.
RIAs are not shown in Exhibit 3, because we lack sufficient public data to draw definitive conclusions about how the RIA delivery model performed. However, RIA performance certainly experienced a negative impact from declining client assets and, in turn, fees, and RIAs had very little to no interest rate exposure to offset that impact. At the same time, the long-standing secular trend of advisor migration to the RIA model continues to persist despite macroeconomic uncertainty. In fact, private-equity-backed acquirers (except for debt-heavy acquirers) continue to be highly engaged in M&A, with 2022 being on track to hit record highs in terms of deal volume (though the focus has transitioned to somewhat smaller deals).
This relative economic resilience of the industry across delivery models brings a sign of relief, albeit with a warning: wealth managers cannot be complacent, as interest-rate-fueled organic growth will subside soon. Instead, wealth managers should find way