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Wealth management: is growth diverging?

Consolidation is an emerging trend across the sector, but can acquisitions deliver sufficient scale benefits?
June 21, 2018

Regulatory reform, along with supportive global markets, has spurred asset growth for UK-listed wealth managers in recent years. The introduction of pensions freedom changes – giving retirees greater access to their retirement savings – has driven demand for investment management services. Meanwhile, a bullish equity market, buoyed by asset buying programmes at the US and European central banks, has driven returns even higher.

Yet during the past 12 months, wealth management valuations have come under pressure, with the UK-listed players priced for lower growth. Margin pressure and sluggish organic growth are likely culprits for this downturn in sentiment. So, in the face of these pressures and rising regulatory expenses, more wealth managers are turning to acquisitions to boost growth. Last week Rathbone Brothers (RAT) revealed it had agreed terms to buy Scotland’s largest independent wealth manager Speirs & Jeffrey for a cash and shares consideration of up to £248m, after consistently failing to achieve its own organic growth targets.

 

Strength in numbers?

Rising regulatory-related costs, the need for technical innovation and increased competition are making the market tougher for smaller wealth managers – but throwing up acquisition opportunities for the larger players. Following the introduction of the second Markets in Financial Instruments Directive (Mifid II) at the start of the year, wealth managers must provide clients with a more detailed breakdown of the fees they incur, including the impact of trading costs on the overall amount they pay.

In January, Standard Life Aberdeen's (SLA) financial advice business 1825 bought Cumberland Place Financial Planning, while Cannacord Genuity Wealth last year struck an £80m deal to buy Hargreaves Hale. Rathbone Brothers acquisition of Speirs & Jeffrey will add £6.7bn in funds, boosting total funds under management by almost a fifth to £44.5bn. Management reckons the deal will also enhance underlying earnings per share by 8 per cent and deliver a 13 per cent return on investment in the third year after the deal completes. Shares in Rathbone closed the day of the announcement up 5 per cent.

Rathbone finance director Paul Stockton says the rationale behind the purchase – which has been partly funded by a £60m placing – was to grow the scale of the wealth manager’s assets. “They’re not doing anything materially different from what we’re doing”, he says. "Scale has become more important given rising regulatory costs, including those associated with Mifid II and GDPR," he adds.

A contingent consideration of 0.6m new Rathbone shares – with an illustrative value of £15m – will be payable to Speirs & Jeffrey, albeit dependent on meeting cost synergy targets. Up to £129m-worth of shares will also be paid out in the third and fourth years after the deal completes, if revenue synergies and discretionary fund growth go according to plan, although management reckons the final amount will be lower. Rathbones reckons it can strip out around £6m in annual costs, too, primarily from rationalising the back-office function.

However, that cost-cutting target looks a little ambitious, given Speirs & Jeffrey only racked up £12.3m-worth of staff costs during its last financial year. One of the biggest expenses for wealth managers are client-facing staff. However, “each investment manager only has a certain amount of clients they can process,” he says. That limits the scale benefits achieved from such bolt-on acquisitions.

 

A rethink needed?

Rathbone's core investment management business has lagged the 5 per cent annual organic asset growth target, since it was set in 2014. Last year it came in at 3 per cent or £0.9bn. Similarly, Charles Stanley (CAY) reported disappointing organic growth for the year to March 2018, with overall net inflows at just £0.2bn and funds under management offset by negative market movements. What’s more, chief executive Paul Abberley warned of potentially lower future returns, blaming the upcoming end of quantitative easing, political risk and slow UK economic growth as risk factors. For wealth managers, whose switch to discretionary funds management means they are increasingly earning revenue based on an ‘ad valorem’ fee based on a percentage of the overall value of a client’s portfolio, a downturn could damage returns.

That’s in contrast to Brewin Dolphin (BRW), which has exceeded its 5 per cent organic growth target during the past 18 months, at 8 per cent. What’s given those wealth managers the edge over Rathbone in driving organic growth is better links with independent financial advisers. Brooks Macdonald (BRK) also clocked onto the benefits of deeper intermediary links early on, part of the reason it has managed rapid fund growth – discretionary funds were up a quarter during the first half, representing 9 per cent organic growth. That said, revenue yields have suffered from a greater proportion of fund inflows into its lower margin managed portfolio service, as opposed to its bespoke portfolio service. As such, it has embarked on an efficiency drive, selling non-core businesses such as property management business Braemar Estates, in a bid to protect margins.    

Admittedly, Rathbone is making more effort to strengthen these links, including buying Vision Independent Financial Planning last year. Charles Stanley is also investing in its financial planning operations, hoping to earn 10 per cent of overall revenues from the business. Nevertheless, the former is reviewing organic growth targets for the next five years, Mr Stockton says.    

The other option open to wealth managers is to launch lower-cost platforms, aimed at a mass market audience and competing with some of the ‘robo-advice’ services rapidly entering the market. That was part of the rationale behind Brewin’s launch of wealth planning and investment advice provider WealthPilot last a year, a simplified and lower-cost version of its core service.