A Moneyball Approach to Wealth Management

Before the crisis, a “Field of Dreams” approach worked for the wealth management business – if you built it, they would come. An environment of deregulation, falling interest rates, a rising stock market and a seemingly unlimited supply of talent allowed banks the luxury of focusing largely on acquiring clients, almost regardless of cost. Now with compressed margins, skittish investors hoarding cash and a changing competitive landscape, smaller to midsized banks have to play their own version of Moneyball.

In Moneyball: The Art of Winning an Unfair Game, Oakland Athletic general manager Billy Beane created a winning team while going up against ball clubs with larger revenue streams and larger payrolls. Smaller banks, likewise, are up against rich competitors throwing big money at talent and technology and have to be more diligent than ever at investing in the right people, technology and opportunities – and for the right reasons and at the right price.

What are the smart Moneyball tactics for this strategy? We worked with WISE Gateway, operators of the Wealth Industry’s Subscriber Exchange, to leverage their knowledge of peer metrics with our collective experience in the industry to come up with six powerful tactics.

Bigger Is Not Always Better. The wealth management business is built on providing personalized advice through personal relationships, and has traditionally been a difficult business to scale. Consequently, many of the larger players have been moving upmarket in recent years, raising client minimums and opening whole new divisions to focus on the ultra-wealthy (defined as clients with assets exceeding $10 million). This segment offers unique opportunities, but also unique challenges, and most banks cannot compete effectively at this end of the market.

Clients with $1 million to $10 million in assets are expected to be “the fastest growing, largest and most profitable segment of the wealth market” in the coming years, according to analysis conducted by McKinsey & Co. Small- and mid-sized banks should find this segment extremely attractive and increasingly in play as very large institutions chase larger portfolios.

Focus on the Right Metrics. Billy Beane considered the traditional baseball metrics such as batting averages and runs-batted-in (RBIs) to be out of date. He favored a more analytical approach that created new metrics such as runs created and value-over-replacement Player. In wealth management, traditional measures such as assets under management and loan volume are poor predictors of actual financial success. Today’s key metrics must favor measures of productivity and profitability over raw volume growth.

Focus on Wins, Not Hits. It’s nice to have batting champs but it’s even better to play in October; wins matter more than hits. Likewise wealth managers need to focus on the activities that are correlated to maximizing profitable growth over the long run.

Legacy approaches focusing almost exclusively on sales can create “hits” that don’t turn into wins because of increasing attrition, inadequate cost controls or both. Clients wooed during the sales process will quickly become at-risk if their ongoing client experience does not match that of the courtship.

Focusing merely on swelling balances rarely correlates with long-term profit growth. Rather, it tends to focus sales activities on lower margin services that are often easier to sell. If incentives are not adjusted for profitability, a disproportionate increase in compensation costs can further exacerbate shrinking profitability. It can also skew risk management efforts if the additional labor, capital and time-value of money of certain product attributes are not considered.

Look Beyond Allocated Costs. Affluent customers have the propensity to carry higher balances, consume more fee-based services and pose lower credit risks, so it’s no wonder that many banks have announced plans to invest more in the wealth management business. It is an efficient use of risk-adjusted capital and can boost precious fee income in a time of compressed margins and tepid loan demand. But the reality is that while many wealth management executives we have talked to feel the burden of high expectations to deliver outsized growth, they are often frustrated by a lack of commensurate commitment of investment from executive management.

One issue that can distort return on investment (ROI) calculations on investments in the business is how costs for centralized services such as information technology (IT), occupancy and other corporate overhead are allocated. According to WISE Gateway, the typical wealth management operation has margins in the high 20% to 30% range. However, when you adjust for allocated costs, you can see a dramatic increase, in many cases well over 60%.

CEOs investing in wealth management services need to look beyond the allocated costs for a better idea of the true marginal investments needed to maintain and grow the business. Regardless, it’s rarely a quick path and executives should expect a three- to five-year break-even period, especially for investments in staffing.

Front Line Tactics: Invest, Support and Challenge. In belt-tightening periods, it is tempting to reduce staffing and stretch client/advisor ratios. While this tactic may improve profitability in the short run, it poses dangers in the long term. First, the client experience is usually impacted in a way that contributes to increased client attrition that offsets the expense savings. Second, peer metrics show that frontline compensation cost as a percentage of revenue is highly correlated to revenue growth.

Typically, we see a ratio of revenue for every dollar of front line compensation somewhere between $2.50 and $5.00. However, those focused on growing new revenue, smaller players taking market share or new market entrants, for example, typically dip below this level as they are growing staff that has not yet achieved targeted production levels. Banks that are harvesting mature markets average $6 in revenue for every dollar of frontline compensation.

Role Players can be More Important than Sluggers. Firms that are growing faster than average are not necessarily hiring home run hitters, but they do tend to staff their front offices with adequate sales support. In our analysis, the ideal ratio of key front line support to client-facing professionals (e.g., relationship managers, trust officers and private bankers) is slightly less than 1:1. This runs counter to many internal cultures that believe that the majority of front line compensation costs must be allocated to direct “revenue producers.”

Sometimes, it is easier to get approval to hire a $200,000 a year officer than a $40,000 a year administrative assistant, but the right mix of each is the winning formula. The obvious benefit of investing in support is to remove lower value tasks from more expensive talent, and increasingly, wise investments in technology can also help scale the business.

In a business as relationship-dependent as wealth management, there is no reason for midsized and smaller banks to resign themselves to lost business or to cede profitable relationships to the big banks. These smaller banks can actually create a competitive advantage if they make the right investments and establish the right metrics to manage them.

Mr. Nicols is a partner at Atlanta-headquartered Bank Solutions Group, and the founder of the research and innovation firm Clientific. He can be reached at [email protected].