Money managers may be sleepwalking through a significant market downturn

7th February 2008
By IB Staff Writer

With a sustained economic downturn forecast for 2008-09, many unprepared money managers will be put at risk of losing both their clients and their investment returns. Despite the evidence that major world economies are heading for trouble, the majority of wealth managers seem unconcerned. This will be to their detriment, and to the advantage of those banks that do take action now.

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The most highly-publicized troubles center on 'sub-prime' mortgages in the US

Over the last few years, many mortgages in the US were originated with 'no money down', effectively giving borrowers a loan with no financial commitment beyond the monthly payments. At the same time, interest rates have risen 16 times since June 2003, making variable-rate mortgages more expensive (around one third of mortgage originations are variable). Furthermore, US savings rates turned negative in 2005, which means that consumers have been spending more than their income since this time, going deeper into debt with a dwindling 'cushion.' As a result, a large number of homeowners have walked away from their mortgages. In fact, in Q2 2007 more than 5% of all US one-to-four-unit residential property mortgages outstanding were in delinquency. The data for sub-prime loans makes even worse reading, with nearly 15% of all sub-prime mortgages in the US in delinquency as of Q2 2007, versus 2.73% of prime mortgages.

The widespread securitization of loans is compounding the problem of delinquencies

However, the residential mortgage market is only one side of the equation. Banks across the US and the world have packaged their mortgages together into mortgage-backed securities (MBS) and sold them into the secondary mortgage market. This market is enormous worldwide, and this is where the knock-on effect of America's delinquencies will be most keenly felt, because these MBS are on the balance sheets of the world's financial institutions.

In Europe, the UK is the largest issuer of residential mortgage-backed securities (RMBS), originating almost half of Europe's estimated E120 billion RMBS issued in 2005. This puts the UK market in a precarious position, because even if UK banks do not hold US MBS, they probably do hold UK securitized loans.

The next two years will see a shift in the demand for wealth management services

During periods of market volatility, clients want to understand the impact that the instability will have upon their portfolios, now and in the future. Unfortunately, as of late September 2007, Fidelity International and Bank of America/US Trust were among the few wealth managers to formally communicate their market view to clients. This leaves most investors uncertain about their financial future during a time when their needs are changing. Several wealth managers are well positioned to take advantage of these shifts in clients' financial thinking.

As central banks cut rates to kick-start the economy, remortgaging will increase in importance. Wealthy individuals' high credit ratings make them particularly attractive targets. First Republic, Wells Fargo, US Bank's Private Client Group, Citi Private Bank and UBS Wealth Management already have remortgage programs in place. Clients will also be tempted to move into cash and 'safe haven' investments like capital protected notes. Merrill Lynch, Wells Fargo and UBS all have cash management facilities linked to their clients' investment portfolios. Some clients will see the opportunities in a property downturn, giving HSBC Private Bank, Anglo Irish Bank Wealth Management and several UK IFAs like Hanson Wealth and Braemer Wealth Management the chance to use their property search and investment services to increase share of wallet and attract new clients.

Savings providers are well placed to take advantage of current market conditions

The volatility in the equity markets will undoubtedly propel more consumers to seek the security and predictability of fixed-income instruments. Despite competition in the form of mutual funds and insurance products, Datamonitor predicts that in the world's major economies, deposits will continue to dominate retail savings and investment portfolios.

In order to secure a greater proportion of customers' savings; in the first instance, banks will derive quick wins by offering competitive rates and steering customers into optimization of their tax-efficient savings options. However, the Northern Rock crisis in the UK and global market uncertainty will demand an equal effort to reassure customers about these institutions' stability and applicable guarantees on customers' deposits. Beyond this, the greater challenge lies in pursuing innovative strategies that will see providers expanding their customer bases and, more importantly, retaining customers when market and investor confidence recovers. Existing examples include direct marketing and 'refer-a-friend' promotions, such as those implemented by Wachovia in the US and Alliance & Leicester in the UK. Product development and marketing should focus on helping customers to improve their overall financial position. Offset accounts, such as those offered by Cheltenham & Gloucester and First Direct; and sweep accounts, particularly those linked to brokerage facilities, such as those available from Merrill Lynch, UBS and Wells Fargo, can also help savings providers to make the most of current opportunities.

Life companies could benefit from market uncertainty, but only if they can reassure clients

Aside from deposits, life company investments and pensions may also see an inflow of funds, but only if the benefits of a long-term strategy are effectively communicated. Life companies will benefit from the current uncertainty as clients move investments into more 'certain' and risk-averse areas. The traditional model that life companies rely on, that of long-term, low risk, low return investments, can be used to attract clients that are looking for a safe haven. However, what is crucial to life companies is that customers fully understand what is happening in the markets and do not become concerned if there are temporary fluctuations in their investments. Whether money has been placed in a pension or a life-based investment, clients must remember that these are designed to meet long-term financial goals and short-term fluctuations should not be the primary concern.

The problem for life companies is the laissez faire attitude within the IFA community; their main point of contact with the customer. Datamonitor research identified that only 17% of IFAs are "very concerned" by the potential for recession in the next year, while 34% declared themselves "unconcerned." These findings come at a crucial point in time when customers need to be reassured and talked to in order to allay their fears; however, it appears that this communication will not be initiated by the advisors. Some providers, including HBOS, have been effective in their direct communications with clients; however, without a follow-up dialogue face-to-face with an advisor, clients will remain nervous.

Providers need to develop a joint strategy in association with the IFA community to ensure that clients are kept informed not only of the major market changes, but also of how this will impact their portfolios directly.
'End Intelliext

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