The right fit

(August 2007) The high-net-worth marketplace in Canada is booming. With a projected growth rate of nearly 88% over the next seven years, it’s a hotbed of opportunity for advisors across all wealth-management channels, says Earl Bederman, who spoke at a marketing wealth management conference in May.

At the end of 2006, the wealth market in Canada comprised approximately $2.4 trillion, which is projected to grow at a compound annual growth rate (CAGR) of 9.3%. Though the demand side of the story is certainly a positive one, Bederman says it still doesn’t make it easy for advisors. He feels there are too many people in financial services who believe such high metrics will make success a virtual cakewalk.

Tim Cestnick, president of the Waterstreet Group, defines wealth-market segments based on net worth rather than investable assets. Though he says there is much work to be done at both the affluent and high-net worth (HNW) levels, Cestnick works primarily with ultra-HNW clients — those with $20 million and beyond.

“The world changes when you’re above $20 million in net worth,” he says, noting his firm, a multi-family office, services 17 families with an average net worth of more than $67 million.

While transparency in all service offerings, particularly with how fees on product are paid, becomes important for clients, those north of $20 million in net worth will also demand objectivity from their advisors. They also place an emphasis on trust and an open architecture setup for investments, taxes and proprietary solutions.

The complexity of products and the time commitment for advisors also tend to increase at this level of net worth. Cestnick’s team spends about three to four days a week at the office of its wealthiest client. He also employs two staff members that dedicate 80% of their time to one client alone.

Those with $50-millionplus in net worth are even more demanding. “Objectivity [transparency and open architecture] is expected, it’s demanded, it’s a given,” says Cestnick.

“Clients have to see exactly what you’re getting paid and how you’re getting paid. There’s no room for proprietary solutions only; there needs to be a broader array of options for clients — whether it’s tax solutions, whether it’s investment solutions, whatever it is.”

And hitting $100 millionplus in net worth demands an entire rethinking of the range of solutions that can be offered. Cestnick says it’s these clients that are inherently guinea pigs that help with his firm’s research and development (R&D) applications. “They’re willing to pay for that…whether it’s creative tax planning or investment solutions,” he says.

He compares it to producers of Formula 1 racing cars, whereby R&D departments will take the technology developed around BMWs and Ferraris and bring it down to their retail-level vehicles. “They can use what they’ve learned to the benefits of other drivers at the lower end. It’s not unlike that when it comes to wealth management,” says Cestnick.

So who are the key players in the HNW spectrum? They include big banks, trust companies, IDA and MFDA firms, investment counsel firms, law firms, accounting firms and family office firms.

While all of these firms profess to service affluent and HNW clients, Cestnick says that in actuality not all do what they say. “That’s where the rubber meets the road. Actually executing on what we say you do is very different than saying or proposing to do certain things,” he says.

One source of confusion is in correctly defining a family office. “A lot of people are going to say, ‘Oh, we run a family office; we do this; we do that.’ But if you take a look at what a family office really is, I wouldn’t call them a family office at all,” says Cestnick. He notes that although the term is catching on, many people still haven’t heard of it.

Cestnick says there are three types of services that advisors of HNW clients typically get into: investment advisory services, wealth advisory services and family office advisories.

Investment Advisory Services incorporate the base level of services provided by most firms, including investment policy development, asset allocation, manager search and selection, fee negotiation, money managers, performance measurements, consolidated reporting, custody and settlement, and income distribution. Wealth Advisory Services add on tax and estate planning, financial and insurance plans, succession plans, as well as business consulting, accounting, tax preparation and bill paying.

The third level is the Family Office Advisory, which differentiates itself from the other two by adding a third category of services: Family Continuity. It’s a starting point that also acts as a blueprint for the family’s overall wealth management, and includes a written document that details the family’s values and the future of its wealth.

Beyond this is where family governance models are developed. Families that have reasonable expectations their wealth will span multiple generations — usually those in the net-worth range between $50 million and $100 million — will need to start managing that wealth like a business in itself. The business is more labour intensive, time-consuming and requires more staff. Participants could be a family council or board, family members themselves and outside participants.

Cestnick’s multi-family office has eight professionals with four chartered accountants, three lawyers and one CFA on staff. Rather than managing assets, Cestnick manages assets under advisement, with a minimum client asset base of $20 million net worth. Wealth is highly concentrated (four families represent half of the combined net worth of his firm’s clients) and its operating structure complex.

Cestnick says significant complexity starts at the $100 million plus mark. It’s this family-office advisory and continuity level that distinguishes it from a wealth advisor and investment advisor. “That’s where things normally start to get more complicated. You can still have $100 million and have it all invested in stocks and bonds, which is a fairly straightforward thing to manage, but once you get north of $100 million and you start investing in private businesses, then there’s just a lot more stuff going on,” he explains.

“These families don’t just invest in capital markets; they’re investing in private businesses, real estate, a lot of alternative things. And when you get involved with direct investing in real estate and private equity, there’s a lot to oversee. So they inevitably have to have help.”

According to the Family Wealth Alliance, an advocate and resource for HNW families, in Wheaton, IL, multi-family offices in the U.S. saw their assets under advisement increase 15.3% in 2006. Cestnick cites the original U.S. family offices as those created by wealthy merchants in the early 19th century. These people hired trusted advisors to oversee their wealth while they were travelling.

A single-family or dedicated family office is one that hires a team of professionals to look after its wealth. For example, a wealthy family that has $500 million of net worth that might hire one or two accountants, lawyers, portfolio managers and investment counselors — to be employed by the family alone. Cestnick notes in Canada there are about 30 to 50 dedicated family offices.

The multiple-family office typically starts with one anchor family. That family will initially have created a single-family office but has now expanded its service offerings to other families. “The next thing you know is you have that same team of professionals — now working for three, four, five, and maybe these days 40 or 50 families,” says Cestnick.

Cestnick identifies a number of significant trends in the HNW and ultra HNW marketplace that will ultimately impact advisors’ service offerings. The first is an aging population. In 2000 in Canada, 16.7% of the population was over age 60, a figure expected to grow to 27% or 28% by the year 2025. “We’re seeing a significant increase in the numbers of wealthy individuals that are over age 60,” says Cestnick, which can only mean there will be accumulated wealth that will need to be managed appropriately.

Another trend is the centrality of business-owning families. Citing U.S. statistics, Cestnick says of those families with a net worth between $10 million and $50 million, 77% are business owners.

Similarly, The Family Office Exchange in Chicago has found that among families with total assets between $25 million and $99 million, 46% are still involved in the original, active operating business. And above $1 billion, 63% are still involved in some capacity or another.

“The importance of businesses to the accumulation of wealth is significant, and will continue to be that way,” says Cestnick, adding advisors to HNW and ultra-HNW clients will need to be able to walk their clients through all business stages, from start-up to liquidation.

Cestnick says people falsely assume that wealthier clients beget more money. But margin-wise, the professional expertise required to execute the proper service offering at the family office level, and to a lesser extent the wealth advisory level, is significant.

“You have to hire expensive people to do that. And you have to hire a number of people to do all kinds of work — bookkeeping, tax return preparation, to have a more full-service offering to wealthy families,” he says.

At the end of the day, advisors need to weigh the pros and cons when deciding where to go in the HNW realm.

What the affluent know

While everyone seems to understand a GIC (certificate of deposit, as they are called in the U.S.), knowledge among U.S mass affluent investors with more than $500,000 in assets falls off rapidly when it comes to alternative investments.

Even REITs are only half as well understood as mutual funds, while less than one in five understands hedge funds. “While hedge funds have been in the news like no other financial product recently, affluent investors still don’t feel they understand these alternative investments. This gap in understanding corresponds with a distinct lack of interest in hedge funds and other alternative investments such as structured products and private placements. Financial services providers offering these products need to be proactive in educating affluent investors about their risks and rewards.

Given their lack of interest, it seems unlikely these investors will step forward themselves seeking more information,” says Catherine S. McBreen, managing director of Spectrem Group, a Chicago-based consultancy.

This article first appeared in the July 2007 edition of Advisor’s Edge Report.

Filed by Heidi Staseson Advisor.ca, heidi.staseson@advisor.rogers.com

(08/30/07)