Global Opportunities in the Private Banking Industry
At Diamond Hill, research analyst positions are intended as career roles with analysts focusing on specific industries for long periods of time. Deep sector-specific research is critical to our idea generation process and decision-making capabilities. Many of the industries and companies we follow either conduct business directly outside of the United States or are otherwise impacted by a mix of global and local competitors around the world. Understanding competitive dynamics both inside and outside the United States has always been an important component of our research process. Therefore, it is natural to conclude that our investment opportunity set does not start and stop at the U.S. border.
Two of our holdings, Julius Baer Group and Credit Suisse Group, are businesses headquartered in Switzerland with attractive global franchises in private banking. Julius Baer is a pure private banking institution (not part of a larger investment bank) that has grown in recent years via acquisition. Credit Suisse is a full-service global investment bank that is currently restructuring in order to focus on its leading global wealth capabilities.
We are attracted to the private banking business for its favorable secular growth trends, recurring fee-based revenue model, and high returns on invested capital. Julius Baer and Credit Suisse represent good examples of how our research process uncovers global investment opportunities.
Private banking involves offering financial and banking services to high net worth (HNW) and ultra-high net worth (UHNW) clients. These are clients with investable assets over $1 million and $30 million, respectively, who typically form a deep, long-lasting partnership with their relationship manager (RM). In addition to investment management and financial planning, clients typically seek additional services such as tax and legal advice, estate and trust management, banking and insurance services, or help in executing philanthropic endeavors. The relationship-driven nature of the business results in revenue that is both recurring and relatively transparent. Firms compete based on the quality and scope of services offered. Revenue is primarily generated from commissions and fees on assets under management (AUM) as well as from related interest and dividend income. Scale is an important component to financial success. The business is less capital intensive than many areas of investment banking and financial services, so returns on capital in private banking tend to be high. According to the Boston Consulting Group, returns on risk-adjusted capital for HNW and UHNW segments are more than 15% and more than 30%, respectively.
Growing Global Asset Pools
The world is getting wealthier every day as global wealth management pools are growing significantly across emerging and mature markets. According to the McKinsey European Private Banking Survey 2016, HNW household assets continue to grow faster than those of average households, driven by their higher proportional holdings of riskier assets and access to better investment products. Globally, UHNW assets are growing faster than those of core millionaires. The assets held by HNW investors will exceed $100 trillion by 2025, up from $63.5 trillion in 2016.1 In 2016, HNW wealth grew 8.2% as the number of high net worth individuals (HNWI) globally topped 16.5 million. The global HNWI population grew 7.5%, on average, with several notable countries across the economic growth spectrum growing double digits. In many emerging economies, wealth is created by first generation families and entrepreneurs. As that wealth compounds with the maturation of markets, the need for a broader suite of wealth management services arises. Emerging markets are expected to see 9% compound annual growth in HNW financial assets over the next five years, compared to 4% in mature markets.2
High Net Worth Individuals By Region, 2016
|Region||Wealth in USD
|# of HNWI
|Source: Capgemini Financial Services Analysis, 2017|
Population Growth of High Net Worth Individuals, 2015-2016
|Source: Capgemini Financial Services Analysis, 2017|
Julius Baer is currently the largest pure-play private bank in Switzerland with 388 billion Swiss franc in AUM. Julius Baer was founded in 1890 and expanded significantly in 2005 when it acquired three private Swiss banks from UBS. In the years after the financial crisis, certain global banks divested private banking units far from their home markets or in places where they lacked scale or expertise, and many of the smaller standalone firms found it increasingly difficult to compete. Julius Baer’s management displayed a desire to expand the firm’s footprint beyond Switzerland and Europe in order gain exposure to high growth markets. In early 2010, the firm increased its AUM by 10% when it acquired the Asian and Swiss private banking units from ING.
Our interest in Julius Baer was piqued in 2011 as it became clear that the firm was in an advantaged capital position that allowed management to consider more potential acquisition opportunities in the marketplace. In 2012, Julius Baer announced a transformational acquisition of the Merrill Lynch International Wealth Management business, which increased its AUM by 40% and further penetrated growth markets such as Asia, Latin America and the Middle East. In the 18 months following the Merrill Lynch deal, Julius Baer continued expanding its business via organic growth, hiring in strategic markets, and subsequent targeted acquisitions in Brazil, Italy and other parts of Europe. The firm now has more balanced exposure to both emerging and traditional markets and twice the AUM it did in 2010. The firm operates in more than 50 countries with over 6,000 employees and 1,400 RMs. As a result of its scope and scale, Julius Baer has very high returns on tangible equity and generates more capital than it needs to run its business. During the firm’s most recent earnings call, CEO Bernhard Holder stated, “Thanks to our unique positioning, we are well placed to take advantage of international expansion and hiring opportunities.” Management also added, “From time to time, if justified, special dividends and buybacks would be considered.” Given the company’s track record of maintaining healthy capital levels while balancing acquisition opportunities and increasing dividend payments, we are confident that management will remain good stewards of shareholder capital. We expect Julius Baer to continue to grow its business and compound its intrinsic value over time.
Credit Suisse is a global financial services company with operations in investment banking, capital markets, global wealth management, and Swiss retail and corporate banking. The firm houses one of the largest private banks in the world and has over 1.3 trillion Swiss franc in AUM. Credit Suisse has more than 46,000 employees including 3,600 RMs around the world. We followed the company for many years after the 2008-2009 financial crisis as it dealt with numerous challenges and difficult legacy issues involving investment banking and mortgage practices, capital and leverage levels, and legal and regulatory settlements. Current CEO Tidjane Thiam took over in mid-2015 as an accomplished financial services executive who was brought in to restructure and right-size the institution. We became interested in Credit Suisse last year, about halfway through the three-year restructuring plan. Thiam took significant steps to shore up the firm’s capital base and outline its investment and cost saving opportunities. The crux of the firm’s restructuring plan involves de-emphasizing capital-intensive investment banking and trading activities while shifting the firm’s capital allocation priorities to its global wealth management operations. During the company’s third-quarter 2017 earnings call, Thiam stated, “Wealth Management typically generates more predictable annuity-like revenue streams with higher fee income and recurring revenues…as we continue to allocate more capital towards wealth management, we expect these benefits to compound and to drive returns higher.” Restructurings of this magnitude do not occur overnight, and we experienced a similar situation with our multi-year holding Morgan Stanley. In that case, our patience was rewarded over time as Morgan Stanley reduced its balance sheet-intensive investment banking and trading activities and shifted focus toward its wealth management business. Ultimately, we believe Credit Suisse will also achieve more predictable, resilient results with higher returns on tangible equity while returning excess capital to shareholders. As Credit Suisse executes on its initiatives in the short term, investors with a long-term time horizon should benefit from the strides made by management.
As competition intensifies to serve the world’s wealthy, scale-driven cost advantages and global reach are more important than ever. We like the market positions held by Julius Baer and Credit Suisse, two firms in different positions taking advantage of secular growth opportunities in private banking. Both companies also represent Diamond Hill’s continued focus on expanding our research efforts beyond domestic equities to find the best opportunities to add value for our clients.
1 Capgemini World Wealth Report 2017
2 McKinsey Wealth Pools 2017, Credit Suisse Investor Day November 30, 2017
As of January 31, 2018, Diamond Hill owned shares of Julius Baer, Credit Suisse Group AG, and Morgan Stanley.
Originally published on February 21, 2018.
The views expressed are those of the research analyst as of February 2018, are subject to change, and may differ from the views of other research analysts, portfolio managers or the firm as a whole. These opinions are not intended to be a forecast of future events, a guarantee of future results, or investment advice.