Monday, July 10, 2006

Tracking the Wealthy Clients

Investment Executive, James Langton, 10 July 2006

Many financial firms covet the high net-worth investor, a market that is healthy but growing faster overseas than in Canada and the U.S., according to a new study.

The latest version of an annual survey co-produced by the U.S. brokerage giant Merrill Lynch & Co. Inc. and the consulting firm Capgemini that tracks high net-worth investors finds there are currently 8.7 million people worldwide with US$1 million in financial assets (the metric the study uses to define a high net-worth investor). Collectively, they control approximately US$33.3 trillion in assets.

These are precisely the sort of clients that many financial services firms have come to focus on in the past few years. As brokerage firms have shifted their businesses away from transactions and toward fees, they’ve naturally become preoccupied with higher-value accounts. Active traders, who can churn out fat commissions for the firm, are out; large accounts with plenty of fee-generating assets are in. It doesn’t much matter if they’re eager traders. It’s big balances that bring home the bacon.

Yet the supply of these big clients is certainly limited. According to the Merrill Lynch/Capgemini survey, there were 232,000 high net-worth investors in Canada in 2005. For a country with about 30,000-odd financial advisors, that’s not many — fewer than eight such clients per advisor.

Moreover, the population growth among this client segment is slowing. In 2005, the number of millionaire clients in Canada grew by 7.2% from 217,000 in 2004. In the U.S., year-over-year growth was a little slower — 6.8% — taking the total number of high-value clients there to almost 2.7 million.

For both countries, these growth rates represent a slowdown from 2004, when the ranks of high net-worth investors grew by 9.9% in the U.S. and 8.3% in Canada. Growth slowed less acutely in Canada than the U.S. in 2005, the report suggests, as wealthier citizens in Canada benefited from higher commodity prices.

North America, however, is not where the population of high net-worth investors is swelling. The strongest growth is in places working from very low levels, such as Russia and India — countries in which the ranks of millionaire investors grew by 17.4% and 19.3%, respectively, in 2005. Increasingly, the fastest growth in the number of these sorts of clients is likely to come in Asia, where economic growth is expected to be strong and there are large populations of once-relatively poor people rapidly accumulating assets.

Although the greatest growth in the population of millionaire investors is expected to come in faraway regions, actual wealth accumulation by these sorts of clients is forecast to be quite strong here at home. The survey predicts the total value of high net-worth investors’ financial wealth will grow by an annual average of 6% from US$33.3 trillion in 2005 to US$44.6 trillion by 2010.

However, not all regions are expected to grow at the same rate. The survey forecasts that North Americans’ wealth will grow at an above-average 7.4% over that period. Indeed, North America is predicted to be the fastest-growing region by assets, surpassed only by the wealthy in the Middle East.

With wealth accumulation expected to outpace millionaire population growth in North America, the obvious conclusion is that the rich will be getting richer — a forecast that dovetails nicely with another recent theory that seeks to explain some of the apparent anomalies in the global economy: the rise of so-called “plutonomies,” or economies that are dominated by their wealthiest citizens.

In a report first published last fall and updated earlier this year, an analyst at Citigroup Global Markets advances the theory that the economies of the U.S., Canada and Britain are increasingly powered by the wealthy. This contrasts with continental Europe and Japan, where wealth distribution is more equal.

The Citigroup report indicates that Canada’s wealthiest people now account for the biggest share of national income since the 1940s — with the richest 1% capturing about 13% of income, and the top 5% accounting for almost 30% of income.

It’s a similar story in the U.S., where, Citigroup reports, the top 1% of households accounted for about 20% of overall U.S. income in 2000. In contrast, the bottom 60% of households also account for about 20% of income. The top 1% also represent 40% of financial net worth, the report notes, which is more than the bottom 95% combined.

The plutonomy notion would seem to be supported by data from the Merrill Lynch/Capgemini survey. It finds that, with almost 2.9 million high net-worth investors in Canada and the U.S. combined, North America is the region with the greatest number of millionaire investors. Europe is a close second at 2.8 million, but the region also has a much greater population to draw on — about 459 million people in Europe vs approximately 330 million in Canada and the U.S. combined. The much higher incidence of millionaires in Canada and the U.S. reflects the fact that greater wealth disparities exist in North America vs Europe.

The rise of the wealthy in North America, the Citigroup report suggests, is largely because of high incomes. It points to U.S. data, which show that in the early part of the 20th century, the wealthy derived most of their riches from dividends and entrepreneurship. Back then, only about 20% of the top 1%’s wealth came from wages, about 30% was attributed to entrepreneurial sources, and more than 30% to dividends.

Today, the picture has shifted dramatically. Now, about 60% of the top 1%’s wealth is from income, another 25% comes from entrepreneurship, with dividends, interest and rents making up the rest.

“The resurgence in their fortunes since the mid-’80s was mainly from oversized salaries,” the report says. “The rich in the U.S. went from coupon-clipping, dividend-receiving renters to a managerial aristocracy indulged by their shareholders.”

The rise of this rich, managerial class in the U.S., Canada and Britain explains some of the distortions, such as the size and persistence of global fiscal imbalances, that have worried monetary authorities for some time, it says.

“We believe that the actions of the rich and the proportion of rich people in an economy helps explain many of the nasty conundrums and fears that have vexed our equity clients recently, such as global imbalances or why high oil prices haven’t destroyed consumer demand,” the report says. “Plutonomy, we think, explains these problems away, and tells us not to worry about them.”

The report also predicts that the disparity will only grow in the years ahead. “We project that the plutonomies are likely to see even more income inequality, disproportionately feeding off a further rise in the profit share in their economies, capitalist-friendly governments, more technology-driven productivity and globalization,” it says.

Globalization is expected to be the biggest force for growing income inequality, as cheap foreign labour keeps wages down and boosts profit margins. “This bodes well for companies selling to or servicing the rich,” it concludes.

To wealth managers and financial advisors, this forecast suggests that their top clients are likely to become more valuable than ever. As the rich get richer, and their rate of wealth accumulation outpaces the population growth, advisors’ smartest move may be to do whatever it takes to keep their richest clients happy.