Changing business environment
The shift in economic policies in the US, UK and the European Union in the post-pandemic period, involving high interest rates and tightening liquidity, had an impact on the Wealth Management (WM) business, too. After more than a decade of sustained growth, the global volume of Assets Under Management (AUM) declined for the first time in 2022 by 10%. The declining equity and bond values and a corresponding decline in portfolio values significantly contributed to this.  At the same time, new business flows also declined, with the Net Flow Rate of AUM falling to 1.6% in 2022 from 4.4% in the previous year.

Average Client Business Volumes (CBV – average assets and liabilities under management) have also been declining, registering a drop of 11.7% in 2022 compared to growth of 12.5% and 6.4% in 2020 and 2021.

Added to this, US investors have been showing an increasing preference for passive investments – Exchange Traded Funds (ETFs) and other mutual funds – during the last decade. In 2022, when active investments showed a net outflow of US$1 trillion, passive investments showed a net increase of US$0.5 trillion

To counter these pressures of declining growth, profitability, and performance, one of the options available to WM firms is to look at opportunities for diversifying into new offerings with better margins. This also needs to be considered in the backdrop of the evolving customer preference for newer classes of assets, viz. ESG-compliant assets and alternative assets.

Diversification into new asset classes
What are the opportunities and challenges involved in including ESG and Alternative Assets in a firm’s portfolio of offerings?

1. ESG compliant investment:
   Given increasing social awareness and responsibility, environment, Social, and Governance (ESG) compliant investing has become a key priority. There is also the potential future risk of regulatory non-compliance impact in investing in ESG non-compliant businesses. Some focus areas for ESG investing have been Climate Control, Air and Water Pollution Control, Data Protection and Privacy, and Deforestation.

   Significant advances in energy transition to clean energy sources have also opened up new avenues for profitable investment, like Electric Vehicles business, and commodities like lithium, copper, nickel, uranium, etc., used in batteries, and businesses associated with these commodities. Thus, purely from a financial perspective too, ESG investing promises to be a good option with the expected widespread adoption of these technologies.

   Research reports indicate that a good majority of institutional investors are planning to increase their investments in ESG assets, and global ESG investing is set to exceed US$53 trillion by 2025. About two-thirds of HNW investors are reported to consider the ESG score before making investment decisions, indicating the strong growth potential of ESG investing.

   WM firms face the challenge of acquiring capabilities for advising and managing ESG investment portfolios. They require specialised platforms for launching ESG-related products and offerings and keeping track of ESG investments. They also need to acquire capabilities for ESG investment opportunities related to data collection, analysis, identifying investment opportunities, risk measurement and tracking in terms of ESG performance, and regulatory and client reporting.

2. Alternative assets:
   Alternative assets like Private Equity, Private Credit, Private Real Estate, and Digital assets like Cryptocurrencies, NFTs, and Tokenised Passion assets (Art, Wine, Nature) etc. – are emerging as a preferred investment option. Investors seeking diversification in the UHNI segment and at Family Offices are looking to increase their allocations in these Alternative Assets. Alternative assets carry additional investment risks and require expertise in understanding the product and the market. But they provide significantly higher returns for investors with deep pockets and a higher risk appetite. They also provide opportunities for increasing income and margins for the WMs. Market study reports indicate that Alternative assets, at US$20 trillion, accounted for more than one-fifth of the total global AUM in 2022 but contributed half of the total global revenues.

   Among alternative assets, Private Equity offerings have been popular recently because of the repricing and valuation corrections experienced due to tightening liquidity conditions. Wealth Managers have been cautious in advising clients on digital assets, especially cryptocurrencies, because of the huge fluctuations in value and uncertain regulatory environment. However, interest in relatively safer digital assets like tokenised real-world assets (RWAs) is showing an uptrend. 

   Alternative assets are inherently more complex in many dimensions—liquidity, regulation, pricing, etc. WM firms need to acquire both the talent in terms of trained advisors who can effectively manage the risks involved and the technology in terms of trading and custody ecosystems to manage this asset class. Boutique firms specialising in alternative assets also pose serious competition to WMs in the conventional asset space in terms of acquiring market share.

Acquiring ESG and alternate assets investing capabilities
While diversification into these new asset classes through organic growth is an option, considering the specialised talent and technology platforms required to advise on and manage these asset classes and time to market, WMs are looking at Mergers and Acquisitions (M&A) as a serious alternative. Both in the US and Europe, there is increasing interest in acquiring additional capabilities, customers and markets through M&A. M&A activities had shown significant growth in 2021 and 2022. In terms of actual deals, the number of deals in the US wealth management sector for the 12 months ending 15 May 2023 is higher than the more than 300 deals concluded in 2021.

Some recent examples of M&A with a focus on acquiring ESG and Alternative Assets investment capabilities are:

Acquiring ESG and alternative Asset investment capabilities presents an opportunity for WM firms to grow their business and also opens avenues for increasing fee income.

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