In recent years, there has been a surge of interest in financial literacy, with people becoming increasingly focused on their financial options for when they retire. At the same time, the proportion of people aged 65 or above in the UK has risen dramatically. People are now living longer than ever, which has led to an accumulation of wealth, inadvertently creating a sizeable pool of defined contribution (DC) pensions. Christian Kent writes

The combination of these factors has created a £2.7trn ($3.34trn) wealth management (WM) market made up of shareholdings, investment funds, net cash, and private and occupational DC pension instruments. The largest segment in the WM landscape is the financial advice market, with £800bn in assets under management. This is hardly surprising considering the abundance of investment options available for people to choose from in what is a highly fragmented market.

All these factors have caught the eye of private equity (PE) players, leading to a large number of deals taking place in the sector over the last few years, especially in the independent wealth sector.

Despite the WM market swell, what else is drawing PE to the wealth management sector and what are some of the risks they may face along the way?

Why now?

One of the key drivers for this trend is the attractiveness of the independent wealth sector, which is growing at a much faster rate than the overall market. This is due to a structural change in the market, where advisors are moving from traditional banks to the independent wealth management sector. Advisers are looking to serve their clients and be freed from the bureaucracy that comes from being part of a large bank.

There has also been an increase in the cost of regulation and compliance. A notable change is the introduction of Consumer Duty in June 2023 from the FCA. This has pushed smaller firms in the sector to sell their businesses to larger ones, increasing M&A activity in the sector.

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Larger firms tend to have greater access to capital to invest in technology and investment capabilities, causing smaller firms to join forces to provide their clients with access to these tools.

At the same time, a generational shift is taking place in the sector. Financial advisors are looking to retire, which means a new home for their clients is needed. Therefore, finding a firm with solid foundations and offering quality advice to clients is important for when they exit.

The relationship between PE and WM firms is also mutually beneficial. PE firms have extensive experience working with similar businesses so can support in areas such as digital marketing, technology or supporting further M&A activity. Where firms have gained experience from previous deals, they will have learnt what has been successful or not and can bring that knowledge into the WM business.

Risks to PE investors

It is apparent that the wealth management sector is a highly attractive sector to PE firms but there are some areas of consideration.

Equity markets are can be volatile with fees often tied to client portfolios that are in turn tied to markets. Despite this, history would suggest that downturns are temporary, and the market will eventually recover so there would be no long-term damage. In addition, client portfolios are typically diversified such that there isn’t a direct correlation between UK equity markets and recurring revenue. The wealth management sector has already demonstrated its resilience through increasing interest rates and the Covid-19 pandemic.

As previously discussed, the sector is facing changes in the regulatory environment. PE firms will want to conduct thorough due diligence to ensure that a firm has adhered to regulatory guidance and that the firm has invested in their compliance function and appropriate risk controls are in place.

As M&A activity intensifies in the industry and with the increasing presence of bolt on acquisitions, this activity is transforming organisations. As organisations grow, it is important that management teams focus on talent retention post-acquisition to reduce the cost and time of training new people and the potential loss of clients. It is important to align incentives and culture for a seamless transition, which will be top of mind for PE firms when working in the sector.

With a limited talent pool and rising costs associated with hiring new talent, a key strategic question is how to optimise productivity. How can technology and AI be used to streamline processes? What is the appropriate adviser to support ratio? Are there different service propositions for different types of clients? Not all clients are looking for face to face advice. As the sector progresses, the adviser generational change takes place and AI and automation and more commonly used, we are likely to see a different headcount structure within firms. In the meantime, there is a great demand for academies to create the next generation of advisers.

Forward looking

As the growth trend matures, differentiation will be increasingly important. In particular, the quality of the client’s offering and their focus on strategic growth. Larger groups will likely take strategic interest in the sector, such as retail banks, asset managers and insurance brokers. There are significant revenue synergy opportunities to be unlocked in this sector as these larger groups work with clients that are underserved from a financial advice perspective.

Christian has been at the forefront of advising wealth management firms on their transactions with private equity, including the sale of Perspective to CBPE, Ascot Lloyd to Nordic Capital, Finli to JC Flowers, Wren Sterling to Lightyear and Cardale to Titan.

Christian Kent is a managing director at Houlihan Lokey