The rise of the HNW Individual
HNW and its exclusive cousin UHNW are terms that instantly command the attention of brokers and bankers seeking to hit ambitious targets in an over-banked world.
But the eponymous initialism homogenizes a diverse group of investors. Certainly, not all wealthy individuals are the same. Why then, do incumbent wealth management behemoths insist on bucketing people into reductive categories, peddling the same uninspiring products to everyone within a certain wealth bracket
What’s in a name?
Despite some digging, we’ve been unable to ascertain who actually coined the term “High-Net-Worth”. Etymologists might raise their eyebrows, but we just have to accept that this somewhat functional way of describing a person’s financial position has entered common parlance – and that it encompasses an increasingly large and disparate community of people globally. We have a decade-long bull run in markets to thank for that.
Sizing up the market is tough, as there is hardly a global census for wealth. But to give you a sense of the scale and composition of the HNW market, here’s some random numbers to toss around at your next HNW dinner party:
An estimated 22.8 million people worldwide have wealth of more than $1m.
265,490 individuals have personal fortunes of more than $30m.
81,000 of the super wealthy people live in the US. 25,000 of them live in China.
Only 15% are women.
The market is clearly large, and growing. But what does HNW actually mean?
Opinions differ. Back in the day, it meant an individual with over $1 million in investable assets. But financial institutions keep moving the goalposts. It seems that firms have very different interpretations of what it means to be wealthy, based on the cost of servicing clients.
One thing is certain; the banking industry is trembling with excitement about the rise of the HNW investor globally. It’s also confused about how to service these clients in a way that is cost-effective and scalable. One might assume that minimum wealth thresholds to quality for HNW servicing have been creeping up in recent years, but in reality the move has been far more pronounced and dramatic. In Singapore, for example, one top-tier bank raised the minimum wealth requirement for HNW individuals from $1m to $3m overnight, leaving bankers and clients scrambling to adjust.
Enter the family office.
A few years ago, seeking to differentiate between wealthy clients and the super rich, banks came up with a stroke of genius – prefix with a “U”. The Ultra High-Net-Worth investor was born, often bringing with them the jewel in every bank’s client book – the family office.
In reality, HNW and UHNW investors aren’t different segments – they’re different species, operating in very different ways and receiving very different levels of focus from financial institutions.
The former group tends to manage wealth with the help of a private banker or financial advisor. Some individuals might do it themselves, for the love of investing, or to satiate the tendency towards control that made them rich in the first place.
UHNWs on the other hand, have been compelled to professionalize their approach to managing wealth via the formation of family offices complete with CIOs and other features of institutional wealth management infrastructure.
The family office actually has a really cool lineage. It’s generally accepted that it began as far back as the 17th Century, when Baron Mayer Amschel von Rothschild had far too many children (it happens).
The great banker’s five sons were dispatched to different corners of the family’s financial empire, to Frankfurst, Vienna, London, Paris and Naples. Although the business was operationally decentralised, the family finances were managed by the head of the family from his native Germany.
In the early 1800s this model was copied by other families, and the private investment office – or family office – investing in a diversified portfolio of assets across geographies, became en vogue. The model thrived in Europe but was not exported to the US and beyond until the early 20th Century, when names like Rockefeller, Carnegie, Pew, Pitcairn and Mellon dominated newspaper headlines – and financial markets.
These days, family offices tend to pursue global asset allocation with diversified, multi-asset portfolios, often heavily weighted towards alternatives. These investors are in an enviable position when it comes to exploiting opportunities in markets. But that’s not to say they have it easy – like all investors, they face many hurdles to preserving and growing assets over the long term.
One challenge for investors in developing markets in particular lies in the interplay of investments and business interests. Many wealthy individuals in emerging markets have built their wealth through old fashioned “real economy” businesses, leaving them exposed to local (and regional) macroeconomics. This can be compounded by investments in local markets. In this way, risk exposure becomes heavily concentrated in the local market. This problem is exacerbated by exclusion from deal flow, with intermediaries preferring to concentrate their efforts on traditional financial hubs like NYC and London. The remedy is simple, but hard to achieve. Global diversification is expensive, bewildering and fraught with difficulties.
An unfair advantage.
Despite the challenges, super wealthy individuals have an unfair advantage when it comes to navigating contemporary markets, fraught as they are with complexity, randomness and risk. Call it a superpower. They might not be able to fly, or see through walls, but they can see through volatility, illiquidity and a host of other ills. The unique nature of their asset-liability profiles typically means they are able to embrace risk in a much more free and expressive way than institutions like pension funds with large liabilities. We’re alluding, of course, to private markets.
UHNW investors and family offices are the big beasts of private markets, and their participation in deals carries a sought after cachet for entrepreneurs and VCs alike. A 2019 survey from UBS found that alternative assets account for a large portion of family office allocations, more than 40% of their portfolios. These are long-term, illiquid commitments that can often require follow-on investment, and family offices are able to accommodate such demanding requirements – provided they are compensated accordingly.
It’s fair to say that the head honchos of wealthy families in emerging markets are often people who have made their money in traditional “real economy” businesses like manufacturing, retail and hospitality – they find direct investments easier to understand and justify than exposure to investment vehicles.
This culture is changing, as family offices professionalise and CIOs step in to manage large mandates. These days, the UHNW playbook isn’t just about the long game in private markets – they can also deftly navigate public markets, tactically deploying capital to preserve (and even grow) wealth in the face of sudden and dramatic market dislocations.
In truth, most clients we speak to employ a barbell strategy, seeking to access huge upside potential through selective investments in private markets, combined with downside protection achieved via absolute return products. Finding such products can be tricky in a world where active and passive management styles have bled into one another. As Institutional Investor points out:
“Family offices are planning to increase their exposure to private equity – the second biggest allocation in their portfolios – amid doubts that hedge funds can protect their wealth in a downturn.”
Outsized returns from private markets are fine and good, but for family offices, everything starts with capital preservation. And the high fees typically levied by active managers simply don’t support the core mission.
Of course, it doesn’t have to be this way. By realigning interests with wealthy investors and getting paid for performance, not management, active managers can make absolute returns relevant again. Three Body Capital’s hydra-esque business model is geared towards catering to a brute truth that all family offices know – private and public markets are not mutually exclusive. They are in fact complimentary, and beautifully so, provided that risk is balanced and transaction costs are kept under control.
We live and work in a world obsessed with categories; assets, markets, investors. But perhaps it’s time we stopped talking about investors and institutions and started talking about people and families? By looking beyond labels we can begin to engage with real people, with real problems to solve, building stuff that makes a real difference.