Royal Bank of Canada at CIBC Eastern Institutional Investor Conference
Sep 17, 2014 AM EDT
RY.TO - Royal Bank of Canada
Royal Bank of Canada at CIBC Eastern Institutional Investor Conference
Sep 17, 2014 / 05:30PM GMT
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Corporate Participants
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* George Lewis
Royal Bank of Canada - Group Head, RBC Wealth Management
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Presentation
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Unidentified Participant [1]
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Okay, welcome back everyone. We are going to begin our afternoon session with George Lewis who is the Group Head of RBC Wealth Management and also RBC Insurance. I'm always heartened when an equity analyst makes good. I think I probably said this the last time you were here, but George worked in a number of positions at RBC, including equity research, before moving into the asset management business which he ran for a number of years before taking on his current role.
The wealth business, in particular, has been targeted by Royal Bank as one they'd like to see provide a bigger contribution to earnings and also act as a destination for some of the excess capital that the Bank is generating. So it should be an interesting discussion today.
So welcome back to the conference, George.
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George Lewis, Royal Bank of Canada - Group Head, RBC Wealth Management [2]
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Thanks very much, [Rob].
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Unidentified Participant [3]
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I figure, maybe just to start, we'll kind of take it to a high level and then drill down. When you think of the collection of assets that you have and the outlook for the business generally, what kind of medium-term growth rates would you assume from your part of the business?
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George Lewis, Royal Bank of Canada - Group Head, RBC Wealth Management [4]
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It is a good collection of businesses and we have strong momentum, particularly in our larger businesses, the one that you've highlighted being global asset management, but also our Canadian wealth business and some of our U.S. wealth as well, had very strong results this year.
I guess stepping back when we created this segment back in 2007, we did target it for a significant growth which we've achieved. The things we believed about wealth management at the time which was very strong demographic trends driving demand for retirement solutions, very strong creation of high net worth and ultra high net worth wealth, those have continued through that market disruption and the market recovery.
And the third thing, which is now kind of a consensus view, but what we like about this business from a financial point of view, from an RBC point of view is it grows with our clients' balance sheet, not the Bank's balance sheet in general. So it's a very capital-light business, one that allows our banking business and our capital markets business, which does need capital to serve clients, needs to continue to grow as well.
So where we focused over the last several years and will continue to be our focus is three things. One is growing our global asset management business. It represents about 60% of our segment's earnings. It's our highest margin business. It's a 50% pre-tax margin business. It's leverageable.
It's our most leverageable business within wealth. So its solutions are used not only by our Canadian wealth business, but of course by our banking business in Canada. It has an institutional business, not only here in Canada now, but in the US and the UK and that's where we've made our -- focused our acquisition efforts within this segment, being Phillips, Hager & North in 2008 and BlueBay in early 2011 and those have gone extremely well.
So we see actually very strong organic growth coming from that business based on those acquisitions. This year, we continue to, in Canada, sell about 16% of the industry's net sales of mutual funds compared to a market share of 14%. So that's a business with strong momentum and we expect it to drive a good portion of our earnings going forward as well.
Canadian wealth, very strong number one business for us here in Canada, about 19% share of high net worth client assets up from 15% a couple of years ago. Couple of competitive advantages of that business would be the growth in our wealth management services capability where we provide resources to our advisors and our clients to help them with financial plans, tax advice and insurance solutions. But I would also say that the partnership with Canadian banking, commercial banking, in particular, continues to drive that growth. And then outside of North America, we continue to invest as well in our global asset management business, but also in our US wealth business as well.
So we would continue -- in terms of going forward, we would continue to target above average growth coming from this segment relative to RBC which we've achieved and we would continue to expect that going forward.
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Unidentified Participant [5]
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There's been some discussion lately about whether demographics are still the tailwind they were for the sector and whether there is something changing on that front. And especially as the population ages and perhaps, we used to think of it as migrating towards an insurance type product that the banks couldn't offer and the insurance companies can't seem to offer them either anymore. But as you see the aging population, is there a level at which demographics stop being a tailwind for you?
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George Lewis, Royal Bank of Canada - Group Head, RBC Wealth Management [6]
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Well I think on that, what we've seen within our asset management fund business is a tremendous growth in portfolio of solutions, and what I mean by that where we take individual mutual funds. So our capabilities in fixed income equities, others capabilities around the world and put it into a portfolio some are designed for accumulation, some are designed for balanced investors, some actually deliver the long-term expected return from the portfolio in a cash return each and every year for clients who need income and principal staying relatively stable. So I think you're going to continue to see innovation from the asset management side to address the de-accumulation trend.
And then on the insurance side, we've got a growing capability within RBC insurance around payout annuity. So I think there is not one silver bullet product solution that we're -- and I think those are somewhat risky, but I think there's a combination of advice and a number of different product solutions from both the asset management and insurance side that will address that need.
The other thing I would say is the market event is challenging as it was for all clients. We were successful in retaining clients through that period and also encouraging them to, in a low rate environment, increase their savings rate. So I think that the de-accumulation phase is a little bit further off than maybe what we would have thought 5 or 10 years ago.
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Unidentified Participant [7]
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I think the Bank was probably early on to using the branch network and to integrating with Canadian banking as a source of clients, as a source of flows. A lot of banks are talking about this now in terms of trying to use that branch network and try to gain share in that business. So are you seeing any difference in -- because it's a more mature trend at Royal Bank, are you still seeing that as a source for market share gains, or are you fighting to protect market share now in that channel?
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George Lewis, Royal Bank of Canada - Group Head, RBC Wealth Management [8]
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No, it's a great question and it's certainly the case that all of our competitors, both independent and bank-owned are focused on this opportunity, and I would say that well before my time, RBC had come to the conclusion in the 1990s that offering long-term mutual funds through a branch network was not in conflict with the deposit gathering business. It was actually complementary and I think that's a battle that was fought and won a long time ago at RBC.
And from that point in time, we've developed a very strong relationship with our Canadian banking partners. We provide not only product, but advice and support to the sales forces. Our industry -- our mutual funds have fees that are on average 15% below the industry average.
The global capabilities that we've added through the acquisitions of institutional firms have actually allowed us to bring those solutions back and put them into our retail mutual fund portfolios and our performance has been very strong in that regard.
So the other thing I would say is that we've developed different options for clients to access our funds. We were the first to launch Series D funds, for example, through our discount broker. So clients at RBC have a choice to come through our branch network, get great service from our financial planners. I would say our banking business has been -- was also very early on in hiring well qualified and well-trained financial planners to provide that kind of advice within a branch context. But we've also got a good online capability channel as well.
So if you look at our market share of long-term funds, and we compare ourselves against everyone in the industry, so on that basis it would be about a 14.5% share. But if you just look at the banks, we would have a share of around 33%. So it does speak to the lead that we've been able to gain in this market and we do not intend to give it up and we actually continue to see our market share increasing.
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Unidentified Participant [9]
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One of the trends that has been -- we certainly talked a lot about this morning in this room is the importance of advice and whether we're talking about the retail banking channel or the wealth management side, that importance of advice. And so how proactive are you at sort of migrating clients through into the right channels? So maybe you have got them in through a branch channel, but as they have grown and accumulated something, maybe they need a financial plan and then off to [an IAA] that kind of thing. How proactive is that process at Royal Bank?
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George Lewis, Royal Bank of Canada - Group Head, RBC Wealth Management [10]
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It's very and I think within the Bank itself, you are right, there is graduation from a team based relationship management model to a dedicated financial planner model. And again, those financial planners have access to the full range of global asset management solutions. So they can handle the needs of clients that are -- as they get larger within that channel as they prefer to stay within a branch network.
If they want a broader wealth management relationship then either an investment counselor or an investment advisor through DS is certainly the solution than that. And that business itself that was very much focused on high net worth individuals are advisors, their book size is 50% larger than the industry average and (inaudible) of that business has done a great job of ensuring that our advisors and the support that we provide are really pointed towards the right clients to your point. And we get good referrals from not only private banking within the banking network, but also commercial banking because there is a huge business succession opportunity that I think will be the next driver of -- significant driver rather of growth in the wealth business in our Canadian wealth area.
So I would say that those are some of the advantages we have and I think part of the values of RBC which we speak about is collaboration and that's something that in addition to building strong businesses and client value propositions individually we do put a lot of emphasis at senior level and at the local market level which is probably even more important in collaborating across the business lines.
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Unidentified Participant [11]
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So let's talk a little bit about how that model translates into the United States market where you have got the big full service brokerage, don't have the branch channel, not that it probably matters, but what is the strategy in the US and what is the vision for what it's supposed to look like?
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George Lewis, Royal Bank of Canada - Group Head, RBC Wealth Management [12]
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So I think before I come to the wealth distribution business in the US which I think is an important element of your question, stepping back and looking at RBC's presence over in the US, we have built a very large capital markets business there. It's actually -- we are actually larger in the US now than we are in Canada in terms of profits. It's transformed as you know, over the last several years to a corporate and investment banking business to a larger extent than a trading business. That has actually been a significant partner to our wealth business and helped it grow in the US.
We've got a very good management team there. We've got very strong 1,800, 1,900 investment advisors in 42 states. So we've built the eighth largest full service wealth management business in the US with a similarly strong capital markets partners we have in Canada.
But where we have an opportunity that some of our peers in the US have that we're not able to access as well as they can would be the commercial banking and private banking capability for high net worth clients to add into that US wealth management client base and solution set.
We do very well with investments with our US wealth clients as well as we do in Canada in terms of investment book. Where we are not taking full advantage of our 400,000 high net worth clients down there is we're not earning as much spread income in that business as we do back in Canada.
And so we do have some lending capability in terms of securities based lending, some deposit capability, but not, for example, a significant mortgage lending capability for high net worth clients. So those are some of the capabilities that we're taking a look at in terms of how we can add that to our US franchise.
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Unidentified Participant [13]
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You've talked in the past about the lending opportunity in your segment. There was a bit of an accident earlier this year, I suppose, but that's going to happen when you lend money. But where are you in -- and you can comment on that if you wish, but where are you in terms of using that opportunity to get some of that spread income and is it still happening mostly in Canada? Is the opportunity in the US? How is this going to unfold?
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George Lewis, Royal Bank of Canada - Group Head, RBC Wealth Management [14]
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Yes, now it's a good question. When we stepped back and looked at our global peer group in wealth managers, companies like JPMorgan, UBS, Credit Suisse and Barclays, on average, they would have about 5% of their client assets under care in the form of loans. So loans would represent 5% of their client assets.
In our cases, it's around 2%. At the time we looked at this, it was around 1%. So we believed and still believe that there is a good opportunity to increase lending with high net worth and ultra high net worth clients as a means to broaden the relationship though. It needs to be profitable in and of itself and we've seen significant growth in that.
We will always still have more deposits coming from our franchise in wealth [than we will in loans] we have more than a two to one ratio and we're focused on maintaining that because one of the advantages of having a wealth business is we do provide funding for the overall bank, but we continue to believe that there is a good lending opportunity. It's primarily backed with liquid market securities. We do have some backing with residential and commercial real estate.
The situation that you mentioned last year related to our Asian business. We were not happy about it. It was actually related to securities based lending. So it looked like part of the portfolio that should theoretically not have any problem, but it was lending against portfolio of securities that had a correlation among them. They were small and medium-cap stocks and they had a significant market decline over a very short period of time, like one or two days. So it was a very isolated event. We've learned from it. We've made significant changes, not only within risk, but within the business itself. And in this business, we are going to have PCL from time to time, but we shouldn't have it to that extent and so far so good this year we haven't.
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Unidentified Participant [15]
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In terms of that international business, I saw a press release a week ago or maybe it's long ago, but closing a couple of offices in South America. And so when you think of that developing market, if you will, what is the strategy and how do you decide which country to be in and which country not to be in? Is this just a tester and see how it goes, and if it doesn't work we close or is there a more established (multiple speakers)?
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George Lewis, Royal Bank of Canada - Group Head, RBC Wealth Management [16]
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No. And that's a great question. The way we look at this business is this is a business we've been in for decades. So it's an international cross-border wealth business. So, in our wealth segment overall, we've got our global asset management business and then our on shore wealth businesses in Canada and the US and then a business that meets the cross-border financial needs of high net worth and ultra high net worth clients in the British Isles, in Latin America and Asia.
This business, we are focused though on reducing our footprint in terms of booking centers to build scale where we are in key centers like London, Hong Kong and Singapore. We just hired some additional client-facing professionals in our Hong Kong office today. We've invested more in this business to strengthen the control infrastructure because it does have a higher inherent AML and other risks that we need to manage quite carefully.
And this business has also historically been one that's been more trust services and banking led as opposed to investments. And unfortunately to low interest rate environment, as we've been making these investments, our revenues have also been negatively impacted by the low rate environment. So this is a business I had mentioned that we've been in for decades. It did represent as late as 2009, 20% of our segment earnings, it's now roughly breakeven.
So in terms of looking at our overall results, we've benefited greatly from momentum in our larger businesses, ones that we've focused on acquisitions like Asset Management, growth in our Canadian wealth, the recovery in our US wealth business. This is a business that we're committed to, but it's one that we're rationalizing to a greater extent in terms of the number of countries and booking centers that we have in order to improve the profitability.
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Unidentified Participant [17]
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Is that decline in profitability just largely interest rates have gone down and so that trust business is no longer as active or as profitable and so will theoretically come back as rates rise?
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George Lewis, Royal Bank of Canada - Group Head, RBC Wealth Management [18]
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That's right. The biggest impact there we would have, I mean we're exposed to the US dollar rates and sterling rates in that business and so, I'm anxiously awaiting both the Federal Reserve and the Bank of England.
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Unidentified Participant [19]
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(inaudible). So most of the opportunity, I think we've talked about to now is organic and you feel good about the opportunity for above RBC average growth rates. So call that I guess my number, not yours, but a low double-digit kind of growth rate.
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George Lewis, Royal Bank of Canada - Group Head, RBC Wealth Management [20]
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Yes, and we've done better clearly than that this year, but I think that's reasonable. If RBC's long term, medium term objective is north of 7%, we should be shooting for low double digits.
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Unidentified Participant [21]
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So then the incremental opportunity from capital deployment into the sector, is this -- you guys have been quiet for a while on this front now, at least from a big splash, [a couple or CAD3 billion, CAD4 billion] acquisition, is it for lack of attractive asset or lack of attractive price?
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George Lewis, Royal Bank of Canada - Group Head, RBC Wealth Management [22]
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That's a great question. I think it's from our -- stepping back, if you actually look to the growth of our asset management business over the last five years, it's been the second fastest growing asset manager in the world, next to BlackRock. Part of BlackRock's growth was the acquisition of iShares and part of our growth was the acquisition of PH&N and BlueBay.
We are very, very focused on acquisitions in this space that have the right culture, are high-performing businesses and ones that we can add value to in terms of helping them do better than they were doing on their own. So in the case of BlueBay, we've been able to distribute their mandates into North America where they did not have a presence before and that's gone very well.
In the case of Philips, Hager & North, we've doubled the size of their retail fund family since they've been a part of RBC Asset Management. So this is a business, as you know, where even more so than for most businesses in financial services, people are critical, the culture fit is critical and being able to identify those revenue synergies and then execute on them is critical.
We have not focused on turnaround opportunities that we think is an area where we don't have the skill set at least within asset management to do that but buy high-quality franchises for a fair price where we think we can add value. That takes time to execute.
And so, I guess I mentioned this before, but I am much more focused in this segment on going three for three, I think we're two for two then 10 of the 15, because that just takes a lot of -- too much management time to execute.
So we continue to look for opportunities. I would say that we also now have a footprint both in the US and the UK where we've hired teams. We've hired a global equity team in London, an emerging market equity team in London, hired institutional sales people in the US. So, we have a much more viable organic strategy today in the asset management business than we did five or six years ago. So the pressure to do acquisitions to grow this highly attractive business is not as great as it was at that time.
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Unidentified Participant [23]
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And is this the case of, given the competition for assets is so high and given where the markets are and the rest, should we just kind of assume, let's focus on organic growth for now and we'd rather deploy when there is a little bit of blood in the water than to try to do it now or if you saw something attractive now have to pay up, you kind of swallow the pricing and drive on?
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George Lewis, Royal Bank of Canada - Group Head, RBC Wealth Management [24]
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I think in terms of the areas within asset management where we would look to add capability from a mandate perspective, we are still -- we do have good capabilities and alternatives, but we, for example, do not have a real estate asset management capability. If that came along, that would be of interest.
But that's getting very specific and by definition will be likely a smaller acquisition size than either Philips, Hager & North or BlueBay.
And so, we will remain very focused on financial returns. We also don't think that we can time the market. I mean these businesses come for sale at particular times generally because you don't take -- you don't need a lot of capital to operate an asset management business. They are generally not for sale at the bottom of the market either. So we've got a clear strategy to your point that's primarily organic. But where we can identify acquisitions that would build on that organic strategy, we will be open to them.
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Unidentified Participant [25]
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That organic strategy comes with expenses. I think I used the comment earlier this morning that you guys (inaudible) expenses. So when you think about the investing you are doing outside the country, can you give us a sense of what those investments are? Are you just hiring people or is at actual systems and distribution et cetera like? What are these expenses and how -- do you see that clear tie to the revenue growth of the company?
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George Lewis, Royal Bank of Canada - Group Head, RBC Wealth Management [26]
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Yes, it's a good question and say it's both client-facing professionals on the distribution side and investment management side as well as investments in improving systems and infrastructure, particularly in our international wealth business. So just to give you a bit of a breakdown. First of all, stepping back, we've been able to generate significant revenue growth from these investments. So we delivered positive operating leverage the last two quarters of a little over 2%. Our objective is to continue that.
In terms of our expense investments, it is very much on client-facing teams, on investment management teams. It breaks down roughly 80% towards our wealth businesses and 20% towards our asset management business.
So the other thing to keep in mind is that a significant part of our NIE as you know is related to variable compensation for our brokerage businesses. So that will go up and down with revenue, but we are definitely investing in fixed costs as well in terms of our asset management and international wealth businesses and we are continuing to see positive flows across particularly our asset management business in support of those investments.
So we are very focused and benefit also though from the overall enterprise focus on investments and technology as well. So that helps us maintain that positive leverage.
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Unidentified Participant [27]
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Is that kind of feel like the right ballpark, a couple of hundred basis points of operating leverage or is it really revenue dependent at this point if -- I'll leave it there. I mean is 200 points of operating leverage, [is that] what you would hope for in this business?
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George Lewis, Royal Bank of Canada - Group Head, RBC Wealth Management [28]
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Yes, I think the way we look at it is, well, we benchmark ourselves against our global peers primarily on pre-tax margin. We were able to get claim close to the 25% pre-tax margin level this quarter and some of our peers are above that, many are below that. Part of that is a function of our business mix. And so, another reason we focused on growing our asset management business is that, it's a 50% pretax margin business.
So we are focused on getting more efficient and effective in all of our businesses within wealth, but to the extent that we continue to grow faster within our asset management business you'll see that pre-tax margin creep up over time and hopefully more than creep up.
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Unidentified Participant [29]
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As probably Canada's largest wealth manager, just period, there has been a fair bit of talk about regulatory change in the industry and given that you operate in pretty much every channel and every business in Canada, can you talk a little bit about how this is going to affect you? How you think it will affect the market and whether you believe yourselves to be more or less exposed?
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George Lewis, Royal Bank of Canada - Group Head, RBC Wealth Management [30]
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Sure. And I think the -- just in general, we've been very supportive of regulatory initiatives in both the asset management side and also the wealth advice side that support transparency and also make clients aware through that of choices and what the value of the services that they're receiving. So we've made significant investments, for example, in our Canadian wealth business, also our banking business in preparing for CRM to. We feel very comfortable and have actually been encouraging of the regulatory moves in that regard.
I think another development, which I think the regulators are taking a very thoughtful approach to is the issue in the mutual fund business around trailer fees and they've issued a preliminary discussion paper to which we responded and others did as well. I think that from our perspective, our strategy within the asset management area has been -- over the mutual fund area has been over the years one of transparency value and choice.
So talked about transparency value, our MERs are on average 15% below the industry average. So we feel very comfortable coming into an environment of greater focus on that. And then choice, choice is important because we've launched different series of our funds. We were the first to launch a Series D fund to provide investors who don't want advice, access to our mutual funds through a self-directed brokerage business. We've launched along with the industry an F-Class fund, of course.
So being able to have choices for our clients to access asset management solutions, whether they prefer to receive advice or not or pay for that advice in an unbundled or bundled fashion, we think that choice is important for clients to continue to have. And so, if you look at the record of our market share over the years, it's increased. I think, part of that's been due to performance to our channel expansion, to your point of operating in multiple channels. Part of it, I think, has been due to our lower MERs and part of it's been due to choice. So clients can access our solutions through a number of different channels.
So to us that's evidence that the market is working and therefore there's not a need for price regulation in terms of capping trailer fees, for example, or some of the other solutions that others have spoken about. I think that that model of embedded device has been one that's provided broad access to mutual funds to all clients. And I think if you take a look at the developments in other jurisdictions that have gone in this direction, there has been a withdrawal of advice from certain clients.
So we're hopeful that and we do expect a positive outcome. We think there's been a lot of progress and a lot of increased awareness among clients and advisors that the regulators and the industry have driven through this focus on transparency and disclosure and that's where we'd like to see the focus remain.
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Unidentified Participant [31]
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We are exactly out of time. So that was great. Thanks, George and thank you for participating in the conference this year.
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George Lewis, Royal Bank of Canada - Group Head, RBC Wealth Management [32]
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Good. Thanks very much. Thank you very much. That was excellent. Thank you.
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