Working with High-Net-Worth Investors

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In 2020, data compiled by the Federal Reserve shows the net worth of U.S. households rose to $130.2 trillion. And, according to a 2020 report by Cerulli Associates, 43 percent of total investable assets owned by U.S. households is held by high-net-worth (HNW) investors. Clearly, the wealth market is expanding. The years ahead should present substantial prospects to advisors interested in working with HNW investors (those who have a net worth of $5 million or more). Below, my colleague Steve Johnian and I look at recent data regarding HNW investor market share, as well as certain investment and planning tools that could be beneficial for wealthy clients.

A Significant Market Opportunity

For independent financial advisors, there’s more to this market opportunity than the soaring accumulation of wealth across America. Historically, wirehouse and private bank channels have maintained control over the advisory business of the very wealthy, but that dominance seems to be diminishing. In recent years, data shows that the market segment of HNW investors appears to have been increasingly put into play.

As the chart below demonstrates, the HNW investor market share held by wirehouse and private bank channels is estimated to have dropped from 56.8 percent in 2016 to 52.5 percent in 2021. During the same stretch, the channels steadily gaining market share included RIAs, direct providers, multifamily offices, and broker/dealers. With the amount of investable assets at stake, even small percentage changes mean massive asset transitions are occurring.

HNW Investor Market Share by Channel
Channel201620172018201920202021
Wirehouses30.80%31.20%30.40%30.10%29.80%29.50%
Private banks26.00%25.30%25.30%24.50%23.70%23.00%
All RIAs11.70%11.50%11.70%12.10%12.50%12.90%
Direct providers10.50%10.50%10.90%11.40%11.90%12.50%
Multifamily offices7.80%7.80%8.00%8.20%8.40%8.50%
Broker/dealers6.80%7.30%7.40%7.50%7.60%7.60%
Bank trusts6.70%6.50%6.30%6.20%6.10%6.00%
Source: RIA Intel, Cerulli Associates; 2019–2021 figures are estimates. 

Shifting Client Preferences

This change comes at a time when the reputation of wirehouse firms appears to be fading, especially with younger age groups. As investors become more educated and sophisticated, they are more aware of the inherent conflicts in proprietary products offered by wirehouses and other channels. According to Pershing/BNY Mellon, “Client preferences are shifting while independent advisory firms are expanding their capabilities to capture a greater share of HNW business.”

What does this mean for you and your firm’s growth strategy? HNW clients offer a substantial revenue source, but often come with complex needs that require specialized services—including custom portfolio construction and planning advice. If your plans include prospecting for HNW clients, your firm should be familiar with the unique investment and planning tools wealthy clients will expect. Below are some useful tools to consider when working with HNW investors.

Investment Tools

Exchange funds. It’s common for HNW investors to have accumulated a large amount of wealth in a concentrated stock position. They may be hesitant to diversify for many reasons, including the potential tax burden. Exchange funds present a tax-aware solution to the risks inherent in depending on a single stock for continued outperformance. An exchange fund (or swap fund) allows qualified purchasers to exchange one or more stocks for an interest in a diversified private placement fund that closely tracks a benchmark index. Typically, exchange funds are exclusive to HNW investors due to qualification requirements.

An exchange fund not only replaces concentrated stock exposure with diversified equity exposure, it also offers pretax return compounding and the ability to defer realizing capital gains. After a seven-year holding period, the investor may redeem a diversified basket of securities without incurring capital gains taxes. Before then, investors may redeem interests in the exchange fund on a monthly or daily basis (subject to restrictions). A potential downside is giving up potential for an upswing in the concentrated holding.

Structured products. These products are deployed to hedge a portfolio, provide diversification, or cater to other HNW needs. Because they’re highly customizable, structured products can be linked to underlying price movements of a single security, a basket of securities, an index, a commodity, a debt issuance, and/or a foreign currency. Some structured products, such as market-linked CDs, offer capital protection of principal. Many offer limited or no principal protection, however, and they’re typically highly illiquid.

Securities-based lines of credit (SBLOCs). Many wealthy investors appreciate SBLOCs (or non-purpose loans), which use a brokerage account as collateral and provide funding for distinct needs. Common uses include covering a large tax obligation, funding a life insurance premium, or acting as a bridge loan for real estate acquisition. Collateralizing a brokerage account is a competitive alternative to selling brokerage holdings and realizing capital gains, depending on interest rates.

SMAs/UMAs. With mutual funds, investors are subject to embedded capital gains and affected by other investors’ liquidations. SMAs and UMAs can be viable options for HNW investors.

  • Separately Managed Accounts (SMAs): Investors hold individual securities, and a key benefit is tax control through gain deferral and tax-loss harvesting. Because HNW investors are typically concerned with tax liability and can meet account minimums, SMAs are a popular option.

  • Unified Managed Accounts (UMAs): Investors open one brokerage account that unifies multiple SMAs, enabling operational and rebalancing efficiencies. 

Wealth Planning Tools

Distribution strategies for compensation wealth. It’s common for HNW clients to hold valuable stock option grants or appreciated employer stock. Complex analysis of the client’s overall financial position may be needed to assess tax impacts of distributions, and evaluating when to exercise stock option grants can be tricky.

It’s important to develop a holistic strategy for tax-efficient liquidity. As with appreciated employer stock, an IRA provision called net unrealized appreciation (NUA) might be beneficial. Typically, clients who qualify for NUA hold employer stock in a 401(k) or traditional IRA.

Estate and charitable planning through trusts. A properly designed trust helps HNW clients manage their taxes, create a legacy, transfer assets to heirs in a tax-efficient way, and effect an estate freeze. A charitable remainder trust offers tax advantages for the sale of an appreciated asset while fulfilling philanthropic goals and offers numerous benefits, particularly for estate tax planning. A tax attorney should review and provide guidance on trust planning for your HNW clients, as these vehicles require careful drafting.

Helping HNW Clients Achieve Their Vision

When working with HNW investors, unique solutions are often needed to help protect and preserve their assets. As with all clients, your guidance will create the biggest impact when you assist in achieving their vision for today and in creating a legacy for tomorrow.

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This material is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Investors should contact their financial professional for more information specific to their situation.

This material is for educational purposes only and is not intended to provide specific advice.

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