International Private Banking Study 2005

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Swiss Banking Institute University of Zurich Dr. Teodoro D. Cocca

The

International

Private Banking

Study

2005

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The International Private Banking Study 2005 Swiss Banking Institute

University of Zurich Dr. Teodoro D. Cocca

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Acknowledgements

The author would like to sincerely thank Stefan Schmid for his extensive support with the statistical analysis and his scrupulous data base management. Special thanks also go to the Swiss Financial Center Watch for its financial support.

Impressum

With generous support from Swiss Financial Center Watch

Author

Dr. Teodoro D. Cocca, Swiss Banking Institute, University of Zurich

Participants

Stefan Schmid, Swiss Banking Institute, University of Zurich Ilario Scasascia, Swiss Banking Institute, University of Zurich Manuela Vielmi, Swiss Banking Institute, University of Zurich Roland Raimondi, Swiss Banking Institute, University of Zurich

Layout

Plasma Design GmbH, Zurich

Print

Kyburz AG, Dielsdorf

Translation

Textra Consulting GmbH, Zurich

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Executive Summary

Goal

This study represents a new edition of „The International Private Banking Study“ published in 2003. 156 institutions focusing on offering services to private banking clients are analyzed. Covering the period from 1990 to 2004, the sample includes banks from Austria, Benelux, France, Germany, Italy, Liechtenstein, Switzerland, the UK and the US. The intention is to compare the relative strength and competitiveness among all banks by measuring a multitude of ratios of operational efficiency, size, growth and investment performance.

New

Differences to the study published in 2003 are summarized here: - The number of countries has increased from six to nine.

- The number of banks has increased from 109 to 156 (totaling 182 datasets, if business units are also counted).

- The number of funds analyzed has increased considerably, from 504 to 1900.

- Fund costs are included in the fund performance analysis, it is therefore possible to calculate net and gross returns.

- Currency fluctuations can distort the comparison of key operating figures. Since the last years were characterized by major fluctuations in the US dollar, all the computations are corrected for this effect.

Profitability

Adjusted gross margins are at around 80 to 100 bsp (basis points) in Switzer-land, UK, US, Austria and Benelux. Above average are France and Italy, whe-reas Liechtenstein has below average margins. Return on equity values have, in general, fallen sharply following the year 2000 and have recovered during the last two years. However, as our analysis shows, the top levels of 2000 have yet to be reached. Average return on equity is the highest in Benelux (29.3%), followed by the US (23.6%), Switzerland (19.7%), the UK (19.6%) and France (19.5%). The lowest figures are for Italy (12.7%) and Liechtenstein (10.1%). Swiss banks and banks from Liechtenstein show significantly higher capital le-vels compared to their peers; their ROE value is therefore distorted and would be significantly higher if compared on the basis of equal capital levels.

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Operating efficiency

Generally speaking cost/income ratios have stabilized on the same levels as be-fore the stock market bubble and its wild swing effect on commission income in private banking. The last two years have turned in favor of Swiss banks again, since cost/income ratios are exactly on average levels compared to the other countries. German banks still show very high values, whereas Italian banks consistently show the lowest level in the entire sample.

Investment performance

Swiss banks have improved their investment performance. They are in the up-per tier of all banks when up-performance measures are compared. Nevertheless, US banks still seem the only group to achieve a slight outperformance compa-red to the market indexes. In the most important single comparison - the net long term overall performance – Switzerland ranks second behind the US who leads the ranking. In the categories mixed over five years, Swiss banks rank number one. Compared to the last study, it is only the Swiss banks that have improved their overall average (net) outperformance.

Size effect

We explore how size, profitability, efficiency and growth affect each other and investment performance. Overall, there seems to be some evidence for a mo-derate level of economies of scale in terms of profitability. However, size has no significant influence on efficiency – when measured with cost/income ratios – in private banking.

Growth

Size and growth variables are not positively correlated. However, we are able to show that the net new money flow reflects past investment outperformance of a bank’s mutual funds, thus implying that superior investment performance attracts money in private banking.

The International Private Banking Study 2005 Executive Summary

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The table below summarizes the most important figures across the different country sub samples:

Table 1: Summary

Switzerland Austria Benelux France Germany Italy Liechtenstein UK US Return on equity (before taxes) 19.7% 12.0% 29.3% 19.5% 12.6% 12.7% 10.1% 19.6% 23.6% Adjusted gross margin on AUM (bps) 79.6 78.7 86.1 115.0 80.7 108.1 57.5 96.4 67.8 Cost/income ratio (before depreciation) 64.4% 60.1% 60.9% 66.5% 75.8% 57.1% 60.4% 67.4% 69.6% Total revenue per employee (in CHF) 543‘363 283‘053 384‘630 355‘094 372‘773 268‘008 484‘149 405‘263 394‘955 Personnel expenses per employee (in CHF) 225‘195 115‘687 130‘087 141‘946 164‘345 103‘108 174‘325 138‘255 176‘176 Gross profit per employee (in CHF) 197‘404 114‘547 157‘795 102‘179 100‘597 108‘338 203‘026 121‘762 136‘665 The International Private Banking Study 2005

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Introduction

Objective

The goal of this study, which is the second revised edition of the study publis-hed in 2003, is to analyze the private banking market by focusing on an inter-national comparison of banks that are specialized in this business area. The analysis follows a three-stage approach. First, internal efficiency of the banking institutions is compared by using accounting data. Second, investment com-petence is assessed by calculating the average mutual fund performance for each bank. The third and final step combines the first two stages and explores interrelations. The intention is to compare the relative strength of Swiss banks to foreign institutions. Therefore, stronger emphasis is placed on Swiss sup-pliers of private banking services. The main focus of the study is on ratios of operational efficiency, size, growth and investment performance.

Data

The sample includes 156 institutions (compared to 109 in the first study) focu-sing a substantial part of their business on private banking markets. The sam-ple selection is based on the following criteria: data availability, income from fees and commission must account for more than one third of total income and a strategic focus on private banking must be identifiable. Three new coun-tries (or country groups) have been included: Austria, Benelux and Liechten-stein. The sample is divided as follows (figures given in brackets are from the 2003 study): 90 (79) Swiss, 5 Austrian, 7 Benelux, 8 (5) French, 12 (5) German, 11 Liechtenstein, 11 (5) Italian, 8 (5) British and 15 (10) US banks. Of the 90 Swiss banks, 55 comprise aggregated data for asset management banks and 12 for “Privatbankiers” according to the Swiss National Bank statistics classifica-tion.1 The sample totals 182 datasets as in 15 cases data was collected for both the entire bank and for the private banking unit. The time period covers the years 1990 to 2004 (2002-2004 for the new countries). Accounting data was extracted from periodical company reports (annual and quarterly reports and analyst conference material), or statistics by the national bank of the respective country. Due to data inconsistency and lack of reported data from several coun-tries in the early nineties, only the figures since 1998 are shown. Currency fluctuation can distort the comparison of key operating figures. Since the last years were characterized by large fluctuations in the US dollar, all computa-tions are corrected for this effect.

1 Because of SNB methodology, 11 banks where counted twice in our sample. The International Private Banking Study 2005

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Profitability

Assets under management

Profitability in private banking is preferably measured in relation to the assets a bank has under management (AUM). We use an adjusted gross margin ratio, which is defined as “net fee and commission income/AUM”. The adjustment refers to the elimination of interest and trading income from the standard gross margin definition. Our narrower definition allows the income genera-ted through core private banking services to be looked at more closely. It can therefore be better used for comparison without being subject to bank speci-fic factors, such as a large credit business or proprietary trading operations. Analyzing the adjusted gross margin, we see that the figure in most countries converges at about 80-100 bsp (cf. Figure 1). The highest gross margins can be earned in Italy, whereas Liechtenstein has the lowest. Increasing competition may be the cause for the steady decline of gross margins in most countries, with the exception only of France. In the latter case, the increasing margin can be explained by an increasing weight in the sample of banks that are subsidi-aries of international banking groups based outside of France.2_{This company} structure often also results in a more favorable income structure. Margins in Switzerland are average and surprisingly constant.

Figure 1: Adjusted gross margin on AUM (basis points)

0 20 40 60 80 100 120 140 98 Switzerland 99 00 01 02 03 04 98 France 99 00 01 02 03 04 98 Germany 99 00 01 02 03 04 98 Italy 99 00 01 02 03 04 98 Liechtenstein 99 00 01 02 03 04 98 UK 99 00 01 02 03 04 98 US 99 00 01 02 03 04 Austria 03 04 Benelux 03 04

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0 0.1 0.2 0.3 0.4 98 Switzerland 99 00 01 02 03 04 98 France 99 00 01 02 03 04 98 Germany 99 00 01 02 03 04 98 Liechtenstein 99 00 01 02 03 04 98 Italy 99 00 01 02 03 04 98 UK 99 00 01 02 03 04 98 US 99 00 01 02 03 04 Austria 03 04 Benelux 03 04

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0 0.05 0.1 0.15 0.2 98 Switzerland 99 00 01 02 03 04 98 France 99 00 01 02 03 04 98 Germany 99 00 01 02 03 04 98 Italy 99 00 01 02 03 04 98 UK 99 00 01 02 03 04 98 US 99 00 01 02 03 04 Austria 03 04 Benelux 03 04 Liechtenstein 03 04

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50'000 100'000 150'000 200'000 250'000 300'000 98 Switzerland 99 00 01 02 03 04 98 France 99 00 01 02 03 04 98 Germany 99 00 01 02 03 04 98 Italy 99 00 01 02 03 04 98 Liechtenstein 99 00 01 02 03 04 98 UK 99 00 01 02 03 04 98 US 99 00 01 02 03 04 Austria 03 04 Benelux 03 04 in CHF in CHF adjusted in CHF in CHF adjusted in CHF in CHF adjusted in CHF in CHF adjusted in CHF in CHF adjusted 0 100'000 200'000 300'000 400'000 500'000 600'000 700'000 800'000 98 Switzerland 99 00 01 02 03 04 98 France 99 00 01 02 03 04 98 Germany 99 00 01 02 03 04 98 Italy 99 00 01 02 03 04 98 Liechtenstein 99 00 01 02 03 04 98 UK 99 00 01 02 03 04 98 US 99 00 01 02 03 04 Austria 03 04 Benelux 03 04

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0 100'000 200'000 300'000 400'000 500'000 600'000 98 Switzerland 99 00 01 02 03 04 98 France 99 00 01 02 03 04 98 Germany 99 00 01 02 03 04 98 Italy 99 00 01 02 03 04 98 Liechtenstein 99 00 01 02 03 04 98 UK 99 00 01 02 03 04 98 US 99 00 01 02 03 04 Austria 03 04 Benelux 03 04

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0 10'000'000 20'000'000 30'000'000 40'000'000 50'000'000 60'000'000 70'000'000 80'000'000 98 Switzerland 99 00 01 02 03 04 98 France 99 00 01 02 03 04 98 Germany 99 00 01 02 03 04 98 Liechtenstein 99 00 01 02 03 04 98 UK 99 00 01 02 03 04 98 US 99 00 01 02 03 04 Austria 03 04 Benelux 03 04

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0 100'000 200'000 300'000 400'000 500'000 600'000 700'000 98 Switzerland 99 00 01 02 03 04 98 France 99 00 01 02 03 04 98 Germany 99 00 01 02 03 04 98 Italy 99 00 01 02 03 04 98 Liechtenstein 99 00 01 02 03 04 98 UK 99 00 01 02 03 04 98 US 99 00 01 02 03 04 Austria 03 04 Benelux 03 04

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2 For example: Banque CCF (HSBC) or Banque de Neuflize (ABN Amro). The International Private Banking Study 2005

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The International Private Banking Study 2005 Profitability

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Return on equity

Return on equity 3_{values have, in general, fallen sharply following the year} 2000 but have recovered over the last two years. However, as Figure 2 shows, the top levels in 2000 have not yet been reached again. Average return on equi-ty is the highest in Benelux (29.3%), followed by the US (23.6%), Switzerland (19.7%), the UK (19.6%) and France (19.5%). The lowest figures result for Italy (12.7%) and Liechtenstein (10.1%). The lowest point after the speculative mar-ket bubble burst in the year 2000 seems to have occurred almost everywhere in 2002. Interestingly, ROE figures seem to converge at around 20% for the top tier of the sample.

Figure 2: Return on equity (before taxes)

Level of capitalization

Return on equity figures cannot be assessed without analyzing the various le-vels of capitalization. Very high ROE figures could be based mainly on low capital levels. Clarity can be gained by looking at the BIS tier one capital ratio (see Glossary for definitions) which measures the capital level in relation to the risk-weighted assets. With this approach, Swiss banks and banks from Liech-tenstein show significantly higher capital levels compared to their peers. It must be pointed out, however, that the large differences between Swiss banks and their peers are influenced by the character of the sample of foreign banks.

3 Return on equity is not the best measure to capture profitability in private banking, as the business does not depend heavily on equity capital. Nevertheless, we use this measure here since it is commonly regarded as a key indicator of banking profitability.

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The International Private Banking Study 2005 Profitability

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Most banks included in the foreign samples are not pure private banking pla-yers in the private banking field. Therefore, their tier one ratio, which can only be obtained at the consolidated level, is probably influenced by their more diversified business fields. Thus, conclusions based on this data series should be drawn cautiously.

Figure 3: BIS tier one capital ratio

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Operational Efficiency

Cost/income ratio

A standard measure for assessing operational efficiency is the cost/income ratio (cf. Figure 4). The last study reported a disconcerting development from a Swiss perspective. In the mid nineties, Swiss banks were top class with respect to cost/income ratios, in the meantime the ratio had increased dramatical-ly. The last two years have turned in favor of Swiss banks again, since cost/ income ratios are exactly on average levels compared to the other countries. German banks still show very high values, whereas Italian banks consistently show very level in the entire sample. Generally speaking cost/income ratios have stabilized at the same levels as before the stock market bubble and its wild swing effect on commission income in private banking (cf. Figure 5)4_.

Figure 4: Cost/income (before depreciation)

Figure 5 breaks down the cost/income ratio further into the changes in the two dimensions costs and income. The apparent downturn in the stock market after the year 2000 is clearly evident by the negative growth of income over the entire sample after the stock market peak. Interestingly, not all banks reacted with the same speed and intensity in this downturn; cost reductions can be observed in Germany and France in 2002 and 2003, whereas in Switzerland and Italy in 2003 only and the US only in 2002. The UK increased costs, but less than the increase in income.

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4 Liechtenstein deserves a special note. The huge increase of cost/income levels is due to a disproportional decrease of income in the years 2001 and 2002. This was not only caused by the market slowdown but also by the FATF and the OECD when they put the Liechtenstein financial center on a „black list“ because it did not comply with international anti money laundering standards. The International Private Banking Study 2005

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Figure 5: Changes in income and costs (before depreciation)

Per employee data (costs)

Company data put in relation to the number of employees can give further in-sight – in particular as human resources are the most important input factor in private banking. Personnel costs per employee are the highest at Swiss banks (cf. Figure 6). US Banks have seen their costs per employee rise to almost Swiss levels (note the currency adjusted values). Banks from Liechtenstein have also seen their personnel costs rise considerably. The lowest costs are in Italy.

Figure 6: Personnel costs per employee (in CHF)

4XJU[FSMBOE 'SBODF (FSNBOZ *UBMZ -JFDIUFOTUFJO 6, 64 "VTUSJB #FOFMVY 0 20 40 60 80 100 120 140 98 Switzerland 99 00 01 02 03 04 98 France 99 00 01 02 03 04 98 Germany 99 00 01 02 03 04 98 Italy 99 00 01 02 03 04 98 Liechtenstein 99 00 01 02 03 04 98 UK 99 00 01 02 03 04 98 US 99 00 01 02 03 04 Austria 03 04 Benelux 03 04

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The International Private Banking Study 2005 Operational Efficiency

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Personnel costs can be further split into two components: salaries (incl. bo-nuses) and other costs (such as social costs). On average 75% of personnel costs can be attributed to direct salary payments.

Figure 7: Division of personnel costs (in CHF)

Figure 8 further narrows the total personnel costs to the wage costs only. Here three groups emerge: Switzerland pays by far the highest salaries, followed by a group consisting of Liechtenstein, Germany, Benelux and the UK – which have more or less the same salary level – with the lowest values being for Italy, France and Austria. Note that wage levels from Figure 8 cannot be directly compared to the cost data in Figures 6 and 7. This is because the sample of banks reporting wage figures separately is not congruent with the entire sample.

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Figure 8: Wage costs per employee (in CHF)

Figure 9 shows the split of total costs, thereby revealing that personnel costs make up two thirds of total costs. A decline of the fraction of personal costs to total costs could be a sign of a higher dependence on IT resources as opposed to human resources. But this trend cannot be identified.

Figure 9: Division of total costs

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Per employee data (income)

Total revenue per employee is generally the highest among banks from Swit-zerland and Liechtenstein (cf. Figure 10). This is clearly attributable to the high average AUM per employee at banks from the two countries as shown in Fi-gure 12. Strong currency effects are recognizable in the US banks, where the weakness of the US dollar results in lower values in Swiss francs.

Figure 10: Total revenue per employee (in CHF)

Gross profit per employee is the highest in Liechtenstein (cf. Figure 11), re-flecting the high amount of AUM per employee (cf. Figure 12). Moreover, it is clearly observable that levels in 1998 to 2000 were dramatically higher in Liechtenstein compared to their peers.

Figure 11: Gross profit per employee (in CHF)

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AUM per employee (not per client adviser) is at around 50m CHF for the top countries and around 25m CHF for the countries with the lowest values (cf. Fi-gure 12). Generally speaking, we observe an increase during the last two years. The steady growth (without the peak in 2000) of the US figures can be attri-buted to the acquisition activities of Legg Mason5_{, Northern Trust and Mellon} Financial and a significant reduction in staff in other cases. Italy was excluded because of inconsistent data. Germany’s figures are influenced by the strong growth of MM Warburg and Sal. Oppenheim in 2003 and 2004.

Figure 12: Average AUM per employee (in CHF)

Stakeholder income

Stakeholder income is defined as personnel costs plus taxes plus net profit.6 It can be interpreted as a key figure measuring the absolute value created for stakeholders who have financial claims on the bank. Furthermore, it can also give valuable insight into how value is distributed among these stakeholders.

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5 On June 24th, 2005, Legg Mason Inc. announced an agreement to sell its brokerage business, including the private client business, to Citigroup.

6 We use net profit instead of dividend payments (which would be the appropriate value measure for shareholders), as private banks have different ownership structures which would distort a comparison of dividend payments. The International Private Banking Study 2005

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Figure 13: Stakeholder income per employee (in CHF)

Banks from Switzerland, Liechtenstein and the US are the largest value gene-rators when measured by stakeholder income. The latter are closely followed by Benelux. Banks from Liechtenstein even had the highest values before the stock market bubble reached its peak in 2000. Lowest values result for Italy and Austria; France, Germany and the UK are in the middle. If stakeholder income is split, as shown in Figure 14, some differences emerge: for example, taxation takes the least part of value creation in Liechtenstein. Here the main focus is largely on creating profits, whereas Austrian banks distribute more to employees. These figures clearly depend heavily on taxation and corporate governance differences between the countries.

Figure 14: Division of stakeholder income 0 20 40 60 80 100 120 140 98 Switzerland 99 00 01 02 03 04 98 France 99 00 01 02 03 04 98 Germany 99 00 01 02 03 04 98 Italy 99 00 01 02 03 04 98 Liechtenstein 99 00 01 02 03 04 98 UK 99 00 01 02 03 04 98 US 99 00 01 02 03 04 Austria 03 04 Benelux 03 04

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Client Investment Performance

Data and methodology

The approach of this study focuses on the investment skills of banks and accor-dingly on the performance of clients’ assets. Since data is not publicly available on the individual portfolio level, a technique to proxy for client investment performance has been used here: First, we take the aggregated performance of all the funds offered to the public under the bank’s name, whereby a dif-ferentiation is made between several fund classes (cf. Figure 15). Second, the figures are aggregated over all banks for a specific country. Only this data, the performance measures on country-level, is then reported here. Although the technique used does not directly relate to actual managed portfolio returns, we assume this to be the closest possible approximation to average client perfor-mance. Furthermore, this technique allows for the simultaneous considerati-on of risk and returns. We have therefore opted for this methodology instead of the alternative one suggested in subsection “Robustness” below.

Figure 15: Performance measurement methodology

Mutual funds performance of a broad set of funds is compared for every bank in the sample (1900 funds in total). Reuters is the source for mutual funds performance data. For an extensive illustration of all the variables computed, please consult the Appendix (cf. Figure A-1). In the analysis we differentiate between four classes of funds and measure the performance for each class individually:

Bank I

Bank II

Bank III

Equity Fund A Volume A Return A

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Equity Fund B Volume B Return B

Bond Fund C Volume C Return C Equity Fund D Volume D Return D Bond Fund E Volume E Return E Bond Fund F Volume F Return F Bond Fund G Volume G Return G Equity Fund H Volume H Return H

Volume A

Average asset allocation Return Average weighted return

Eq ui ty B on ds Volume B Volume D Volume H Volume C Volume E Volume G Volume F x Return C Average weighted return Bond Average weighted return Equity Average weighted return Overall x Return E x Return G x Return F x Return A x Return B x Return H x Return D

The International Private Banking Study 2005 Client Investment Performance

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- Overall: returns on all funds (equity, bonds, mixed, strategy) of each bank are value-weighted by net asset value. Overall yearly return per bank reflects the average client performance assuming an investor only invests in the bank’s own funds. Under this assumption, the return also reflects the average asset allocation of the bank’s clients (cf. subsection “Robustness” for discussion). - Equity: only returns on equity funds are considered. This category allows consistent measuring of the bank’s skill in investment by using relative per-formance measures. The outperper-formance relative to a benchmark allows a comparison of returns across markets and identification of superior invest-ment skills among all banks (even if their funds invest in very specific mar-ket sub segments).

- Bonds: only returns on bond funds are considered. Bond funds are often used to produce income or to help stabilize a portfolio. The primary goal does not seem to be outperformance and so bonds are not central to this analysis.

- Mixed: only returns on mixed funds are considered. Mixed funds are defined as mutual funds invested in both stocks and bonds.

- Strategy: only returns on strategy funds are considered. Strategy funds in-vest internationally and in various asset classes.7

Figure 16 summarizes the performance matrix calculated on the basis of the above methodology for the nine countries in the sample. We distinguish bet-ween absolute and relative returns. Annual returns for each fund are calcu-lated for a one (2004) and five-year (2000-2004) period. Relative returns are calculated against the funds reference index. Absolute returns are computed in CHF and in the fund currency to account for exchange rate effects. Aggre-gated return figures for each bank are computed as a weighted average (weight = fund’s net asset value). Fund costs are taken into account (gross vs. net re-turns) but they are only referred to if they change results significantly in terms of country rankings. Costs are defined as “management fees” since any other cost definition does not allow for international comparison. For a comparison

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7 We will omit detailed comments on strategy funds since the sample size is too small. The International Private Banking Study 2005

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on a risk-adjusted base, the Sharpe Ratio and Jensen Alpha for a one and three-year period is calculated for all funds. The Appendix contains all the detailed fund data, in CHF and costs included (cf. Figure A-3).

Figure 16: Performance matrix

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Robustness

A number of consistency tests were carried out in order to uncover potential bias and distortion of the sample data (e.g. through outliers). The outcome of these tests confirmed the scale of the findings. An alternative methodology for measuring performance would be to take the year-to-year difference in total AUM, account for net new money flows and compute the annual rate of return on clients’ assets (cf. Figure 17).8

Figure 17: Performance measure II

Empirical application of this technique is limited since data on the differentia-tion between net new money and growth through market performance is only broadly available for Swiss banks. Even if we cannot use this technique for the other countries in the sample, the Swiss peculiarity can be used to compare the two techniques and to derive some conclusions on the robustness of the technique used in this study. Since the two methodologies aim at measuring the same artifacts, results should be very similar. Indeed, for the Swiss sam-ple in 2004, we calculate an average difference (size-weighted) between the two performance measures of 90 bsp, with a standard deviation of 24 bsp. The Pearson correlation coefficient between the two performance measures in 2004 is high (0,783) and significant on the 0.05 level (p=0,0372). It can be concluded that the two methodologies have similar results. However, the one used here allows for a more complex analysis (especially risk adjustment) and therefore seems more appropriate. Moreover, it allows a comparison of perfor-mance measures internationally which appears to be the most important as-pect. The average asset allocation resulting from the aggregation of the funds data can also be tested in terms of its robustness.9_{The average recommended} asset allocation to bonds by Swiss banks in 2004 is 38.5% and the allocation re-sulting from the aggregation of the funds data in this study for Switzerland is

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8 This concept is also used in Vontobel (2005), Swiss Asset Managers.

9 We therefore compare the average asset allocation resulting with our approach for Switzerland, with the average asset allocation recommended by Swiss banks. The latter is derived from the published portfolio allocation recommendations of each bank, such as those published by the banks in their periodical publications to their clients or as regularly collected and published by the Neue Zürcher Zeitung.

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37.7%. The average recommended asset allocation to stocks by Swiss banks in 2004 is 42.4% and the allocation resulting from the aggregation of the funds data for Switzerland is 45.3%. These small differences show that the methodo-logy of this study captures the average asset allocation.10_{The conclusion of the} robustness assessment is that the quality of the data is satisfactory.

Assumptions and comments

By analyzing the investment performance of a client assets, one can assess the ability of a bank to invest the funds in the client’s best interests and to the bank’s best investment knowledge. Even if one can argue that these aspects may not be the essence of private banking, it certainly has some importance as regards a bank’s competitiveness. Our approach rests on three important assumptions: (1) clients invest only in investment funds, (2) clients invest only in investment funds of banks from one country and (3) clients invest their as-sets in all investment funds, proportionally to the size of the funds. Since any interpretation of the results deriving from the study design sketched above can be distorted, some comments follow on these assumptions:

(1) Clients invest only in investment funds: usually a considerable part of as-sets is either invested directly in stocks or bonds or in an alternative asset class not covered by the sample of this study. In some cases the bank ma-nages the client’s assets on the basis of a discretionary mandate. Neverthe-less, our approach serves the purpose of the study since performance of the investment funds is certainly attributable to the bank that labels and sells the fund. Furthermore, investment funds still make up a relatively large part of invested assets in private banking, also in discretionary accounts.

(2) Clients invest only in investment funds of banks from one country: certain-ly not all investors buy investment funds from just one country or one bank exclusively (investments in own funds accounts usally for a maximum of 30% within a bank). However, since we want to compare banks country by country, we need to make this assumption.

10 The robustness test can only be performed consistently for Swiss private banks since only they publish portfolio asset allocation recommendations regularly. Other sources focus more on investment banks and asset managers which are not included in our sample.

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(3) Clients invest their assets in all investment funds proportionally to the size of the funds. This assumption leads to the best estimate of the real asset allocation since we only take the data on an aggregated level. The perfor-mance aggregation on country-level eliminates company-specific factors and therefore seems appropriate to assess the overall investment skills of a group of banks. Our methodology of aggregating all fund products results in an asset allocation which is almost equal to the average asset allocation recommendation of the banks involved, therefore proving the consistency of our methodology. We highlight the importance of the fact that this me-thodology is based on aggregation of data on the country level.

Some other aspects need to be addressed:

- We regard the performance measures as an indicator for the bank’s invest-ment ability. The assumption is that banks achieving a sustainable out-performance with their own funds most likely signal superior investment skills. Note that the focus is on relative performance; it is therefore possible to compare banks across investment markets.

- It does not matter if funds are in-house or third party funds carrying the label of the respective bank (white labeling). What counts is the client’s per-spective. And the client will attribute any performance, good or bad, to the label of the respective investment vehicle.

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Performance figures

We use a candlestick graph to compare the performance country by country. The narrow stick represents the range of returns during the period (the upper limit of the stick shows the maximum value and the lower limit the minimum value within a country group) while the broad mid-section represents the first and third quartile of the distribution of returns. The mean value is market within the mid-section. The gray horizontal line depicts the average for the whole sample (cf. Figure 18). For example, the interpretation for Swiss banks in Figure 19 is as follows: in 2004 the bank with the best performance over all mutual funds reached an average annual return of 12.5 % (upper end of the stick), whereas the worst bank only achieved an average annual return of 1.9% (lower end of the stick). The average for all Swiss banks amounted to 5.8%. The entire sample average was 5.37% (horizontal line).

Figure 18: Description of figures

1-year absolute return

Figures 19 to 24 show a comparison of the average one year annual return for banks in the different country groups within the sample. For example, a first tentative conclusion from Figure 19 would be that Swiss banks have achieved an average absolute return for their clients compared to their peers. US banks have performed the worst but this effect is likely to have been distorted by the currency effect (falling US dollar compared to the Swiss franc). Figure 20 com-pares the same returns but takes fund currencies instead of Swiss francs. This figure highlights the considerable distortion caused by the falling US dollar in 2004. If the currency effect is taken into account, UK banks performed best, whereas Italian banks performed worst. Banks from Benelux also show an above average absolute performance over the last year.

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Figure 19: Overall 1-year absolute return (in %, in CHF)

Figure 20: Overall 1-year absolute return (in %, in funds currency)

Equity fund 1-year abs. return

Because of the considerable currency effect of US dollars, we chose to focus on performance in funds currency in this section (see Appendix for the figure

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0 2 4 6 8 10 12 14 16 -6 -4 -2 0,6 US 8,0 UK 4,1 Liechtenstein 2,9 Italy 5,3 Germany 6,3 France 9,6 Benelux 5,6 Austria 5,8 Switzerland

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0 2 4 6 8 10 12 14 16 18 -2 US UK Liechtenstein Italy Germany France Benelux Austria 7,7 6,7 11,0 7,5 7,7 3,9 6,1 11,8 6,8 Switzerland 12 17 22 27 -3 2 7 US UK Liechtenstein Italy Germany France Benelux Austria 10,1 7,9 15,0 10,4 8,8 5,2 7,9 13,7 11,5 Switzerland

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-6 -4 -2 0 2 4 6 -12 -10 -8 US UK Liechtenstein Italy Germany France Benelux Austria -1,1 -2,3 -0,7 -0,4 -1,4 -3,2 -4,8 -2,3 -0,6 Switzerland

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-8 -6 -4 -2 0 2 4 6 8 -12 -10 US UK Liechtenstein Italy Germany France Benelux Austria 0,0 -1,6 0,0 0,8 -0.2 -2,0 -3,5 -1,3 0,0 Switzerland

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-5 0 5 10 -15 -10 US UK Liechtenstein Italy Germany France Benelux Austria -1,8 -6,2 -2,7 -1,8 -4,0 -5,4 -4,0 -1,3 -1,6 Switzerland

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0 2 4 6 8 -6 -4 -2 US UK Liechtenstein Italy Germany France Benelux Austria 0,0 -1,2 -0,8 -0,3 -0,3 -2,2 -1,8 -0,8 0,8 Switzerland

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0 2 4 6 8 -6 -4 -2 US UK Liechtenstein Italy Germany France Benelux Austria 1,2 -0,5 0,0 0,8 0,9 -1,0 -0,6 0,2 1,5 Switzerland

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-4 -2 0 2 4 6 8 -10 -8 -6 US UK Liechtenstein Italy Germany France Benelux Austria -0,5 2,7 -2,6 -2,0 -2,4 -5,5 -2,5 0,1 0,1 Switzerland

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-6 -4 -2 0 2 4 6 8 10 -10 -8 US UK Liechtenstein Italy Germany France Benelux Austria 2,1 0,2 -0,2 -0,6 -3,3 -3,0 1,6 _1,2 1,4 Switzerland

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0 2 4 6 8 10 -6 -4 -2 US 2002 US 2004 UK 2004 UK 2002 Germany 2004 Germany 2002 France 2004 France 2002 Switzerland 2004 -0,2 0,0 -0,2 -0,3 -0,3 -0,3 0,0 _-0,8 2,4 0,8 Switzerland 2002

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-6 -4 -2 0 2 4 6 8 10 -12 -10 -8 US UK Liechtenstein Italy Germany France Benelux Austria 0,9 -0,5 -1,0 -1,8 -4,5 -4,2 0,4 0,2 0,8 Switzerland

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-6 -4 -2 0 2 4 6 8 10 -10 -8 US UK Liechtenstein Italy Germany France Benelux Austria 2,1 0,2 -0,2 -0,6 -3,3 -3,0 1,6 _1,2 _1,4 Switzerland

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in Swiss francs). A more detailed view than in Figure 19 and 20 can be provi-ded by looking at specific asset classes individually. Figure 21 summarizes the annual rate of return for pure stock funds only. Swiss banks do slightly better than the average whereas Benelux, the UK and the US are again very good performers.

Figure 21: Equity 1-year absolute return (in %, in funds currency)

By comparing absolute returns, one risks over or under estimating the part of the performance that is due to wise investment advice, as opposed to the part connected to aspects not directly influenced by the bank. Since it is general-ly known that private investors invest primarigeneral-ly in local shares, factors such as economic cycles, local industry structure, etc. can systematically influence annual return differences between countries. For this reason, relative perfor-mances (compared to a benchmark) are analyzed in the following section.

Overall 1-year relative return

Average overall 1-year relative return was -1.9%. Investment funds therefore underperformed relative to their benchmark. Half of the underperformance is explained by the costs, since average management fees were 1.00%. Still, the average underperformance net of costs was -0.9%. France and the US have the highest outperformance levels, although they are still negative if return figures are calculated as net returns. If return figures are taken before costs (gross

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-6 -4 -2 0 2 4 6 8 10 -10 -8 US UK Liechtenstein Italy Germany France Benelux Austria 2,1 0,2 -0,2 -0,6 -3,3 -3,0 1,6 _1,2 _1,4 Switzerland

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International Private Banking Study 2005

International

The International Private Banking Study 2005 Swiss Banking Institute

Author

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Contents

Client Investment Performance 23

Executive Summary

Profitability

Size effect

Introduction

Objective

Profitability

Assets under management

Return on equity

Operational Efficiency

Cost/income ratio

Per employee data (costs)

Per employee data (income)

Stakeholder income

Client Investment Performance

Data and methodology

Bank II

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ZFBS JO$)' HSPTT 1FSGPSNBODF "CTPMVUF 'VOETDVSS HSPTT

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Assumptions and comments

Performance figures

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Overall 1-year relative return