The most frequently ignored topic in the wealth management industry may be its first cousin, the independent trust industry. While many still associate trust work with banks, and banks still represent more than three-quarters of the trust industry, the growing prominence of independent trust companies is causing many participants in the investment management space to take another look. In some regards, independent trustcos look a lot like wealth managers, only more evolved.

Fees

Since the credit crisis, there has been a broad-based decline in pricing power across the investment management industry. Assets have poured into low-fee passive products, driving down effective realized fees for asset managers. Wealth managers have been more resilient, but the threat of robo-advisors remains. Virtually all discount brokerages have been forced to cut trading fees to zero. The message is clear: assets across the financial services industry are gravitating towards lower-fee products.

So how have trust companies fared in this environment? Despite the pricing pressure in the broader industry, trust companies have fared remarkably well, with fees at least flat if not headed higher. For many of our independent trust company clients, the story has been similar. Realized fees have remained steady or even increased over the last five years, while assets under administration have grown through market growth and net inflows.

Market Correlation

The 2022 bear market is having a significant negative impact on the top line for trust companies, as it will for all investment managers that charge a percentage of assets under management. As of the date of this post, equity prices are down around 20% year-to-date.

The effect on trust company profitability will depend on the length and severity of the economic slowdown caused by the market dynamics and the potential of a looming recession.

Normally, trust would be shielded from some of the market volatility because of a higher exposure to fixed income. Unfortunately, the change in the term structure of interest rates this year means bonds are also well off their prices from a few months ago. Consequently, trust company revenue will take a big hit. The effect on trust company profitability will depend on the length and severity of the economic slowdown caused by the market dynamics and the potential of a looming recession. The range of likely scenarios is beyond the scope of this post, but it suffices to say that there is still significant uncertainty regarding the impact on people, markets, and economic activity.

Unlike many asset and wealth management firms, trust companies often have revenue sources that aren’t based on AUM (e.g., tax planning, estate administration fees) which should provide some protection during a market downturn. This, combined with a resilient fee structure, should help trust companies weather the economic climate.

Favorable Demographics

As America becomes older and wealthier, the number of potential clients for the trust industry is poised to grow markedly.

Trust companies primarily service high net worth and ultra-high net worth clients, and both demographics are growing in number. Credit Suisse’s Global Wealth Report estimates that fully 1% of Americans are millionaires, numbering almost 22 million people in 2021. This is more than double the number a decade ago, and represents more than a 20% increase over the prior two years. At the same time, the median age in the U.S. has increased by 1.5 years in the past decade, and the oldest members of the baby boomer generation are now in their mid-70s.

The average age of millionaires in the U.S. is 62, and over a third of U.S. millionaires are over the age of 65. Consequently, there is a growing pool of clients in need of the kinds of services that the trust industry provides, and that points to a sustained period of organic growth for the industry. While this will also provide a tailwind for wealth management firms – who often start working for clients around the time they retire – it is a more certain opportunity for trust providers, especially to the extent that wealth transfer services are part of a client’s equation.

Regulatory Trends

As trust law has developed, a handful of states have emerged as being particularly favorable for establishing trusts. While the trust law environment varies from state to state, leading states typically have favorable laws with respect to asset protection, taxes, trust decanting, and general flexibility in establishing and managing trusts. Opinions vary, but the following states (listed alphabetically) are often identified as states with a favorable mix of these features.

• Alaska
• Delaware
• Florida
• Nevada
• South Dakota
• Tennessee
• Texas
• Washington
• Wyoming

Over the last several decades, many states such as Delaware, Nevada, and South Dakota have modernized their trust laws to allow for perpetual trusts, directed trustee models, and self-settled spendthrift trusts (or asset protection trusts). The directed trust model, in particular, is a major change in the way trust companies manage assets, and it has been gaining popularity among trust companies and their clients. Under the directed trust model, the creator of the trust can delegate different functions to different parties. Most frequently, this involves directing investment management to an investment advisor other than the trust company (this could be a legacy advisor or any party the client chooses). The administrative decisions and choices related to how the trust’s assets are used to enrich the beneficiary are typically charged to the trust company.

The directed trust model, in particular, is a major change in the way trust companies manage assets, and it has been gaining popularity among trust companies and their clients.

The directed trustee model leads to a mutually beneficial relationship between the trust company, the investment advisor, and the client. The trust company avoids competition with investment advisors, who are often their best referral sources. The investment advisor’s relationship with their client is often written into the trust document. And most importantly, this model should result in better outcomes for the client because its team of advisors is ultimately doing what each does best—its trust company acts as a fiduciary, and its investment advisor is responsible for investment decisions.

Succession

In our experience, the ownership profile at independent trust companies is often similar to that which we see at wealth management firms, and ownership succession is often a topic of conversation. Ownership issues include concentration at the founder level or even extensively held by outsiders who helped capitalize the firm’s startup. As with most investment management businesses, independent trust companies tend to be owner-operator businesses, so finding ways to include younger partners and key staff in equity participation is sometimes a challenge.

As we’ve written about in articles, blog posts, and whitepapers on buy-sell agreements, the dynamic of a multi-generational, arms-length ownership base can be an opportunity for ensuring the long-term continuity of the firm, but it also risks becoming a costly distraction. As the trust industry ages, we see transition planning as potentially being either a competitive advantage (if done well) or a competitive disadvantage (if ignored).

Outlook

Many independent trust companies performed remarkably well over the past decade and much better than expected during the pandemic. The current bear market is an immediate headwind, but demographic trends in the U.S. and the increased visibility of independent firms as an alternative to bank trust departments should form a solid basis of growth for the foreseeable future.