One of the most frequently ignored sectors in the wealth management industry may be its first cousin, the independent trust industry.  While many still associate trust administration with banks, which still control more than 75% of the space, the growing prominence of independent trust companies is capturing the attention of many participants in the investment management community.  In this post, we examine current trends impacting independent trust companies.

Fees

There has been a broad-based decline in pricing power across the investment management industry

Since the credit crisis, there has been a broad-based decline in pricing power across the investment management industry.  Competition from low-fee passively managed products and increasing fee consciousness among institutional clients has driven down effective realized fees for asset managers.  Wealth management fees have been more resilient, but the threat of low-fee alternatives remains.

So how have trust companies fared in this environment?  Despite pricing pressure in the broader industry, trust companies have fared remarkably well.  Fee levels have been supported by increasing demand for trust administration services driven by generational wealth transfer trends and the increasing complexity of trust arrangements that require specialized knowledge with respect to legal, tax, regulatory, and investment matters.  The story has been similar for many of our independent trust company clients.  Realized fees have remained steady or increased over the last five years, while assets under administration have grown through market growth and net inflows.

Market Correlation

After a turbulent start to 2023, the stock market has since rallied, positively impacting 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, the S&P 500 is up around 19% year-to-date.

Normally, trusts are shielded from some of the market volatility because of relatively higher exposure to fixed income.  However, the change in the term structure of interest rates over the past 18 months means bonds are well off their prices from a few years ago, resulting in a lower fee base for trust companies with fixed income exposure.

Unlike many asset and wealth management firms, trust companies often have revenue sources that aren’t directly tied to assets under management or administration (e.g., tax planning or estate administration fees).  Such fee structures can serve as a buffer during market downturns, providing trust companies with greater resilience in adverse market environments relative to their asset and wealth management peers.

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.  Credit Suisse’s 2022 Global Wealth Report estimates that there are nearly 25 million people in the U.S. with a net worth over $1 million.  This is more than double the number a decade ago and represents a 21% 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 high-net-worth individuals is 57, and over two-thirds are over the age of 60

The average age of high-net-worth individuals (those with a net worth over $1 million) is 57, and over two-thirds are over the age of 60.  Consequently, there is a growing pool of clients in need of the kinds of services the trust industry provides, which points to a sustained period of organic growth.  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 financial plan.

Additionally, the impending wealth transfer as baby boomers age should spur growth in trust assets.  According to Wealth Advisor’s 2023 report, the heirs of baby boomers are expected to inherit roughly $3 billion a day or over $1 trillion annually over the next 30-35 years.

Regulatory Trends

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

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

Over the last several decades, many states like 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).  In particular, the directed trust model is a major change in how trust companies manage assets, and it has been gaining popularity among trust companies and their clients.  Under the directed trust model, the trust’s creator 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).  Administrative functions and decisions on how the trust’s assets are made available to beneficiaries are typically delegated to the trust company.

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 what we see at wealth management firms, where ownership succession is often a topic of conversation.  Ownership issues can include concentration at the founder level or even extensive ownership held by outsiders who helped capitalize on the firm’s startup.  As with most investment management businesses, independent trust companies tend to be owner-operator businesses, so conversations about equity ownership are frequently centered around finding effective ways to provide equity incentives to the individuals most impactful to the firm’s future.

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

The independent trust industry has showcased resilience and strong performance in recent years, even amidst market turbulence and evolving industry dynamics.  Demographic shifts and increasing visibility as an attractive alternative to bank trust departments present an encouraging outlook for independent trust companies’ growth in the foreseeable future.  As these trends continue to shape the financial landscape, prudent planning, innovation, and adaptability will be crucial for trust companies aiming to thrive in the competitive investment management arena.