National Bank Financial Markets 17th Annual Financial Services Conference

Mar 27, 2019

All right. I'd like to welcome our next speaker presenter to the front of the room, Doug Guzman, head of RBC's Wealth Management business. Recently had an Investor Day at RBC. Yeah. So a lot of meat to chew on there, and we'll probably dive into a few of those topics. Okay, great. I don't know if you have any opening remarks or anything you want to set the stage with. You couldn't find chairs that were lower? You're telling me. No, I don't think I had a few one-on-ones this morning. At the top level, the wealth and insurance strategy is, in my view, winning, and is in a sort of a boring way, not going to change in the near term. Some of the things we talked about on Investor Day are having differentiated, sustainable competitive advantage in both our distribution and high net worth, which is the part of the distribution I've got accountability for, as well as the asset manager. While I don't have direct leadership accountability for City National and what goes on in the U.S., being optimistic about its prospect from an organic growth perspective remains in place. Finding the right line to sail on technology investments and sharing that investments and working with our partners in the retail bank is, I think, a really key theme. If I was in your shoes trying to differentiate among banks is, I think a differentiator will be the leadership team's ability to execute across silos and get the right client to the right value proposition at the right price. So, a lot of the same themes for Investor Day for those who were there, and we can take this anywhere you like. Well, you used the word boring. One thing that wasn't boring, not too long ago, was the announcement of the partnership or joint venture between yourselves and iShares. Just curious, how did that deal come about? Sure. What was the genesis? Yeah. Maybe a bit of background on that. Yep. So we call it an alliance. The notion is at its core, it's us bringing to the table distribution and non-passive asset management, at which we're good at both. And them bringing to the table passive asset management and their cost structure, and they're good at both of those. So if you say, "Where were we both before this happened?" We had no interest in manufacturing passive. That's been a position we've had for a number of years, and it's gotten more and more firm because the profitability on actually manufacturing passive has continued to collapse. And those who will capture whatever profit's left at the end of this process will be those who have scale, and we were never going to be of the same scale as the Vanguards or BlackRocks of the world. We were white labeling State Street's product, so we had some of the product for our customers in most of our channels. BlackRock had the most liquid passive ETF in XIU. It's a higher priced ETF relative to some of the other beta options. They had bought Claymore and were kind of not growing at the rate they'd like in terms of markets share, and had not made a significant investment in distribution. We have a significant investment in distribution. Our asset management team markets to all of our peers, including your colleagues in your wealth system. They get to take advantage of our distribution. We get to fill out our product shelf. In simple terms, what we did on our side of the table is we looked at what we thought we could do alone and what we thought we could do together, and there's a meaningful difference. If there's a meaningful difference at that level, there's probably quite a wide range at which you could strike an agreement because you're now splitting up economic rent for something that neither of you were going to do before. That's, I think, how to think about how it makes sense. We've gone through products and channels and decided how we'll split after-cost profit on a product distributed in a channel, depending on what product and what channel. BlackRock will continue to manage all the passive product. We will continue to manage any factor-based and quant product or pseudo active. We're launching a family of ESG related funds that'll have our portfolio management intellectual content in it. If it's a passive ETF sold in a channel where our distribution force didn't really have a role, BlackRock keeps the lion's share of the economic rent on that activity. If it's our new ESG ETF sold in through a Canadian branch to a retail customer, we will keep the vast majority of the profitability. Trying to bring each party's strength and weakness to the table, and split what you think you're going to have as incremental profitability in a rational way going forward. Of course, then what it does for us and all our client facing channels is really complete our shelf and provide options to any client facing professional to deliver something that suits what the client wants. How's the deal structured? Any money changing hands or it's the distribution agreement part? No. Yeah. It's much closer to an alliance for stuff that goes on going forward. Some of the big hurdles on getting to this place, which we thought we might have to cross, were exactly those, which is, okay, are either of us really going to want to cede control of this, or either of us really going to want to make a big payment to make this happen? Are both of us going to feel like we've preserved what we feel like we need to preserve if this doesn't work? By doing it the way we did, we feel like we've done that. We've got a few of our people went over to their side in terms of who played a role that fits better with what they're going to do going forward, but we'll preserve all of our active management capabilities. The deal is structured. Alliances can be difficult, but the deal is structured. We hope to make it long-lasting, very long-lasting. What you know with certainty in these alliances is that relative to whatever our expectations is, one, three, five years out, one party or the other is going to be farther ahead or behind of where they thought. We've structured the exit clauses so that it's a market-based test, that if you feel like you're disadvantaged and you want out, well, you've got to pay me a market price for what we've built together. It's not non-rational to. It's not easy for someone to just push the exit button and get out. The final thing I'd say, though, is our relationship as entities is really very strong. We're big supporters of theirs in their private equity and real estate business. They're a big client, a counterparty of ours in our fixed income business. The two CEOs, Dave and Larry Fink, talk a lot of the same language around corporate purpose and long-termism. I think I'm optimistic that even if all of these structural items don't get you over a relationship hurdle, that the relationships between the two will allow us to have a rational discussion. All the normal structural stuff, like we have an advisory board that's 50/50. Yeah, we're optimistic. It's early to estimate financial success or failure, but certainly our teams are really excited about it. You mentioned, I guess there's time periods where you reevaluate or. No, there's nothing. This is kind of intended to be a forever thing. It's just that- Really? It's not a 10, 15-year contract or- No. Okay. You have to have some discussion around how do you get out if someone wants to get out, right? So there's not a point at which we mature, we reach a maturity date, but you have to have some exit provisions, and we've built them to try to make it not economically rational for someone to feel like they should exit. Aside from your perspective, the desire to do this deal, aside from obviously the shift of more consumption of these types of products, is Vanguard coming into Canada, and that was a- They're kind of here, yeah. Yeah. I think, I don't know whether that's something BlackRock considered or not. Obviously, on the pure passive game, being the most liquid ETF is really a fundamental or it's a fundamental advantage. To the extent that they, I don't know whether this was their belief or not, but it would be logical to the extent that they looked at it and said, "This can only help our pursuit of liquidity in all of the different ETFs." I presume that would've been an attraction for them. Obviously, us having a piece of the action on the most liquid ETF is an attraction for us. What we've really done is traded a little bit of our profitability on non-passive for a little bit of their profitability on passive and their operating costs, and they traded for our distribution, right? Both have a firmly held view that all of that's just on status quo, but there won't be status quo. That we'll be able to do more volume because of the alliance and the pairing of the brand and the distribution and the cost to the consumer and the product. The way I see it is sort of an evolution of an ongoing trend at Royal, where the proprietary products you've been leading the charge, so to speak, on reducing cost to your consumers. This is more aligned, I guess, with that strategy and how- Yeah, I think you look at it that way. It depends which channel you are looking at. The retail fund channel, which would be between CAD 100 billion and CAD 200 billion of AUA, is largely balanced mutual funds, largely internally manufactured. Wraps, that thing. Yep. DS, which is CAD 250 billion, or if you throw Investment Counsel, which is a similar flavor of high net worth, would be about CAD 350 billion of AUA. DS is about 90% of that, is a completely open architecture. Very low penetration of funds, very low penetration of internally manufactured products. Investment Counsel would be high penetration, but maybe two-thirds, three-quarters internal funds. So it really varies by channel. It is not new for us to be open architecture because our DS platform has been since the day the bank acquired it in the 1980s. Okay. Now moving on to other issues. The broker, the online broker business. Last year, the big surge in crypto and cannabis stock trading drove big performance for all banks, including yours. Are we facing a drop-off this year with maybe less activity? It becomes as a problem as much as an opportunity in that a lot of the players on the street, including us, the volumes went up by quantum multiples, and we had execution problems through that cycle. The whole industry did. I wouldn't get overly concerned about that we still expect the business to do more this year than it did last year. There's a proportion of the profitability in that business is the actual trade fees, a proportion of it is spread. I wouldn't make that a material element in your models in terms of drop-offs because of cannabis. I had to get a cannabis question in there. Yes. Spice things up a bit. How about M&A? There has been PH&N in the past. BlueBay was the most recent one, but that's already been a few years. Is there any potential we could see Royal? Well, there seems to be a lot going on in the industry. Yeah. I was joking with one of the folks in the room if they are the last independent asset manager standing, and did I miss any announcements this morning? Yeah, I think so you should assume that we have seen most of those things go by on the way through, and people are making investments to fill strategic holes they have at prices that are not bargain basement prices. We look at our capability suite, and there is none of those acquisitions that have happened over the last couple of years where we regret not filling a hole, either because we feel like we have the capability or because we feel like the price paid was more than we were willing to pay. I think, as a general matter, I would not expect to see this bank buying a whole lot of much, but in the near term, we have a strong bias for organic growth. You have heard that on our quarterly calls. I think the place is more and you have seen some of this in our Investor Day and in other places. Are we more open in the past to think about relationships with partners, in some of our alliances and our relationships that we profiled on the retail part of the bank? Yes, we are. Are we more open to think about how we build capability around technology or around artificial intelligence or around specific subject matters and buying small places so you can acquire the teams? Maybe. I think the world is changing, and you have got to think broadly about how you think about corporate growth. There is not much that we look out there and say, "Here is a big hole that we just have to fill by acquisition." At the end of the day, a lot of these businesses, not all, but a lot of these businesses are people businesses, and people businesses are sometimes hard to keep together on acquisitions. So never say never, but it is really not a focus. Okay. Now rates, the rate environment, how is that affecting your business? Deposit margins would have been a tailwind for wealth last year, presumably. Yeah. Let's start with that. It's hard to disentangle from the, you guys know better than I do, from in the bank P&Ls, right? Obviously we have cash balances in direct investing, which just shows up in the retail banking P&L. We have cash balances in Dominion Securities, which shows up in my P&L. Depending on the product those cash balances are invested in, that profitability may actually show up in the retail P&L. Right Depending on the product. It's kind of hard to disaggregate. I think as a general matter, if we are still in a raising rate environment, which seems to be more debatable than it was six months ago, yeah, there's an opportunity on cash balances across the enterprise, but I think it's going to be hard for this group to disaggregate it across silos because of the way we book it. Was it a big revenue driver for you last year and maybe? It was helpful, but it was not a Okay real big needle mover. What about the In wealth Right. The, I guess, consumer behavior element, whereby as rates were going up, did you see any shift to your clients moving more money out of wealth products into the deposit products and- Yes maybe that accelerated as market volatility. Yeah. People sometimes ask about our clients de-levering and therefore not investing as much, and I don't think we've seen as much of that as what we certainly have seen as an industry and in our own bank, a preference for cash products, rate products over longer term assets. It's the exact same thing we saw in 2015 when we had the market sell-off. Hopefully, these clients are getting the advice they should, that it's not always the right thing to sell when markets are down and the right thing to buy when markets are up. But unfortunately, that's sometimes retail behavior, and we're seeing that. Having said that, what we watch closely is what share of that cash are we capturing as a bank. So our deposit products, GICs, high interest savings accounts, and what we see on those products is we're punching above our weight. Assuming what happens in 2015 happens again, which I think is a good bet, those balances will eventually move over into longer term investments and be in a place, frankly, where they should be, which is a more logical asset allocation across markets because it's difficult to time markets. But for sure, the disruption has caused industry fund sales. Well, industry funds were in redemptions most quarters Right of last year. We were in net sales, and so our share has gone up over the course of that experience, and we can track that pretty closely into deposit products. We don't think it's de-levering. We don't think it's massively going in this country into passive ETFs. We think it's gone into cash deposit products and will migrate over as we get through the cycle. Is there a broader opportunity that may be untapped for deposit gathering in the wealth business? I admit I don't spend as much time thinking about deposits in your business as I do in the P&C bank. But wealth is maybe an underappreciated. Yeah, I hope there's nothing big. I think what I've said a few times this morning in some of the smaller meetings is, what I think is a differentiator across all these banks is the leadership team's ability to execute across silos, right? We've showed at Investor Day, and if you look at penetration levels across groups, we have quite a high market share of physicians in our insurance group, and I think there's an opportunity for us to do more banking product with them. Obviously a number of banks are focused on that on the back of the MD Financial Management transaction. We talked about on our website and Investor Day, the share of high net worth clients at the bank that own a wealth management product and vice versa. I still think there's a lot of opportunity there. We've rolled out in the last, we've talked about it a couple of times before, a high net worth card and deposit product service for our DS clients. If you're a DS client over a certain asset threshold, we will discount or give you for free a premium for no charge, a premium card service with a dedicated banking team and a dedicated deposit account. That's something this business industry should have gotten to a long time ago. Our clients have received it incredibly well. Our IAs in Dominion Securities have been enthusiastic about it as another conversation to have with a client about something else you can bring to them. I still think there's lots of opportunities to do more across groups. We have an extremely successful commercial banking business in Neil McLaughlin's team in the retail bank. That group of customers is going to face the much-talked-about baby boom retirees and the transfer of wealth from private company wealth into more liquid forms of wealth over generations. That's something that we're focused on. We've just got to keep getting focused on how do you bring at the right time, the right insurance expertise, the right wealth conversation to that private business owner who today may believe they're never going to die, because that's what successful entrepreneurs sometimes believe. But we're their trusted client advisor on commercial, and how do you work that across? I think that general theme of which leadership teams can actually execute on that, I think is going to be a differentiator on capturing share. You're touching upon some cross-sell- Yeah efforts there. I just want to make sure I get these numbers right. This is from your Investor Day, one of the slides. The percentage of high-net-worth banking clients that have a relationship with Canadian wealth, 35%. And the percentage of banking clients with an RBC Mutual fund, 16%. Are these too low? Yeah, I think there's opportunity to do more. The regulatory environment is quite rightly focused on are you doing the right thing for the customer? That's my next question, so hold on. Okay on that one. Okay. You've got to balance a focus on doing the right thing for the customer. You kind of alluded to it, but if you look at the chain, and we've shown the slide before, but it used to be pretty simple, which is, you kind of had three models. If you were self-directed, you were an online broker. If you were below a certain asset threshold, you were in a RBC Mutual fund in a branch. And if you're above a threshold, you had an IA or a broker, and that was that. And that's gotten a lot more blurred, right? There are going to be very high-net-worth clients who are going to prefer to interact with us digitally. There are going to be direct investing clients, in fact, there are today, who get the advice from their IA and then go replicate it over here for a lower fee in the online brokerage. We're going to share technology across the piece. Our retail customers now have some very good options to interact with us digitally and by video. That's a capability that would be useful to our IAs, even for our most highest customers. So getting the right customer to the right spot on the continuum for the right price and service is a big, big deal, right? And that includes cross-sell. And that's an opportunity to do more with your existing customers who obviously already trust you. But frankly, it's part of resilience to the environment, where if the environment and the internet and digital generally is making your products more commoditizable, then having a relationship that leads with advice and perspective and understanding of the client is really critical. And that is going to lead naturally to doing more with your customer across these silos. And I think organizationally, therefore, the leadership, including me, of these organizations, have to really focus on building a culture that's client focused and that does the right thing for the client. Because at the end of the day, there's more we can do for clients across the capabilities we've got. How do you, in the regulatory angle here, how do you walk the line- Yeah accomplishing your organizational goal of selling more products and then avoiding running into the regulatory issues of cross-selling stuff you shouldn't have? Yeah. We all got a chance to live through a quite detailed set of question and answer with our regulators over the last few years. The catalyst for which was certainly not our bank, and the catalyst for which was not the wealth business. It was our partners in Canadian banking spent more time talking to regulators about that. But there's some core principles, right? Which is sales targets, cross-sell targets, all those things can't live and breathe exclusively as the incentive metric for client-facing people. You've got to have a balance. We talk about a balanced scorecard where we consider the client's needs, wants, desires, as well as the bank's targets. You have to have a willingness and a culture that's willing to reset targets. If the market's not going to let you get to a certain level, you can't have your employees on the front line feel like the only way they can get paid their bonus is by doing things that get them to a level they shouldn't otherwise, right? It's really got to be sewn into the fabric of the place. We all got sort of graded on that last year, and we were quite happy with how the regulators came in and asked us about it. At its core, it's having a place that is willing to say no to things. I grew up on the investment banking side, right? The place where you earn the most credibility with a corporate CEO is when you tell them not to do something. That's when they want to do it and you're going to get paid a fee if they do. That analog, which is the way I grew up, not the way most people grow up, applies to the whole business, which is you've got to just have a level of maturity and confidence in the business that has that as a fundamental, and then all of your systems and communication and measurement tools have to match up. Do you think we benefit from, we Canadians and I guess Canadian banks, from mishaps that take place in other parts of the world where We certainly react to them. Yeah. I do not know if we There is nothing that that discussion of our industry, nothing came close to what the catalyst in the States, the bank that had the problem in the States. Or Australia a while ago. But yeah. Or Australia. Yeah, exactly. I think you do have to look at it, right? When the financial crisis happened, we took a look at some of the independent, it is a long time ago now, but some of the independent reports on what happened at the banks that had real problems. We sat around a table and said, "Okay, could this happen here? Let us take a half a day with the senior leadership team and go through everything that went wrong and could it happen, and how do you do your best to mitigate it?" I think you have to pay attention, and you have to take it seriously. You could ask the same thing around AML or know your clients or what is going on with other banks or cyber problems at other banks, right? Every time that happens, you have to, as an organization, try to understand what happened and why and satisfy yourself you are doing everything you can to not have it happen here. Luckily, we are of a size and our relationships are global enough that in terms of dialogue with governments, dialogue with taxation authorities, dialogue with like-sized or bigger banks, we have got no impediment to having those conversations. Well, that is all the time we have. Okay. Thanks for coming in this show.