Recent survey and anecdotal evidence is bolstering support among investors to choose in-house products from their firms rather than externally sourced products. Following recent scandals and losses, this makes sense but does not mean open architecture is in full retreat.

At the very time that the US government is planning to take the step of breaking banks into their component parts to ward off future financial crises, it appears that a more fractured banking market is becoming less popular with clients, as recent survey evidence shows. There appears, at any rate at first glance, plenty of reason for why this shift in opinion makes sense.

In my recent conversations with bankers, it appears that firms such as Credit Suisse, Barclays Wealth and BNP Paribas say their wealth management customers have shown greater demand for in-house products, with the security and familiarity of such products proving key attractors. And a survey by Scorpio Partnership, the consultants, said that clients increasingly preferred the in-house option.

The trend is not all one way, however – several banks I have spoken to are adamant that open architecture works for their clients, spreads risks and harnesses best-of-breed managers from all quarters – but the movement towards in-house products has been striking.

This surely means that big, integrated banks which combine asset management, investment banking and wealth management under one “roof” have distinct benefits and any attempt by policymakers to split such firms or shackle their functions must be addressed carefully. It is ironic, therefore, that US president Barack Obama is proposing to take the US financial world back to the period from 1932 to 1999 when investment banking was firewalled off from other parts of a bank.

It is not hard to see why in-house is also the new “in thing”. Clients at private banks who had been put into products provided by external firms, such as AIG and Lehman Brothers, were badly rattled when these businesses hit trouble – or in the case of Lehman Brothers, terminally so. Lehman Brothers, for example, was a major player in the structured products market; its bankruptcy of September 2008 hit that sector and worried investors about counterparty risk, although structured products have since revived. To take a different example, a number of wealth managers had exposure to the Ponzi fraudster Bernard Madoff via some of their investment arrangements, such as Union Bancaire Privee, for example. (That bank has since beefed up its risk management with a number of important hires).

So to borrow from a line from the English writer, Hilaire Belloc, it pays to “keep a-hold of nurse for fear of finding something worse”. (In that particular poem, the boy called Jim went astray from his nanny and ended up being eaten by a lion.) In other words, a private bank client feels more comfortable in using products used by that bank’s sister investment house. Never mind worries about investment banks pushing products at clients down the corridor – such clients are, it seems, happy to lose a few basis points of yield if the product comes from a proven source.

Hard evidence

A survey issued recently by Scorpio showed that there has been a sharp rise in the number of investors preferring to use in-house products rather than those manufactured by outsiders. The report showed that the aggregate allocation to in-house products rose to 40 per cent at the end of last year from 22 per cent at the start of last year. The survey is based on responses from 33 private wealth management institutions, which together run more than $7 trillion in assets for high net worth individuals. So even if only a fraction of that money has shifted towards in-house products, that represents a big transfer of money.

Sebastian Dovey, managing partner at Scorpio, says the results are significant, although he points out that the picture is complex.

“At a simplistic level we often hear the following comments, such as either that shifting toward in-house funds is a defensive play to save fee margin or shifting to out-house is to address the market trend to show impartiality,” he said.

“The reality is more, in our view, now based on a need to look at the composition of the portfolio. For instance, economically, it is not necessarily the best option to outsource active investments in money management and even fixed income. If a private bank has an adequate capability - lets assume at least second quartile or above, then the savings of going in-house against the costs of performance make it more economic sense,” he said.

“Therefore, another positioning is that for beta then the banks will look toward internal solutions if they have the options. While for alpha, if they are not competitive in this arena, then they will look externally. This appears rational to most private investors, particularly the ones that we interview,” Mr Dovey said.

What all this points to is that it is far too early, and indeed unwise, to claim that the open architecture model is in full-scale retreat. For many firms, especially the smaller ones without the big teams to manage in-house products, sourcing products from outside firms makes perfect business sense.

So long as relationship managers can show to their clients that the due diligence checks have been done and products have been thoroughly scrutinised, there should be no reason why taking the external route will not make plenty of sense. But there is no doubt that recent events have rattled investors sufficiently to choose the in-house option. The advice that is contained in Belloc’s famous poem about a boy called Jim is proving persuasive.