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In defence of asset-linked fees

Some people in the financial advice industry think linking fees to assets under management is akin to smoking behind the bike sheds; others think it’s no different to charging commissions; and there are those who think you cannot call yourself independent if you link your fees to assets. A few even believe it’s just downright unprofessional.

What is it about asset-linked fees that generates such heated emotion?

Detractors of asset-linked fees argue they are too harsh on the rich (!); work too well for advisers; result in fees that are too high; and incentivise investment of money in the stock market (albeit an asset class that has compounded at 11.6% since 1979).

Poor advice practices needed addressing

Following the introduction of FoFA and the proposed amendments, the two most pernicious features of financial planning in Australia will have been materially addressed – the payment of commissions by product providers (other than for 'general advice') and the ability for advisers to collect a ‘trail’ fee from a client without actually telling them about it. The previous Labor administration was right to tackle both issues. Investment product commissions payable by fund managers have gone. Good riddance. The new Fee Disclosure Statements require advisers to send a regular letter to all new clients detailing the dollar amount of fees charged to their account. This will rapidly reduce the too high occurrence of Australian consumers paying for financial advice without receiving any – a blight on our industry.

Financial advisers tend to use one or more of three different methods to charge their clients; hourly fees, fee-for-service (FFS) and asset-linked fees. It is critical to point out that there is no perfect method to charge for financial advice – all have their pros and cons.

Hourly fees can incentivise inefficiencies, encourage over-servicing, discourage client contact and are widely loathed by clients. They are a retrograde step for the industry.

The FFS method has, for some reason, attracted a deeply illiberal and puritanical crowd. It is seen as morally superior to all other methods and little tolerance exists from its advocates for alternatives. However, the vast majority of those who proudly claim to have transitioned to a FFS arrangement merely use the client Funds Under Management (FUM) as a starting point and work back.

We see three crucial weaknesses in FFS. Firstly, it is just so opaque. From our experience (and Stanford Brown has reviewed the books of many FFS advisory companies), advisors using a FFS methodology base their final figure partly on complexity, partly on hours worked but mainly on sticking a finger in the air and hoping the client can pay. Second, it is nearly always linked to client FUM anyway. And finally, they are a tax on those who can least afford it. FFS is a regressive pricing methodology that makes advocates of flat taxes resemble 1950s Cold War socialists. Our Ultra High Net Worth clients (the 0.1%) are cheering the FFS crowd from the rafters. If the advice industry really starts to charge those with $10 million the same as those with $100,000, one could scarcely dream up a more regressive fee structure.

Asset-linked fees are also problematic. Yes, they do incentivise the collection of assets for advisers to manage. Despite the 11.6% stock market return, there are occasions when this generates a conflict of interest. For example, the best advice for most home-owning clients in their 30s and 40s is the repayment of their mortgage (simple but valuable nonetheless). However there are undoubtedly some less than scrupulous advisors that would recommend establishing share trading funds instead, on which they can charge a 1% fee. Fair criticism.

There are multiple reasons why the cost of servicing a client with $5 million is greater than one with, say, $50,000. These include the cost of correcting mistakes, the greater asset diversification that is invariably required, and the far higher stakes involved. And those who point out that the cost of servicing a client with $10 million is not ten times that of one with $1 million are absolutely right. This is why Stanford Brown, along with many other investment advisers, applies a rapidly dwindling percentage fee as the assets build.

But asset-linked fees provide two key benefits. First, they permit much closer alignment to the client due to fees declining in a falling market. In contrast, a FFS adviser is insulated against poor investment performance. And second, they are transparent and logical for the client to understand.

There's no one right answer on fees

Progressive firms charge clients through a combination of four factors; the complexity of the client's situation (which should diminish over time if the job is being handled properly), the amount of communication required by the client (e.g. how often and where they wish to meet), the amount of planning strategy required (estate planning, lending, insurance, budgeting etc) and the investment responsibility placed with the adviser (FUM). Younger or working clients with much planning and strategy work to be done are predominantly charged via a fee-for-service arrangement. Older clients who engage their adviser principally to manage their investments are more suited to an asset linked fee. And clients with one-off project work are charged an hourly rate. In essence, different types of advice lend themselves to different fee structures.

There is a world of difference between, on the one hand, preferring one method of charging clients, and on the other, demanding that everyone conform to your personal opinion and calling for legislation. The freedom to engage in robust debate is what makes Australia such a wonderfully successful country. However demanding a private business charge its clients according to your own preference is the road to euro-socialist hell.

If financial advice related asset-linked fees are banned, who will be next to feel the sharp end of new legislation? Fund managers? Stockbrokers? Super funds? And what about real estate agents? After all, does it really cost twice as much to market a house for $2 million than one for $1 million?

In summary, all three charging methods have their drawbacks. There is no panacea. We believe that asset-linked fees, though far from perfect, are the most transparent, easy to understand and honest of all the available choices. Let those who wish to charge by the hour or as a negotiable fee-for-service set up shop opposite our offices in North Sydney, let the invisible hand of competition work its magic and let the customer decide.

 

Jonathan Hoyle is Chief Investment Officer at Stanford Brown.

24 Comments
Julie Matheson
April 01, 2014

Agree, the fee should be agreed between the client and the giver of the advice in private. The fee/income for the advice becomes muddied when a third party becomes involved, ie, an AFSL or product provider who provides incentives for certain products or services. Questions are then raised in the public domain whether or not these incentives are the cause of conflicts.

Jamie Forster
March 31, 2014

Tim

I am not aware of any super fund charging 3%. Nor am I aware of any charging 0.18%. Perhaps you could cite evidence. If only for the industry super fund charging 0.18%.

I do agree that members of super funds who receive advice pay more than those that don't. That is because they are receiving advice.

Perhaps you don't agree that financial planning advice is worth anything but plenty of others do value it and should be free to make their own decisions. Confusing the issue by comparing costs of industry funds without advice to other funds with advice makes that difficult for them to do so.

As to your claim that members of super funds are being charged $15,000, I agree that this is exorbitant. Perhaps that is why, in the last ten years, I have only seen fees of this magnitude in very, very rare circumstances. In each circumstance the adviser lost the client. Furthermore, any business offering products and services that are over-priced will very quickly find themselves without any more clients.

Tim
April 01, 2014

Some wrap account fees on $500,000 amount to 80 bps. Fund manager MER another 110 bps, adviser fee another 110 bps. All adds up to 3.00%. A big bank I used to work for charged exactly that.

I can invest $500,000 with an industry fund in an indexed diversified option (11 bps) which is a multi-sector option with 70% exposure to growth assets. Admin fees on top of this are $1.50 per week; so total cost to me is $628 per annum, verus $15,000 in the retail world.

Or alternatively I can invest in direct stocks within an industry super wrap and my total admin cost ongoing is $258 per annum (albeit with $800 upfront brokerage to get into the market with 16-18 different stocks and ETFs).

(Editor note: this costing compares active management with an advice component versus with index management without advice. And to be fair, retail wraps are usually less expensive than 80bp on $0.5 million).

Jason
April 04, 2014

Wow I find those fees high. No wonder you got out. A quick calculation of one of the largest wrap accounts owned by the big four works out on $500K an admin fee of 0.54%, the MER of a very well known active managed fund beginning with P starting in 1967 sits at 0.99% and an advice fee of say somewhere between 0.6% to 0.8% lets work at 0.7% comes in a total of 2.24%. Lets say the goal is around 1% you're paying $6,200 extra. Now let's look at the what you get, the performance of this fund outperformed the index every year over the last 10 years- lets work on 7 years as an example is 5.3% whilst the ASX 300 did 3.8% and the most popular index fund in the land is around 3.02%. Some 2.28% lower than the active fund manager. My clients who have been with me for over 10 years have outperformed the best performing industry fund over a 10 year, 7 years and 3 year period after paying for my advice. The key to this whole debate is transparency.

Jamie Forster
March 31, 2014

Hi Dacian

Just as you have moved to a FFS model, my business has a model based on percentage of FUM. Like you we gave it considered thought and including, amongst other things, both issues raised here by you.

Firstly, whilst we don't claim that our remuneration model completely removes the conflict of interest, it is the model that best aligns our interests and our client's interests and best allows us to make clear and manage conflicts of interest. In our opinion, and for our business, a FFS model would have given the appearance of removing conflicts of interest without in fact doing so.

As to what we do for clients, I think your point is a good one. I don't know anything about your business or about your service offering but agree that a FFS remuneration model would suit some businesses very well depending on what it is they offer and whether they are generalists (GPs) or specialists and, if they are specialists, what they specialise in.

Dacian Moses
March 31, 2014

The reason we moved from asset based fees to FFS was two-fold. Firstly, we wanted to remove what we saw as the final 'obvious' conflict in our business model. Avoiding conflict is a superior ethical choice to managing it. The second is that we do so much more for our clients than manage money. We wanted to be paid for what we do rather than how much FUA we accumulate.

Stephen Romic
March 28, 2014

Whether FFS or otherwise, the cost of advice generally bundles structural advice with (ongoing) portfolio management.

Would unbundling the fee structure provide a potential solution or exacerbate the problem ?

Does FoFA have the structural advice piece in mind or is it all about reducing the ongoing cost of the investment piece?

Eric Walters
March 26, 2014

Whilst David's point may be compelling to some, it is a well worn view that ignores the fact that mere disclosure doesn't necessarily address the issue of conflict of interest: and here the issue is more one of perception than reality when we talk about forms of remuneration.

In individual circumstances, there is no reason that an otherwise assumed item of conflicted remuneration need actually be conflicted: it's the professionalism of the service provider - and their ethical approach to the client-adviser relationship that will make that difference (and yes, full disclosure at all times would be part of that mix).

Tim
March 25, 2014

The big issue for me, and I am an ex-adviser, is that most advisers' total cost to their clients is coming in at almost 3% per annum (platform fee, MER, adviser fee). In a world where true 'balanced' portfolios are expected to return 8% at best, 38% of the client's total investment return is being eaten up in fees. Everyone's in it for their 1% take, courtesy of the SG super gravy train.

Conversely I can put my $500,000 in an industry super fund and be charged 18 basis points or $900 p.a. It is a sad indictment on the industry that it costs a client $15,000 per annum in fees to have a $500,000 portfolio in the retail world. Advisers are struggling to convince a client they will be much better off financially if they opt for the $15,000 p.a. fee solution which the adviser proposes.

Rod
March 25, 2014

I don't see how it makes sense to describe FFS as regressive. That's like saying car prices are regressive because the same car costs a higher proportion of the income of a person with a lower income.

Taxes can be regressive exactly because they are unrequited. Of course, we benefit from the raising of tax revenue, but not in a way directly related to the tax. That's the difference between a tax and a fee.

If you're paying for something reasonably concrete - like a service that can be defined at least fairly well - then in a competitive market the price (fee) will tend towards the cost of providing the service, including a reasonable profit margin.

If the provider has some kind of market power, eg because of an exceptionally good reputation, then he'll be able to do better. But it 's an inefficient market where the price bears no relation to the cost. Since the barriers to entry appear low, the cause is probably deliberate obfuscation and complexity.

This is not to argue against the other points that Jonathon Hoyle made.

David O'Donnell
March 25, 2014

Surely the ONLY reasonable and ethical basis for determining a fee is as compensation for the service provided. Any discussion about whether that is asset based or otherwise seems a waste of time - except between service providers contemplating how to best work their businesses.
The provider of the service determines what is reasonable to them and the client agrees or otherwise (if 'otherwise' they don't do business). The key to all this? - the client has to know and understand what is being charged and why That disclosure has been missing in far too many cases. That regulators have to be involved to push towards that basic level of honesty is disappointing. Regulators have no role (and I'm sure want no role) in determining how a business charges for its service.

Jamie Forster
March 24, 2014

A good article but not such a great discussion.

From the "Tyranny of the Billable Hour" to the controversy around "No Win, No Fee", the established professions have been having debates about remuneration for decades. They, unlike our profession, do it amongst themselves.

Unfortunately the discussion on remuneration seems to have been made public by those outside the industry with an axe to grind or those in the industry seeking to discredit their colleagues and gain a competitive advantage. Whilst I would present the strengths of my offering to prospective clients (including fees) I would never (ever) seek to discredit a competitor especially based on their method of charging.

The fact is, whenever a professional (whether that be medical, legal, tax or financial), there will be a conflict between the adviser and the client. There is simply no method of charging that completely negates that conflict.

The method of remuneration should compensate the adviser for their time, expertise, experience as well as the professional risk in providing advice. Ideally it will reduce the conflict between the practitioner and client as much as possible and enable those conflicts that can't be removed to be managed. It should also be transparent.

How much to charge should be between the practitioner and the client (as long as it is transparent). Fairness is a subjective term and, if a fee is unreasonably high, a highly competitive market will soon adjust.

Greg Einfeld
March 24, 2014

Graham you are right that the industry airing its dirty laundry in the media results in the public losing confidence. The public and media are now more aware of this issue and are taking the position that they don't like conflicted remuneration. So as long as elements within our industry continue to argue in favour of conflicted remuneration then the reputation of our industry will suffer.

There is an alternative argument that everyone should keep quiet, whatever their position, to get the topic off the front page of the newspapers. This is naive, I think the media and public have wised up to the existence of conflicted remuneration. If there is silence then they might just assume the worst (and rightly so!)

Graham Hand
March 24, 2014

Thanks, Eric and Greg

The equally important aspect of this public debate is that it is doing a lot of harm to financial advice and advisers. The public reads the media criticisms, where the main message is that advisers (or the major banks, which account for 75% or more of advisers) want the best interests duty wound back, and they want to continue to receive commissions. The distinction between general and specific advice is lost. The the public is outraged because it sounds as if advisers don't want to act in the best interests of their clients.

If you want to hear an example of how confused people are, listed to Geraldine Doogue on Radio National over the weekend, interviewing Steven Muchenberg from the Australian Bankers Association. http://www.abc.net.au/radionational/programs/saturdayextra/2014-03-22/5336510.

When Muchenberg says the banks will not be paying commissions for general advice, Doogue is almost exasperated trying to understand why the banks have lobbied so hard for the changes: "Why did you put the effort in? I can't see what's in it for the banks".

Then Ian Verrender comes on and says the banks are "alienating every section of the community".

There's a lot of reputation damage being done here when we should be having a debate about how to convince more people to seek advice.

And despite what Muchenburg says about banks not paying commissions, most people think otherwise. In this week's poll, less than 2% of voters think allowing commissions on general advice will NOT create conflicted payments.

Greg Einfeld
March 24, 2014

Graham - its good to be having this discussion.

Any method of charging fees should be acceptable, as long as it is agreed by the client and the adviser., and paid by the client to the adviser This includes flat dollar amount p.a., hourly rate, % of assets, % of investment returns.

This is in contrast with commissions and any other method of payment which has these characterisics:
- Opaque to the investor, even if it is disclosed
- paid by a party other than the client

The issue should not be around how much it costs - that is for negotiation between the adviser and client. The issue should be around transparency and conflicts of interest.

Eric Walters
March 24, 2014

Graham - my practice is a Fee For Service focused operation, but still carrying a legacy book of asset-based fee payers. We are satisfied with the fairness of our calculation of the annual charge for the service packages we offer (and the charges vary according to time and resources calculated as needed top provide the agreed service, with a 'risk' overlay where more complex structures are involved and/ or substantial sums of money under advice).

We have been involve in many debates with colleagues regarding the greater suitability or otherwise of the various systems mentioned in the article (FFS, Commission and asset-based - and in some cases a hybrid of some of these) - and usually end the discussion with agreement that different client groups are more accepting of the different models.
FFS suits our practice philosophy and the small business operators we deal with on referral from a few accounting practices local to our service areas.

Good to have the discussion: and easy to see how the regulators have so much difficulty coming down with a recommendation in favour of any one fee charging method!

Client of adviser
March 23, 2014

The issue from my point of view is this: why should my adviser get paid an increasing amount of money just because the stock market goes up? The problem with asset-linked fees is that the dollar cost to me of being invested increases faster than most other costs that I face in life.

But even from the other point of view, why should my adviser's income fall just because the market has a bad year? .

There has to be a better way and it does look like the industry is working that out.

BTW my adviser charges FFS, which we review whenever my situation changes.

Jamie Forster
March 24, 2014

Client of Adviser

Yours is a fair point.

However, each method of charging has its flaws.

The percentage of FUM method works best for my business in establishing a fair way of being compensated for the time, skill, experience and professional risk in providing advice. It also, as you point out, creates a neat alignment between the interests of the client and the adviser.

However, just like democracy, it isn't perfect. Just for my business and my clients, it is better than the rest.

Just as percentage of FUM is not perfect, FFS and hourly fee methods are also flawed.

I acknowledge that there are other advisory businesses with different business models to mine and, just as percentage of FUM works best for me and my clients, FFS and hourly fees may work for them and their clients.

It sounds as though this is the case with your adviser. I would certainly never criticise their method of charging without knowing anything about their business.

viewsxew
March 22, 2014

How sanctimonious we can all become about which is the right way to charge fees - and whose clients are better served by the way we charge! I find AB's comment above about right: all we need to add to that, is an economic collection of clients who pay fairly so that we can stay in business.

Like most smaller practices, we have a mix of fees, biased towards FFS (which we believe is a fair method) - but there are many clients for whom we work in this way, who are being over-serviced relative to fees paid: unfortunately we have a legacy book of many ex-employee super clients whose asset-based fees are way less than the cost to service them.

Our practice philosophy, culture and client profile favours FFS which we are evolving towards more completely - and we offer annual opt-in discussions (at which time we also reset the fee cost for the coming year).

Andrew Buchan
March 22, 2014

Jonathan
Good article, I'm in the camp:

"There’s no one right answer on fees", it has to be adapted to the client.

I always say to clients:
1. I do not care how I am paid as long as I am paid, and
2. If we do not do a good job, we're fired. If not paid fairly and timely, we quit.

Cheers
AB

Jamie Forster
March 21, 2014

An excellent article and well said.

One thing that I would add to the argument for percentage based fees is risk.

Fees charged by any adviser (legal, medical or financial) are remuneration for the adviser's time, skill, experience and for the professional risk associated with the service being provided.

Some years ago there was a plethora of legal actions against obstetricians with the result that their fees increased dramatically. The increase was to compensate them for the increased professional risk associated with providing their service not to mention the commensurate increase in expenses as a result of increases to PI insurance.

Even if there was absolutely no difference between managing a client with $10,000 in FUM and one with $10,000,000 no-one with any understanding of risk could possibly argue that the professional risk associated with the latter client is the same as the former.

The FFS mob are deeply conflicted due to their incentive to re-risk themselves by underinvesting their clients in growth assets with the inevitable problems caused as inflation erodes their financial position. In my opinion, this is an untenable and unmanageable conflict.

I agree that each method of charging has its pros and cons. Each method can therefore be used by unscrupulous operators to undermine their competitors.

In my opinion the FFS is a deeply flawed method of charging financial services clients. However, each to their own and I would never criticise a professional colleague least of all on the basis of their method of remuneration.

As for the hourly based method, the "Tyranny of the Billable Hour" has long been the subject of debate: at least since the legal profession started charging by this method. It is ironic that, as the legal profession continue to debate the merits of this method, some in our fledgling profession see it as the only ethical and pure way.

Tortoise
March 21, 2014

The fundamental issue is not how or how much an adviser is paid. It is has the job been done for the client and how well?

This year I took over a client account. The client had been invested far too conservatively over the last 12- 18 months and missed much of the stock market rise. The conservative portfolio was due to the advisers nature not the clients.

The fee-for-service applied to the FUM was 1% or approximately $10000.

If I was the client, I would have been happy to pay far more than this and have my money correctly invested and thus reap the rewards! Commissions, fees, whatever. Just get the right result.

Bob
March 21, 2014

Jonathan some great views expressed. At the end of the day so long as the client understands what their paying is the main point. The fee structure charged really comes downs to the individual business and the type of clients they are predominately dealing with. I worked for a firm that charged based on percentage of FUM. We always placed the needs of our clients first regardless of whether we'd make money off their assets as this is just good common sense business practice. During the GFC our revenue went down by a third but work load and client contact more than doubled. It got to the point where we put off staff, and eventually the business was sold off. We also experienced that we were providing more advice around term deposits and cash based products, from which we made no asset based fees or it was harder to justify a fee during this period. The clients we'd see ranged, we'd often visit the elderly in their home to assist with an age pension form or problem or aged care issue, we'd talk to a young couple about budgeting and recommend they pay off their home mortgage, or top up their super, to get the co-contribution or salary sacrifice into their industry super fund at no charge as we only charged based on assets. FoFa legislation and work around opting in and fee disclosure statements effectively means at our new firm don't do this work and only work with the clients with substantial assets.

Asset Based fees work well for firms that predominately work with higher worth individuals where over time their assets grow or at least stay stagnate. For the majority of ordinary Aussies their capital runs down over time but will continue to need ongoing advice. Sadly ordinary Australians are priced out of seeking advice due to fee disclosure statements and work around opt in. Now we work with ordinary Mums and Dads and charge a fee for once off work based on an hourly rate, and charge a combination of flat fees and percentage of fum for those seeking ongoing assistance. the flat fees cover the cost to keep our doors opens regardless of what markets are doing and remove any perceived conflicts of interest and the additional percentage is based on managing clients funds.

Bill
March 21, 2014

Very well said. It's nice to hear some common sense every once in a while. We always offer the client a choice,. The FFS starts higher, but moves only with CPI while the asset based fee starts lower but offers more upside for the adviser in future. It also aligns interests.
When the client knows what they pay for admin, advice and investment management without requiring a spreadsheet then they are happy and so are we. It is hard to hide excessive fees when you have to disclose the combined total as a % and a $ value.
For what it's worth I believe the industry will aim for a 1% total fee in a few year's time (I'm working towards that already) with platform fees coming down, investment management costs easier to contain (e.g. using LICs and ETFs) and advice costs being forced down by market pressures (perhaps at the expense of service). The asset based fee fits in well with this. In the near future when a client of mine is asked what they pay for advice, super admin and investment management on their TTR strategy they'll be able to say 'no more than 1% p.a.'

 

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