By Pam Krueger
As automated investment programs multiply, more clients are likely to ask advisers to justify their fees. There is a good answer.
“Don’t confuse a sales pitch with what’s right for the client,” a former boss of mine once said.
He was referring to industry pricing, noting that fees might seem less conflicted, but arguing that commissions are far more appropriate for low-turnover portfolios like municipal-bond ladders where individual securities are held to maturity.
Fees versus commissions—it is still a hot debate among registered investment advisers and the wealth managers formerly known as stockbrokers. Increasingly, the thinking is that fees are the way to go.
However, the arrival of robo advisers is pressing a different pricing issue to the forefront of wealth management: What value-added services are included in management fees?
Without an accurate, detailed and compelling answer to that question, I believe financial advisers risk being lumped into the same bucket as robo advisers, which charge rock-bottom fees for asset allocation, now a commodity service.
Stampede to ‘management fees’
Let’s start with client statements. In general, they show how firms charge for their expertise, fees versus commissions, for example. But they provide few details about what services those charges actually include.
I am a veteran of wire houses and a registered investment advisory firm. In both types of organization, our statements simply reported “management fees,” a bland description that leaves the explanation of what is included to individual advisory teams.
Historically, a thorough explanation hadn’t been necessary, perhaps because the fee versus commission debate was paramount. Fees often are presented as an alignment of client-adviser interests and a solution to churning—an argument I find underwhelming given the money at stake for firms that convert from brokerage to fee-based business.
According to PriceMetrix, a practice-management software firm with data on seven million investors, fee accounts generated average revenues during 2014 equal to 1.02% of assets.
That is double the average return on assets of 0.53% from transactional accounts. It is no wonder PriceMetrix also reports that fee-based assets under management grew at an average annual rate of 19% over the last five years.
On a macro level, an increase of 0.49 percentage points is a huge incentive for wealth-management firms to push fee-based accounts, especially at the wire houses, where the stakes are so large. At Morgan Stanley, for example, 40% of the $1.9 trillion in client accounts is fee-based. The remaining 60%, $1.14 trillion, is tied to traditional brokerage accounts and cash deposits.
If fee-based accounts add 0.49 percentage point to revenue, a securities firm that shifts, say, $500 million to fee-based accounts would boost annual revenue by $2.45 million.
But what do fees include?
In fairness, the role of financial advisers has evolved from trading to asset allocation to a wide range of value-added services that extend beyond investment advice. Wealth managers regularly assemble and quarterback teams of outside accountants, lawyers, and insurance experts to offer comprehensive financial planning.
These services aren’t only a fair reason to charge ongoing management fees rather than commissions. Today, they are a matter of survival.
Pat Kennedy, a co-founder at PriceMetrix, says new competitors are trying to commoditize the value proposition of wealth management, with the low fees of automated investment platforms pushing financial advisers “beyond portfolio construction as their value add.”
The problem, however, is that pricing mechanisms are disconnecting from the source of value. Financial advisers can make structural recommendations, for example, which save clients millions in estate taxes.
But they get paid though “management fees,” which look like, sound like and are calculated the same way as the asset-allocation fees that robo advisers are cutting to the bone. And standard industry disclaimers—such as that we don’t give tax advice—reinforce the message that lawyers, accountants and other outside professionals, whom clients pay separately, are the team members offering the real value.
What investors are getting for their money is “clear as mud to the consumer,” says Pam Krueger, who is launching a new website called WealthRamp that matches up clients and financial advisers.
Ms. Krueger, also the creator of the MoneyTrack television series on PBS, adds that advisers have “got to do a better job educating the consumer” about the broad breadth of their services and whether their fees include holistic financial planning.
I buy that.
During those year-end meetings with clients, I would allocate at least 50% of the time to issues beyond investment selection and asset allocation—not only to areas like financial planning for college tuition or retirement, but also to the more intimate components of an advisory practice, like teaching the next generation about investments. And I would make these areas a standard practice of portfolio reviews going forward.
Otherwise, discussions are likely to gravitate toward an uncomfortable variation of this question: Are your services a commodity?
— The Talk Wealth Managers Need to Have With Clients About Cost, Norb Vonnegut