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.