I’m not suggesting AUM is about to disappear, but alternative models are certainly becoming more normal. It’s not surprising with the average current client age in Australia about 62 yet with more advisers seeing opportunities within the ‘HENRY’ market (high earners not rich yet) that new fee models need to be considered.
In the past, the typical remuneration model has moved from upfront commissions with no trail commission, to no upfront commissions (but perhaps an upfront fee) with a higher ongoing fee or commission (or a combination).
In the late ’80s, upfront commissions were about 6-8 per cent of funds invested; trail commissions then started at about 25-40 basis points. Advisers then moved from being the price taker to the price maker, removed any commission and typically moved to an AUM model. Today, AUM fees are the dominant model. Over time, at say 1 percent of AUM, advisers started to add more and more value all bundled into that fee, but there was typically no line in the sand between the portfolio management fee and the advice fee.
The percentage-AUM fee model, particularly on a sliding scale, can work for the affluent, but what about the other 80-90 percent? They have needs as well. Robo-advice may help fill the void for the non-affluent, non-HENRYs.
AUM is arbitrary
The weakness in the percent AUM model has always been that the amount paid to the adviser has little to no bearing on the value the adviser delivers. Charging 1 per cent on $1 million in assets generates $10,000 for the adviser, while charging 1 per cent on $100,000 in assets generates $1000 for the adviser. Granted, there is more risk for an adviser with larger accounts, but does the adviser do 10 times the work? Almost certainly, no. Unsurprisingly, advisers with a percentage-AUM fee model will typically have an affluent ideal client.
Maybe it was fine charging 1 percent of AUM 10 or 20 years ago, when an adviser’s core value proposition was running a client portfolio. But now the baseline for investment pricing has been set by robo-advice, exchange-traded funds and index funds; we know it’s possible to run a portfolio for 20 to 40 basis points. So, for an adviser charging 1 per cent AUM, we know that about 60 to 80 basis points is paying for advice.
In many cases, under current advice models, advisers would subsidise the first year to 18 months before a break-even point, given the often-heavy lifting required upfront. But once things are in place, clients will start to ask what they are buying more often.
That’s fine if you can demonstrate and articulate the value in an investment-only proposition but based on myriad research projects, such as S&P Indices Versus Active surveys and individual portfolio benchmarking, there are few advisers who would be able to demonstrate value over and above the return to which an investor was entitled for the risk they have been prepared to undertake.
End of an era
It is for these reasons I believe AUM-based fee models will steadily decline or value propositions will become significantly enhanced.
One Australia and New Zealand-based study I’ve seen recently has found that while nearly 56 per cent of advisers still use AUM as the primary part of their fee structure, 39 per cent also use retainers and/or flat fees; and only 23 per cent of advisers now use an AUM-only model.
Simon-Kucher & Partners Global Pricing & Sales Study 2017 suggested that “percentage deals can’t compete in a world of dirt-cheap index funds and price-cutting robots. Financial advisers charge too much. [They] have to come up with alternative fee structures that do a better job of matching price to value.”
The $100 billion that flowed into Vanguard’s personal financial advisory service in the US last year shows that people will vote with their feet, and money.
In Australia, it would be hard to imagine 100 basis points of AUM being the norm in the future, following the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry. Simon-Kucher & Partners suggests clients of the future will choose the services they want on an annual or other periodic basis – and pay only for what they use.
Advisers will need to substantiate any advice fee above 20-40 basis points. Right now, there is a trust issue with consumers and, as a result, many advice businesses are simply not growing.
Of course, there are many alternative models. The most important factors are that they must be transparent and easy to articulate and understand. It must provide value to clients and must be profitable for shareholders after they pay fair and reasonable salaries for staff. So other than the AUM model, what are the alternatives?
The hourly fee: As unusual as it is, there is no reason an adviser can’t charge the way a lawyer or accountant does, paying only for time used. AUM can be irrelevant. The upside for the client is that it’s transparent, the downside is they may feel it’s open-ended.
The flat fee (package or annual fee): Examples would include a recurring flat fee with no AUM component. Fees would vary from one client to another based on complexity. Typically, there would be a minimum fee. When assets move past a threshold, charging a fixed fee starts to become cheaper than the AUM model. There may be packages available for different fee levels, such as platinum, gold, silver, etc – needs-based financial planning packages with bundled service hours.
Combination/hybrid – a mix of fee and AUM. The separation of the financial advice fee and the portfolio management fee can help clients see what they are paying for. Investment management can be dropped for clients interested in planning only, or vice versa – there is flexibility in this model. A person with no liquid assets can still become a client.
There are various derivatives of these models, such as value-based fees, but let’s keep it simple for now.
Headlines about fee compression may apply to some firms, but others are successfully increasing client fees from 10 to 25 basis points, as they are compelled to get better at articulating and demonstrating a value proposition to clients, and then find it allows them to charge more for the greater level of services they’re providing.
Advisory firms that offer more comprehensive and holistic services will be able to charge more. Research by Peloton Partners, an Australian business-to-business consultancy, has found firms are typically working on gross margins of 77-85 basis points, not that Peloton recommends AUM-based fee models.
Flexibility will win
It’s my view we will see more advice businesses move towards a flexible fixed fee structure aligned directly with an individual client’s level of complexity, service needs and expectations. Clients will be absolutely attuned to this structure and will recognise that fees will ebb and flow as their circumstances change. As a result, their understanding, trust, and connection to their adviser will improve markedly. The industry proxy is 1 percent AUM, yet the evidence is clear that this old proxy has not kept pace with the rising costs of delivering a full service financial planning offering.
Fixed costs in the average wealth management practice have increased from 12 per cent to 15 per cent in the last five years and are still rising, Peloton managing director Rob Jones says. This additional cost is directly related to compliance with ongoing regulation and general inflation and we will soon see further increases as employee costs rise in line with mandatory minimum qualifications.
As Jones points out, the problem is that few fee models permit firms to pass this expense on to their clients, particularly under a percentage-AUM model. More than ever, advisory practices need to review their business critically – too often we see complacency and unwillingness to change cripple a good business.
David Haintz writes exclusively for Professional Planner and is principal of advice consultancy, Global Adviser Alpha.