It is a well-established tenet of business that while price is defined as the financial reward to your business for providing services to your clients, value is defined as what your clients perceive as the worth of your services to them.
Traditionally in the advice business there has been a mismatch between those two concepts. Because advisers have struggled to pin down their value proposition, their pricing models – from the old commission era to the asset-based fees model – have reflected the confusion.
But now, as advice transforms into a profession, we see greater clarity about the price of advice, reflecting a better understanding of the value of what is being sold. As a result, compensation structures are evolving from the old AUM model to more direct fee models.
Australia is moving much faster along this path than other countries, but this is a global phenomenon. Advisers are changing from being price-takers to price-makers as their focus shifts from commoditised asset management to holistic, personalised and accessible advice.
The AUM Debate
The arguments for and against the AUM model are well-trodden. In their favour is the notion that charging a percentage of assets signifies that advisers have got some skin in the game because their own fortunes are tied to the ups and downs of the markets.
On the other side is the view that an asset-based fee introduces at least a perceived conflict of interest. What if the client’s best interests are to sell assets and pay down debt? What about potential clients with low balances who need advice as much as anyone?
There’s also the problem that under the assets model, advisers take a cut in compensation precisely when they are working hardest for clients – in down markets as we have seen in 2020.
Ultimately, though, the biggest issue with the AUM model is that it ties the adviser’s compensation, not to the true value of their advice but to the size of the client’s pie. And that leads us back to the question we started with – what is your advice really worth?
Evidence from the US
The evolution to new models is evident in the world’s biggest advisory market, the US. In his 2020 ‘Inside Information Fee Report’, financial services journalist Bob Veres found that while AUM fees remain the dominant revenue model there, a change is starting to emerge.
In a survey of a thousand advisers in May and June 2020, Veres found that just under 73 per cent relied primarily on the AUM model, down from the mid-80s five years ago, while about 14 per cent of firms did not charge AUM fees at all. “This appears to reflect a trend away from AUM, albeit in the very early stages,” Veres said.
For now, the Veres survey finds that many advisers still have no clear idea about the value of advice, with almost half of his sample reporting that they charge nothing at all for the initial financial plan, seeing this service as a loss-leader whose costs will be made up later.
But while the AUM model remains dominant in the US, the survey also found that just 37 per cent of firms are charging only asset-based fees for their clients. Indeed, the most popular arrangement is a combination of AUM plus quarterly or monthly flat retainers.
Veres takes this trend toward hybrid compensation structures as evidence of a way of serving younger or less wealthy clients. And it is a trend that is accelerating, with about a third of participants anticipating making changes to their revenue models.
Elsewhere, the Financial Times’ latest ‘FT 300: Top Investment Advisers’ survey also discovered advisers testing new fee models, although the AUM model remains prevalent despite investment management these days taking up only about 25 per cent of advisers’ time.
Highlighting that time shift, a report this year from the Boston-based Aite Group argued that the COVID-19 crisis may force advisers to change from AUM-based to advice-based compensation – including flat fees and/or subscription or retainer models.
“While AUM-based fees are still a core driver of compensation, many advisors will need to examine alternatives to unbundling advisory fees and consider lowering or eliminate their advisory fees and adopting advice-based compensation,” Aite said.
The slowest markets to change are undoubtedly in Asia, where much of the industry is still stuck in a commission-driven pricing model. Taiwan, however, moved early this year to eliminate commissions and adopt asset-based pricing. Still another generation to go.
Australia Leads Pack
Against that background, Australia remains well ahead of the bunch. According to the research group Adviser Ratings, the proportion of advisers charging fixed fees increased from 50 per cent of the industry in 2018 to 69 per cent last year, with another 24 per cent of advisers adopting a hybrid model. What’s more, the average fee rose 12 per cent to $2,800 per client per annum.
For now, Adviser Ratings says fees have become more consistent as firms find their feet, but it expects that with growing specialisation and tightening practice economics, fees will start to diverge as value becomes more important.
This is the crux of it for the industry. In future, value will lead price rather than vice-versa. And that, more than anything, is a sign of how important it will be for advisers to be able to clearly articulate the value of their services in a new, more competitive environment.