When an asset-based fee is equated to a commission – or described as “commission by another name” – it elicits a heated response. We saw that notably in a recently reported exchange between David Whitely of Industry Super Australia (ISA), Mark Rantall of the Financial Planning Association of Australia (FPA), and John Brogden of the Financial Services Council (FSC).
Opponents of asset-based fees often describe them as conflicted. And there are other arguments why professional financial planners shun asset-based fees, in addition to the perceptions of conflict – and they relate to business sense, and simple professional pride.
There seems to be little understanding of why the opponents of asset-based fees describe them as conflicted. If a fee is agreed between a planner and a client, goes the argument, they are fine. But to understand the position of the “conflictistas”, you have to back up a couple of steps and examine what they think a conflict of interest is in the first place.
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A matter of interest
In essence, they see a conflict where the interests of one party are best served by one course of action, while the interests of the other party are best served by an alternative course of action. The conflict may encourage or reinforce a certain kind of behaviour or action, to the benefit of one party over the other. An individual receives a benefit for doing something that they would not receive if they did something else.
In a fee sense, they see conflict in any kind of payment (or other benefit) that only gets paid if the adviser follows a particular course of action – they do not get paid unless they do a certain thing, in a certain way.
In the case of asset-based fees, they see conflict because a planner only gets paid if they aggregate client funds in a way that lets them calculate and charge a fee on those assets. If they do not aggregate those assets somehow, they don’t get paid. The conflict exists because aggregating client funds is in the best interests of the planner, even if it is not necessarily in the best interests of the client.
A simple example
Here’s a simple example this kind of conflict: Say a client inherits some money, and seeks advice on what to do with it. It may very clearly be in the client’s best interests to use that money to, say, reduce their mortgage. But that advice won’t generate an asset-based fee. The client’s best interests are served by doing one thing, the planner’s by doing another.
Here’s another one: Say a client has a substantial portfolio of managed funds and direct investments, sitting on a platform and generating a tidy asset-based fee for the adviser . The client is thinking about selling some of the assets. This will reduce the value of the assets on which the planner calculates her fee. The client’s best interests are served by doing one thing, the planner’s by doing another.
And another: Say a client is a member of a defined-benefit superannuation fund, and will be entitled to an inflation-linked, perhaps even government-guaranteed pension. The client seeks advice on whether some or all of it of it should be commuted to a lump sum. A recommendation to commute some or all of the pension and invest the proceeds in managed funds would enable the planner to earn a fee. Recommending that the pension be left alone would generate no fee. The client’s best interests are served by doing one thing, the planner’s by doing another.
In all of these cases (and there are thousands of others), the planner could and would be paid if they employed some form of remuneration other than an asset-based fee. And in one stroke, the conflict vanishes. It does not matter what course of action the planner recommends, he gets paid, and it can’t be disputed whether the client’s interests have been placed first.
Making sense commercially
All of this is extremely effective ammunition to the opponents of asset-based fees. But in addition to that, there are arguments that asset-based fees make no business sense, and they devalue your professional qualifications, experience and expertise.
How do you value your business? Is it a multiple of recurring revenue? Is it net profit after tax? However an asset is valued, a potential acquirer (and asset only has actual value when it’s sold) needs to have some confidence about the reliability of its income stream.
How predictable and stable is your revenue if it’s linked to the value of assets that can be up one year and down the next, though no particular action or inaction on your part? And how does that compare with a business whose revenue is a simple function of how many clients its planners see every day, every week, every month and every year, multiplied by how much you charge them for that – bearing in mind that you have the absolute power to set the fee you want to charge.
Valuing the professional
Think for a moment about the time and the effort (and, frankly, the expense) it’s taken you to get to where you are today.
Think about the years spent at university studying to gain an undergraduate degree, and perhaps to achieve a postgraduate qualification. Think about the cost.
Think about the time it takes to gain the right level of practical experience in the profession and the dedication and the expense of studying to gain appropriate industry-based certification or qualifications.
Think of the ongoing cost, and the time it takes, to remain appropriately qualified by attaining the required number of continuing professional development (CPD) points. And think what it takes to pay membership fees to a professional association and to adhere to a stringent code of professional conduct, on top of all that.
Time, cost and effort
All of that time and effort and cost is relevant to this debate, because they all go towards creating a fully formed professional. It is the professional’s qualifications, experience and expertise that the public pays for. And therefore the basis of the fee should be those very same qualifications, experience and expertise. Not something that bears absolutely no relationship whatsoever to those qualifications.
If the basis for the fee is something else – say, the value of the client’s assets – then it not only runs foul of claims of conflict, as set out above, it removes the focus from the skills and the expertise of the professional.
It’s a question of pride. What’s really valuable in the relationship you have with your clients – your experience, your qualifications and your expertise, or the arbitrary value of some investment assets?
If you don’t ask your clients explicitly to value your qualifications, experience and expertise, then you shouldn’t be surprised if your clients do not value them at all.
Simon I couldn’t have expressed it better myself. I find it hard to follow the logic that an adviser’s fees should be intrinsically linked the value of the client’s assets. Why should an adviser’s fee suddenly increase exponentially if a client comes in to some money which they want to invest. Conversely why should an adviser’s fee suddenly decrease if a client starts drawing down their capital based on sound strategic advice. I can see some arguement in relation to correlation around risk but surely a professional financial adviser should be paid relative to the depth and complexity of the advice that is being provided to the client. If advisers are still sitting in front of clients and justifying their engagement and % of fee structure solely on their expertise in picking investments then that is not a sustainable relationship. Growing a client’s portfolio is certainly important but is just scratching the service in terms of properly engaging with a client.
Simon, same old argument of a couple of examples which have been trotted out before. That’s why the codification of best interest was done. For examples just like this.These advisers are breaching Section 961.
Hourly based fees can be conflicted as well. I can give you three examples as well on hourly based fees. However advisers are measured whether we like it or not on the result of the investments. If the client measures the advisers performance on whether their investments go up or down then why shouldn’t an adviser be paid on that basis. In other words the alignment of interest is quite strong and no conflict exists. Client returns go down, advisers revenue goes down, clients returns go up, adviser revenue goes up. Client complains, compensation based on assets.
Don’t agree with your supposed logic about compromising professionalism. professionalism is a state of mind, not a state of fee charging.
But I suppose we will have to agree to disagree.
Of course asset based fees are conflicted. To suggest otherwise only shines a light on the interests of those making such comments.
Commissions of all sorts, be it insurance, asset based, etc… are all poor proxies for remuneration. One issues is that there has been no real suggested alternative put forward on an industry wide basis. They are there, but not well communicated. Perhaps an article to be written on this..?
The ‘problem’ is politics and vested interests. When the firms that have lots of money lobby politicians and the industry they will always defeat those that don’t. Just look at the ridiculous amendments the Liberals are making to FoFA. Who’s interests do you really think is being served there? As a Liberal voting financial practitioner I am very unhappy with the proposals as it will just keep the industry in the dark ages.
There are progressive elements, as suggested in your article re Stackpool. I know a number of good advisers that wish things were different. But how do you effect change when the institutions have greater firepower and a clear and obvious conflict?
I find these ‘simple examples’ nothing more than examples of where poor advice would be provided. At least asset-based fees are finite and can usually be varied and be agreed with the client. Hourly fees do not make the conflict disappear and can be conflicted in the same way, in that work could be charged that is either not done, is overpriced or even unnecessary to the client. Again, it’s down to the actions of the Adviser (and the compliance regime of their licensee), not always their interests.
The examples tend to assume that clients are fools and would be misled by inappropriate justifications to follow the advice.
The comments about ‘valuing your profession’ relate to how much you charge, not how you charge to arrive at that income.
I will ‘shine a light’ on myself in that my preferred model is a hybrid of a small asset-based fee (disclosed and agreed by the client) and primarily a flat fee based on predictable work expected to be undertaken each year. I’m not going to justify it but to me, it’s my integrity and conscience that determines whether or not I work in the clients best interests.