June 13, 2003

The Forces Behind the Pressure on Fees

The Forces Behind the Pressure on Fees

At the end of 2002, the average advisory fee stood at 1.10%, a substantial decline from the 1.21% reported in 2001 and a bigger drop from the 1.24% reported in 1999 at the height of the bull market, as shown in chart 1 below.

Source: AdvisorBenchmarking.com.

So are advisory fees really under pressure? Well, yes, but the reasons are different than most advisors may think. Contrary to popular belief, the protracted bear market and the resulting losses in clients' portfolios did not play a major role in the reduction of fees across the industry. While the value of clients' accounts fell sharply during that period, the dire market conditions increased clients' need for and appreciation of their advisors' services. In a March 2003 survey of 655 RIA firms, 37% of advisors rated "clients' appreciation of the value of the firm's services" as being a "very positive" outcome of the bear market, compared to just 5% who noted the impact as being "very negative." Due to the heightened perceived value of the advisory firms' services, clients better tolerated the advisor fee, despite its magnified negative impact on the portfolio's value.

We observed two other factors as being more responsible for the downward fee trend: an increased demand for comprehensive financial planning and growing competition from external sources.

1. The Growing Use of Consulting Fees

Clients' rising demand for comprehensive financial planning in the last three years has triggered advisors to increase the use of consulting fees to properly compensate themselves for the additional financial planning services they offer. These project-based fees have grown gradually over that time period, making up nearly 24% of the average firm's total revenues in 2002, as shown in chart 2 below.

Source: AdvisorBenchmarking.com.

As these consulting fees proved lucrative, advisors began to use them with more clients. At the same time, advisors also saw the need to lessen their clients' focus on asset management--the one service where the firms' value-add was most dismal. Instead, advisors wanted to shift the focus to comprehensive planning, where their services were more valued and the consulting fees were more applicable.

With those two objectives in mind--increasing the use of consulting fees and reducing the focus on the asset management service--the average RIA firm realized the potential gain in lowering its asset management fee. This fee reduction would serve to appease clients who are charged the hefty consulting fees. It would also create a shift in clients' perception of the advisor's value away from asset management and more toward comprehensive planning.

2. Competition

The growing competition from outside forces also put pressure on fees. Wirehouses, regional brokers, discount brokers, and CPAs increasingly adopted the fee-based model, effectively competing head-to-head with RIAs.

Between 2000 and 2002, full-service brokers increasingly lured clients away from independent advisors (as shown in chart 3 below) with nearly one out of every four RIA firms reporting losing more than one client to wirehouses in 2002.

Source: AdvisorBenchmarking.com.

And after posing minimal threat to advisors in the first two years of the bear market, discount brokers began offering private client services to the high-net-worth investor. At year-end 2002, 13.50% of advisors reported losing one or more clients to a discount broker, up significantly from the negligible 5.20% reported in 2001.

As a fairly new entrant to the field, CPAs did not constitute a recognized competing force for advisors until the last two years. Between 2000 and 2002, the impact of competition from CPAs nearly tripled, with more than 8% of RIA firms reporting losing clients to a CPA in 2002, up from 6.20% in 2001 and 3.25% in 2000.

While these competing forces do not necessarily possess a competitive price advantage over independent RIAs, their successful foray into the fee-based financial advice space has undoubtedly pressured advisors to fortify their value propositions. Lowering the asset management fee was a first step in that direction and constitutes the second impetus for the fee reduction across the industry.

Both of these factors--the increased demand for financial planning and the intensified competition-- led advisors to lower their fees in 2002.

The average fee reduction is likely to serve its objectives of balancing the impact of the additional consulting fees on clients, shifting the focus away from asset management and toward financial planning, as well as fortifying the firm's competitive edge in the face of growing competition.

As an advisor, you should consider the impact a fee reduction or a fee increase will have on your overall business. As we have demonstrated, there are more issues involved here than merely the impact on the bottom line.

To receive a customized benchmarking analysis report of your practice, visit the free online tool www.AdvisorBenchmarking.com

AdvisorBenchmarking.com is a free online resource of research and analysis on the RIA marketplace. The service is aimed at helping advisors grow and enhance their practices. By participating in the online surveys, advisors can see how their businesses fare against other advisors, as well as learn best practices based on the most successful advisors in the business. The instant analysis they receive offers valuable insight that can help them take their practices to the next level and weather the challenging market conditions.

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