From the February 2007 issue of Research Magazine • Subscribe!

February 1, 2007

A Progress Report on Fee-Based Business

The industry's exhortation about the appeal of the fee-based business model has never been more emphatic. Firms are pushing it. Advisors are embracing it -- or at least giving it lip service. And, notably, survey after survey shows that fee-based advisors have wealthier clients, larger practices and earn more money as a result.

"It's clear that advisors who have fully adopted the fee-based model have been more successful than their peers. It's become one of the most powerful hooks for other advisors to incorporate a lot of these disciplines into their own practices," according to Bing Waldert, a senior analyst with Cerulli Associates, the Boston-based research and consulting firm. "It represents the confirmation of a lot of trends. It speaks to the sophistication of financial advice and the move to a more holistic model. Simply put, it's the more successful business model."

Research from Cerulli shows a fairly precipitous decline in commission-based advisors between 2005 and 2006 -- 26.3 percent versus 13.3 percent. There's a corresponding jump in the fee-and-commission model, 24.9 percent in 2005 as compared to 40.6 percent last year. Fee-based-only declined a tick, 48.8 percent in 2005 versus 46.1 percent in 2006. The long view suggests that fee-based-only is on the rise. It was just 34 percent of the mix in 2002. [Technically, there's no uniform definition for "fee-based," but most industry experts would likely agree it means that 50 percent or more revenues are generated from fees.]

Michael Grant, a Raymond James Financial Services advisor in Oklahoma City, was compensated exclusively by commissions until 18 months ago, when he began transitioning to fees. He's never looked back.

"With commissions, it was a horrible life. You need another new customer every month and then you can't properly take care of the ones you have so you end up with 1,000 accounts or more. That was my situation," says Grant, an advisor since 1994. "Now, I have 140 accounts and the money I see today is five times larger. I have time now to seek out those types of accounts and referrals. If a client wants me to attend an attorney's meeting or CPA's meeting, I can do it. There was no time before. Now, I can do the full planning I'm capable of doing. Am I having a better time? Oh Lord, I have my life back."

In 18 months, Grant, with $45 million in assets under management, has slashed his commission-based business to 10 percent. He doubled his income during the same period.

But here's the reality check.

Only 16 percent of client assets are in fee accounts, compared with 84 percent sitting in commission products, according to Tiburon Strategic Advisors, a research-driven consulting firm in Northern California.

"It's a smaller number [the 16 percent] than everyone thinks. On the flip side, you'll hear that 30 percent to 40 percent of new assets are going into fees, which is a true fact as well. You'll also hear that 30 percent to 40 percent of revenues come from fee accounts -- also true," says Chip Roame, Tiburon's managing principal.

"The top line is this: Fee accounts are absolutely a big trend in the industry and they are absolutely outgrowing commission accounts, but this is a big battleship. The brokerage industry historically is a commission battleship. It takes a long time to move what is essentially a $6.2 trillion battleship," adds Roame, referring to the assets held by wirehouses, regional firms and boutique broker/dealers. "My bottom line is the industry will continue to trend toward more fee accounts, but commissions will be here for a very long time. The world will keep trending, but don't look for this year's data to jump from 16 percent to 40 percent. It will be 17 percent, then 18. Flows can go somewhere for a very long time, but you still don't pick up the assets."

On top of that, fee-based enthusiasts criticize the failure by many firms to offer any kind of deep training or support. "There's a difference between knowing what you should do and doing it," says John Bowen, founder of CEG Worldwide, a Northern California-based consulting and coaching firm. In the mid-1980s, Bowen converted his former financial firm to fees, making him one of the industry's earliest adopters.

"Most of the firms have not put in training programs to support this. I had a conversation with a senior person at a major firm recently and he was proud of spending $3,000 on the first-year advisor for training." he adds. "That's not much of an investment and they're a leader."

Fans of the fee-based business model also believe that a lot of firms are treating the move, in essence, as another sales ploy or product pitch.

"In general terms, it seems to me that a lot of broker/dealers have figured out that recurring revenue is a good thing, but they haven't figured out what fee-based advising is about," notes Brent Hicks, a fee-based pioneer who now heads FocusPoint Solutions, a firm in Portland, Ore., that helps financial advisors build profitable fee-based businesses. "The big distinction is that broker/dealers continue to greet this as a product, something else to pull off the shelf, and not as a way of doing business. There's substantial room for improvement."

Manage Portfolios or Relationships?

The move to fees is occurring across all industry channels with broker/dealers offering enhancements to their managed account platforms on an almost routine basis.

As Jeff Strange, a senior analyst with Cerulli Associates, puts it: "Client assets at all firms are moving toward being fee-based. What we're seeing is firms enjoying recurring revenue. Advisors like the revenue stream too. Plus, it's a better way of doing business. Basically, the advisor can turn over the bulk of investment management legwork to the broker/dealer in whatever channel it is, and they'll satisfy that investment management competency with varying degrees of flexibility. What that's doing, almost, is being able to put part of your client advice on auto-pilot, which means you can meet with clients more often and move toward holistic planning. And the clients benefit. Inherent in fee-based programs is additional profiling so you're getting to know more about your clients and how to address them."

What to be on the lookout for, according to Strange: new investment vehicles designed to fit on fee-based platforms and deeper training and support.

Clearly, the outsourcing of investment management duties is one of the biggest advantages of operating a fee-based business, according to advisors who have made the move.

Wachovia Securities advisors Dan Ludwin and Dalal Solomon, senior partners in Solomon and Ludwin Financial Consulting Group in Richmond, Va., began converting their practice over six years ago. Today, the firm, with $375 million in assets under management, generates $2 million in revenue. Of that, $1.9 million is recurring fee-based revenue.

"What we tell clients is that in our belief, you can be one of two things in this business: a portfolio manager where you're managing money day-to-day or a relationship manager. You can't be both," says Ludwin. "I think high-net-worth individuals understand that brokers can't be all things to all people. It took us five years to make the official transition and the challenge we all faced is the change in our belief system. This is a different language, a different way of running your business. We think it's the right way. Ultimately, the thing the client is buying is the relationship they have with their advisor."

One of the biggest hurdles in the move to fees is an initial income dive, sometimes a dramatic one. The drop shouldn't be surprising -- not with fees ranging from 1 percent to 2 percent and commissions from 3 percent to 5 percent.

Solomon and Ludwin Financial Consulting, as an example, experienced a 20 percent revenue drop the first year. "You have to go backwards before making the massive jump forward. That's why we took five years to make the transition," says Ludwin. "But fees are the gifts that keep on giving; it's not about the [transactional] activity. But there's a fallacy about fee-based business, too. This is not just a way of getting a commission in perpetuity. This is something you have to earn. There are responsibilities that come with the business."

Mutual Services Corp., a network of more than 1,600 independent advisors, has doubled its assets under management [to $5.8 billion as of last Nov. 30] over a two-and-a-half-year period, a growth spurt the company attributes to fee-based platforms and products along with market value appreciation.

Nearly 75 percent of the firm's advisors are registered to conduct fee-based business, according to Jeff Vivacqua, vice president and director of advisory services. Half of those advisors do the bulk of the broker/dealer's fee-based business; the rest are beginning to work it in.

Advisors don't need to be convinced that fee-based programs represent a terrific business solution, Vivacqua says. What they do need is help with business development.

"There's not one magic way of converting it. It depends on staff, what your practice can support and mindset," he adds.

Vivacqua counsels advisors about three types of transitions. An instant conversion, he says, simplifies the process but the downside is that income can plummet temporarily. In a "new management" approach, new clients are put into an advisory fee-based program while existing clients are left alone. That method reduces the confusion current clients may have but could prove challenging to a staff that now has to service two distinct client segments. Using an "optimization" tactic, the advisor studies each client to determine who would be best suited for a fee-based business and who would be served better through commissions. The downside, again, is the perpetuation of two business models.

Historically, Mutual Services Corp. advisors have opted for the latter two approaches.

"Advisors, and I agree with them, are not going to risk a client's relationship or assets on something they're just getting used to themselves. There's a lot to understand about fee-based versus commissions," Vivacqua notes. "There are a lot of options; it's a different way of doing business. When it comes to advisory services, they have to decide: Do they produce quarterly performance reports? Buy software to do it? Use a platform provided by their broker/dealer or do they hand it off to a third-party money manager, which may offer different types of management styles? And all of this they have to understand and explain to their clients. They're looking at things they didn't look at when they were commission-based. They're outside of their simple world."

Commissions Not Going Away

Even as the move to fee-based gains traction, no one is forecasting the demise of the commission.

Brand Meyer, president of Wachovia Securities' financial services group, estimates that the firm is now 55 percent transactional, down from 80 percent or so five years ago.

"That trend will continue directionally as more clients look for fee-based solutions. But we'll probably hit a point where it will level out," says Meyer. "We're always going to have clients with different needs, and some will have a preference for transactional. We need to have that kind of flexibility."

Wachovia Securities advisor Christopher Sargent has been an advisor for 40 years. With $700 million in assets under management, Sargent, who is headquartered in Washington, D.C., has never pondered making the switch. In fact, he thinks his clients are better served under the commission model.

"Once you get used to a system, you don't want to change. Even though I'm transactional, I'm not a trader. We don't do a lot of trading in our accounts. Fee-based would be more expensive for my clients," says Sargent, who discounts every trade by 30 percent. "I don't have one client who's asked me to go fee-based. I'd rather listen to them than to the Street. I'm not here to say my method is better. I just think for my clients it's better."

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Advisors are making the move to fees for multiple reasons -- as a lifestyle choice, to create more value in their practice, as a succession strategy, and in an effort to become more of a relationship manager.

Fee-based pioneer Brent Hicks operates FocusPoint Solutions, a Portland, Ore.-based firm that helps financial advisors build profitable fee-based businesses. Most of his clients come to him because they are stuck in the transition process.

"Traditionally, we see advisors who have kind of slid into some fee business. Everybody talks about it and most advisors are doing some of it," he says. "Initially, most advisors sort of get the concept and they think it's nice to have recurring income so they'll do fees for this or that client. But what happens is they're treating it as just another product. They say they want to be primarily fee-based but they're walking with a foot on each side of the line, kind of stuck, which is a messed-up business model."

Here is Hicks' best advice on how to make the move:

o The single biggest hurdle is mental. As Hicks notes, "It's a big mental shift for a lot of advisors to say: I'm going to be fee-based." Clarify what it is you want to create. What do you want your business to look like?

o Approach your business as if it is a completely new one, which it is. "This is a different business than you're used to," says Hicks. "Write a business plan just as if you were starting a new business and going to a bank for financing."

o Create a timeline. A lot of industry pundits suggest taking two to three years to transition from commissions to fees. Hicks believes that's too long. "It misleads advisors badly to talk about a long timeline like that," he adds. "We've done it in as short as three months or a year for fairly complicated situations."

o Consider outsourcing as much as possible -- not only investment research and money management but back-office functions, reporting duties, even marketing. "Our belief is that advisors should outsource everything they possibly can and preserve their time and energy for client relationships," says Hicks. "In today's marketplace for advisors, I can't think of anything that can't be outsourced. You can outsource in pieces or bundles, finding the right solution."

o Sit down with each client, making a specific proposal for what the change can mean for them. Explain exactly what you are doing -- and why. "What we help advisors think about is this is a good time to clean up some of the messes you have in the business. There may be a number of clients you don't feel are appropriate," Hicks says. "There are solutions to that." It's rare, Hicks says, for clients to "hedge." In his experience, 98 percent to 99 percent of clients make the move with the advisor.

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"It's almost entertaining. You get to do the right thing by the client and make twice as much money."

--John Bowen, founder, CEG Worldwide

"I'm sure the move to fee-based has been good for some reps, hopefully good for their clients too. It's not the answer for all reps or clients, certainly not for my clients -- and therefore not for me. We get compensated well for what we do. In the long run, we will earn back by retention and quality referrals what we lose by not covering ourselves with recurring commissions."

--LPL advisor Mike Ghelfi

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