August 3, 2009

The Problem With Retainers

Even though it's too early to have any hard data, I've been hearing troubling reports from advisors I know and in some online chat rooms about advisors who had converted to all-retainer compensation. Contrary to what you might expect, the word I'm hearing is that many are struggling in this market downturn.

As I understand it, the problem is client perception: As portfolios shrank--as much as 50%--the retainer fees to the advisors obviously didn't. That meant not only did advisors not financially share their clients' pain, as a percentage of assets under management, their compensation actually went up.

I know, I know, their comp didn't really go up, but apparently the mere appearance of an increase was enough to set some clients off.

In fact, the way I'm hearing it, more than a few retainer-paying clients were troubled enough to change advisors, which of course is exactly the opposite reaction most advisors were hoping for in a down market.

We're all constantly on the lookout for better ways to structure compensation from clients. And after the dot.com crash, there was a movement within the fee-only advisory community to charge a flat retainer--which had the benefit of helping clients to appreciate the myriad other services beyond investment management, and, of course, keeping revenues flat in down markets.

Now we're beginning to see how these flat retainers play out in the real world, and early indications are not promising. It seems that even though asset-based fees have their drawbacks--such as declining revenue during bear markets--the shared identity of interest that fees create between clients and advisors should not be overlooked. Clients are never happy when their portfolios lose some value, but apparently it's much easier to take a decline when they see their advisor sharing in the same economic fate.

For many years now I've been a fan of combining flat retainers with fees on AUM, typically about a 50/50 mix. That way, advisors' revenues are entirely at the mercy of the markets, but they still have enough skin in the game that clients pay noticeably lower fees when their portfolios are down. So far, my clients who charge this way haven't lost any clients from this down market, and are in a better position to grow when things start to turn around.

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