Apparently, I stuck a nerve among flat-fee charging advisors with my March 26 blog for ThinkAdvisor, “Why AUM Fees Still Make (Im)Perfect Sense.” The responses included a Twitter conversation started by financial planner Carolyn McClanahan, and a ThinkAdvisor guest blog by James Osborne of Bason Asset Management, titled “No, Asset-Based Fees Don’t Make Any Sense.”
First, let me say that I have the greatest respect for flat fee-ers: The folks in the Garrett Planning Network and others who have made the choice to earn less money and create less value in their practices in order to follow their consciences and serve the middle market and/or reduce conflicts with their clients. My hat’s off to them.
In fact, the flat-fee folks embody the reason I started writing about and for independent advisors 30 years ago: back then virtually all of them could have made more money as brokers or insurance agents but chose to go independent to better serve their clients. I’ve always had great respect for that approach—and still do: Today’s independent advisors who charge AUM fees invariably charge a fraction of the 160bps to 250 bps that many breakaway brokers seem to feel is appropriate. With that said, I have a hard time getting behind the current “flat-fees for everyone” movement for two reasons:
1) rather than a “new” idea, it’s an old idea with a history of very limited appeal, for good reasons; and
2) the current tactic by flat-fee advocates to vilify AUM fees.
Here are two examples of the current trend to denigrate fees on AUM. Last week, I wrote about an advisor I talked with who referred to AUM fees as “commissions.” As if. And the above referenced title of Mr. Osborne’s blog: “No, Asset-Based Fees Make No Sense.” No sense? Really? I respectfully suggest that this kind of over-the-top hyperbole (is that redundant?) only serves to make the flat fee-ers look like true believers, while doing nothing to further a reasonable discussion of the relative merits of these two methods of advisor compensation.
As I acknowledged in my earlier blog, Osborne and others are right to say that flat fees offer many of the same advantages as AUM fees: a fiduciary duty, economic independence and recurring revenue. But as far as putting the advisor on the client’s side of the table, I’m not so sure. For one thing, flat-fee advisors make the same money whether their clients’ portfolios go up—or down. AUM fees, obviously, reward advisors when client portfolios go up, and penalize them when portfolios go down. That kind of identity of interest seems better.
At the same time, while flat fees “eliminate the asset-gathering/asset-retention conflict,” as Mr. Osborne wrote, they also create conflicts of their own. Osborne went on to say: “I always find myself scratching my head when people in the industry claim that a retainer fee structure isn’t a viable business model. For one thing, it works for practically every other profession – CPAs, attorneys and others have long worked under an hourly or retainer structure to great success.”
Great success? Really? The average small accounting firm is worth about 1x annual revenues: the average AUM fee-only advisory firm is worth between 2x and 3x revenues—and those revenues per client are usually much higher. What’s more, anyone who’s ever worked with an attorney and/or accountant is well aware right from the start of the built-in conflict of interest: billable hours. The client has no way to know how long those professionals spend on their case, and the professionals have an incentive to take as long as possible. Why should one lawyer or CPA get paid more if they have to research a question than one who already knows the answer? Bad example, Mr. Osborne.
The most cogent comment in Carolyn McClanahan’s Twitter discussion came from Bob Veres (Bob Veres @BobVeres Mar 28): “[Bob Clark’s] column ignores the evolutionary nature of the profession. AUM is a waystation, nothing more.” Bob is absolutely right: the present is prologue for the future. But I’m not sure he realizes the full implication of that thought. The other side to that coin is that no one knows how the present will evolve into the future: not me, not Bob, not the folks who advocate flat fees. Yet some want to use the concept of change to support their own predictions of the future when, in fact, they are just that: merely predictions, nothing more.
I have no doubt that the current business model(s) of independent advice will change. It is both my hope—and my prediction—that part of that change will include a move toward even greater independence: such as away from conflicting affiliations (including the custodial perks that Michael Kitces has written about), and away from technology platforms that limit access to investment choices. We see this happening already, as many independent advisors are working with multiple custodians to offer more choices and get better pricing for their clients.
Flat fees are more problematic. Are they really the “wave of the future” or a recycled idea from the past that didn’t get widespread traction the first few times they were tried? To wit: financial planning fees in the ‘80s, the Garrett Planning Network, which to my knowledge has never attracted more than 300 or so advisors, and the advisors who shifted from AUM fees to flat fees in the wake of the Dot.com crash in 2001, only to shift back to AUM fees in time to take another hit in 2008.
Despite our current “youth-culture” mentality, the past does inform the present—and the future, as Harvard philosopher George Santayana reminded us when he said: “Those who cannot remember the past are condemned to repeat it.”