Recent attention to the high price of financial advice means that consumers now benefit from a lower-cost environment in which to deploy their investable assets. How does this price compression manifest in advisory firms? Interestingly, the custodians, mutual fund companies and other providers are covering the costs, at least for now.
The 2016 InvestmentNews Financial Performance Survey, sponsored by Pershing, revealed that most advisors who made price adjustments in the preceding year actually raised fees by five to 10 basis points. Further, the median fee advisors charge on assets under management (AUM) has remained steady for the past decade at 77 basis points.
Now, a new survey by Bob Veres of Inside Information provides additional insight into how the advisory profession is managing the price/cost/value equation in their practices and how consumers are benefitting.
The study confirms that the total cost to consumers has come down, driven mostly by those who support the advisors rather than by the advisors themselves. In breaking down the cost to clients, the advisor fee is just a portion of expenses that also include the underlying investment products the advisor uses, including mutual funds, ETFs and other packaged solutions. According to the Veres study, the median expense ratio on these products is 0.50%, but this ratio can be as high as 2%.
If the median fee is 0.77% and the median expense ratio is 0.50%, a client's all-in costs would be 1.27% or 127 basis points. Based on the Veres study, it appears that many advisors are charging fees above the median, are using more expensive financial solutions for their clients or both (see Table 1).
Beyond the transparency regarding underlying costs to consumers, the most startling finding of the Veres study is the noted shift away from variable or asset-based pricing to a fixed pricing model.
The survey covered a range of business models, and more than 30% of the firms that participated use a retainer or hourly rate as part of their fee structure. Roughly 5% were retainer-only and many had a blend of pricing models.
This trend may provide a clue to what the advisor of the future will look like.
Advisors who have made the move to retainer or hourly rates seek to align their charges with the services they deliver, rather than the value clients bring. As an example, in the Veres study, the median advisory fee for assets of between $1 million and $2 million was 85 basis points. Does the larger client in this bracket actually require more of the advisor's time and attention that would justify the higher cost?
The Evolution of Pricing
Historically, financial services firms charged clients a commission based on transactions or a fee based on assets. This has been the easiest way to differentiate between a broker and an advisor, though it's important to acknowledge the considerable differences beyond pricing.
Back when financial professionals were mostly investment-oriented, aligning payment to the performance of the assets made some sense. Brokers were paid for selling stocks and bonds to investors; the commission structure was designed to incent sales. Advisors, too, operated differently: Large blocks of money required investment advisors to work harder to deploy assets in an effective, tax-efficient manner without the technology tools available today.
Much has changed, however. Today, advisors enhance their value by delivering other services while outsourcing most of the investment management process to turnkey asset management programs (TAMPS) or to manufacturers of mutual funds, ETFs and alternative investment products, and many brokers have shifted to a fee-based method of pricing.
Some investment-forward firms still compete for assets, but the greatest growth in the profession has been with “planning-forward” advisors who focus on anticipating and addressing life events such as retirement and college funding, and creating a strategy based on goals, not just investment return. A healthy emergence of wealth management firms highlights the current emphasis on the total complexity of a client's financial life including liability management, philanthropy and tax planning. From a pricing standpoint, how does one charge based on AUM when the client seeks to give away money or purchase other assets without using debt? If the client engages in strategies that will reduce fee-generating assets, should advisors implement pricing structures tied more to their work than to AUM?
Two types of advisors have materially reduced their own fees: the so-called “robo-advisor” platforms and the pure money management firms. Both of these are investment-forward businesses, but robo-platforms use price as a competitive advantage while investment management firms reduce fees as a survival mechanism.
Investment advisors who use individual securities instead of packaged products do not have the same underlying expenses outside of their own fees, though trading costs could be passed along to the client. Consumers often do not see the total cost of doing business with a particular advisor because these numbers do not appear on their quarterly reports. Pure investment managers might realize a marketing advantage if they effectively demonstrate the all-in cost of using them compared with advisors who may have lower advisory fees but use expensive products. Of course, this assumes similar if not superior performance.
Investment-forward firms must differentiate from the robo-advisors, especially if their competitors have giant retail brand names. For example, according to Fidelity's website, current all-in costs for individuals to access their robo platforms range from 0.35% to 0.40%, including the advisory fee and underlying fund fees. Schwab's Intelligent Portfolios platform charges no advisory fees and can use proprietary products such as ETFs with underlying costs in the same range as Fidelity. Other robo platforms such as Wealthfront, Betterment and Vanguard compete with advisors on all-in prices ranging from 0.25% to 0.35%. Active investment managers will have to sustain superior performance and find other ways to add value if they hope to maintain price integrity.
The marketplace for advice is changing. Fortunately, the current oversupply of potential clients and undersupply of advisors supports a solid market for financial services. Competitors are becoming more innovative, however, and many have developed lower pricing, enhanced value and better branding.
As a leader of an advisory firm, take the time to contemplate the big picture, including how the business may change over the next decade. Then zoom in to determine what you must change about your proposition, including price, value and total cost. Advisors of the future likely will absorb costs clients typically pay, including fund expenses, custodial charges and trading fees. Many will also shift to a fixed-fee arrangement or an à la carte menu of charges based on what they deliver. Plan your strategy now in order to stay competitive in our rapidly changing industry.
--- Read RIAs Add Services Without Raising Fees: Schwab Advisor Study on ThinkAdvisor.