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Have Fee-Based Models Won the Battle ... or the War?

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Discussion about compensation with clients is never easy, but advisors can take some relief that clients who rely on their advice are happier with fee-based models than commission models. In fact, 62% of investor households prefer fee-based payment arrangements over commissions, a Cerulli Associates study found.

That figure includes self-directed investors. For those who rely on advisors for investing guidance, the share is even higher.

Source: Cerulli Associates

Investor preference has shifted in the last seven years, the study found. In 2011, 27% of all investor households preferred to pay a fee based on assets under management, while 44% preferred a commission arrangement. (The remaining investors preferred to pay a retainer or hourly fee.) In the third quarter of 2018, 36% of investors preferred AUM fees, while 38% preferred commission only.

Another big change: investor awareness of fee structures. Whereas in 2011, only 10% of investors were aware of fee-only models (18% were aware of commission models), in 2018, 34% were aware of fee-only structures while 22% were aware of commission models.

Of course, who the investor was made a difference. There was a major “bifurcation” between do-it-yourselfers who preferred to tie costs or commissions to a specific activity, and advisor-assisted/directed investors, who preferred a fee-based model.

Other points of the study were:

  • Development of fee-based programs signals the transition of stockbrokers to advisors.
  • Movement toward fee-based models will continue as advisors move toward being “client partners in pursuit of long-term goals rather than transaction facilitators.”

The study, an online survey of 10,000 households, was was done in partnership with Phoenix Marketing International.

Fee-Based Asset Growth

The Cerulli study also found rapid growth of fee-based assets between 2008 and third quarter 2018. Overall fee-based assets grew to 45% from 26% of total advisors’ assets. Although broker commission-linked assets still are the bulk of the fee business, total fiduciary/AUM fee-linked assets are closing in fast. In 2008, brokerage/commission assets were $7.5 trillion, while fee-linked assets were $2.6 trillion. In 2018, brokerage commission-linked assets were $11.2 trillion, versus fee-linked assets at $9 trillion.

Source: Cerulli Associates, The Cerulli Edge – U.S. Retail Investor Edition, 1 Q 2019 issue

The study found one problem with fee-based models tied to AUM: a “hazard of ‘reverse churning,’ wherein advisors were not delivering the ongoing care and maintenance of portfolios intrinsic in fee-based advisory accounts,” according to Cerulli. “Just as commissions can incentivize marginally necessary transactions, AUM fees can bias advisor toward inactivity.”

To counter this, several BDs added “elements” to advisor compensation based directly on rewarding new client acquisition, the study noted. “For example, in 2018, Merrill Lynch added a ‘growth grid,’ which could alter advisors’ payout rates up or down up to 2% based on new client acquisition.” The program was so successful, Merrill renewed it for 2019. Cerulli also pointed out that fee-based advisors got “built-in raises” as assets grew with the stock market rally,

Fees and Trust

It’s possible, according to Cerulli, “that investors are just not that interested in understanding the details of these arrangements.” That said, investors who pay AUM fees “indicated the highest satisfaction and willingness to refer among widely used arrangements.”

The study also found that self-directed investors made up a large share of those who were unsure of their provider’s compensation.

Perhaps the best news for advisors was those clients in AUM fee-based arrangements (65%) and those who pay hourly fees (74%) were the most likely to agree that their financial services firms looked out for their best interest. Commission payers, at 34%, had the the lowest levels of trust in their financial service firms.

Overall, the share of clients willing to refer a primary advisor has risen to 84% in 2018 from 61% in 2010. Further, according to Cerulli, “the general trend in investor trust in financial professionals has increased since 2011, with every measurement in our index increasing since that time.” In 2010, investors’ agreement with the statement that financial firms were looking out for them was at a net -11%. In third quarter of 2018, it was a positive 33%.

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