Robert Reid: Can you justify your fees?

ReidRob

The FCA’s asset management market study published in November will, in time, be considered a seminal moment in changing the shape of remuneration for all concerned in this sector.

Those who have commented on the paper to date have focused mainly on the impact on fund management companies, giving insufficient attention to issues regarding advisers. But consultants (ourselves included) warn of levels of remuneration for advisers being compressed too.

Such a downward trend has not been seen in the time since RDR came into force. Indeed, some propositions have doubled their charge, even though the level of service remains unchanged.

Recent press comment suggests some nine out of 10 advisers now refer the bulk of their investment advice to discretionary fund managers. But it is difficult to see how a charge of 1 per cent could be taken from a client’s assets for simply referring them.

Even if we accept there is a cost associated with due diligence before any referral is made, I would argue such a charge is excessive (unless, of course, the amount being referred to the DFM is under £100,000, in which case the percentage is not as important as the overall charge).

It would be more understandable if someone was to charge 25 to 35 basis points to monitor the DFM and prepare analysis of its performance against the benchmark, together with a performance analysis against alternative players in the marketplace.

If this was being done on an annual basis with triennial beauty parades, then it would definitely be reasonable value for the client. DFM due diligence should always be robust, as if it was being used by a charity or large pension arrangement.

But it is difficult to see how 1 per cent per annum can be charged for simply referring to a DFM, especially as the level of work done by the intermediary must only decrease in subsequent years.

Although the regulator is not minded to control fee levels, it is trying to control how services relate to charges. If the level of service is more than adequate and provides significant additional value, then there is nothing to worry about. Where someone’s financial plan is being fully implemented, monitored, reviewed and managed in the format agreed, then a 1 per cent charge is not necessarily excessive.

“It is difficult to see how 1 per cent per annum can be charged for simply referring to a DFM, especially as the level of work done by the intermediary must only decrease in subsequent years.”

The principles of pricing

On the other hand, if all that happens is an annual investment review, this is bound to come under increasing pressure from the regulator, as well as from the more informed clients. Poor disclosure creates confusion and makes complete transparency impossible.

I recently read The Psychology of Price by Leigh Caldwell, which lists the seven principles of pricing. I would thoroughly recommend taking a look, as it brings the client’s perspective into focus and reminds us we should charge on what is valued by them and not on our need to cover our fixed costs.

Clients need to be able to see what they are getting so they can appreciate it and compare it with alternatives. How we communicate our charges will be, for each of us, the long-term determinant of our success. Low charges are not the answer; justifiable charges are. That is what will enable long-term profitability.

Robert Reid is director at The Ideas Lab

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Comments

There are 13 comments at the moment, we would lover to hear your opinion too.

  1. To the only person(s) that matters – Mr Client Yes!

  2. I have recently had the same conversation with 3 separate advisers (each from a different firm). They were very proud of their post RDR proposition, particularly the layers of investment resource employed, starting with sophisticated risk analysis and asset allocation and then including a DFM for fund selection and tactical tilting. The sum total RIY including adviser ongoing charge, platform charge, fund charges and DFM charge varied between 2% and 3% (one used mainly passive funds but still used a DFM to select them). The problem as I saw it was that their clients all had existing investments so they were all advising on replacement, in which case FSA FG12/16 applies. The existing investments included life company plans. These had a poor reputation for high charges but much of that was because of high initial charges. The ongoing charges now are often as low as 1%. The replacement proposition frequently had a higher cost in excess of 1% pa extra RIY. So my question was; how can that past replacement

  3. I have recently had the same conversation with 3 separate advisers (each from a different firm). They were very proud of their post RDR proposition, particularly the layers of investment resource employed, starting with sophisticated risk analysis and asset allocation and then including a DFM for fund selection and tactical tilting. The sum total RIY including adviser ongoing charge, platform charge, fund charges and DFM charge varied between 2% and 3% (one used mainly passive funds but still used a DFM to select them). The problem as I saw it was that their clients all had existing investments so they were all advising on replacement, in which case FSA FG12/16 applies. The existing investments included life company plans. These had a poor reputation for high charges but much of that was because of high initial charges. The ongoing charges now are often as low as 1%. The replacement proposition frequently had a higher cost in excess of 1% pa extra RIY. So my question was; how can that pass the replacement cost comparison requirement? The answer in each case was that the charges were all disclosed to the client and they were happy!!!

  4. 1. The large majority of clients are not cost aware or sensitive however much some advisers like to think they are.
    2. Most clients are incapable of comparing costs, charges and associated products and services in a meaningful way even if they wanted to.
    3. The client’s perception of their adviser and the service they see and receive is more important than anything else, including costs, products and services.

    You only have to look at the success of SJP to see this in action. This has not changed in the 30 plus years I have been in the business. It’s not going to change by tinkering or giving clients yet more information – they passed saturation point many years ago. The only way prices will go down in financial services is by direct price control. Which isn’t going to happen.

  5. Great book recommendation well worth a read (no pun intended

  6. It’s interesting that the current debate around fees often focuses on advisers outsourcing to dfms. Prior to the advent of the managed portfolio service offered by dfms, similar style funds were offered by life offices under the multi asset banner. The job of the ifa was to monitor the multi asset manager, continue to check a clients atr and cfl was in line with the fund and move where appropriate, use tax allowances such as pension and isa, give clients reassurance in turbulent markets etc. Commission was paid for this (albeit many advisers didn’t bother reviewing their clients).
    Post rdr, advisers using model portfolios continue to do all of the above and offering at least the same service (for a start they’re actually doing reviews and documenting the ongoing advice), but in most cases more through cashflow modelling, tax planning and other full financial planning services. The advisers in most cases are more qualified than they were, have greater liabilities to fscs and higher costs due to increased regulation, yet the constant argument is that they should be taking less for doing more.
    While the business I work in is profitable, many aren’t exactly earning fortunes when compared with solicitors, accountants etc who the profession is supposed to be on par with in the era of professionalism. I wonder how many will stop trading if regulation forces them to charge clients less? Given the average age of a financial adviser is late 50s, how many will simply retire and widen the advice gap? I’m young and it won’t make my life harder if they do, but I wonder how good it will be for advice and the public at large who without advice will leave their funds in the bank earning sub 1% and won’t make use of tax efficient allowances, put enough away for retirement and will pay too much IHT or tax in general?

  7. I agree Robert. Hiding behind the ” 1% norm ” is the refuge of the commission cowboys, still alive and well and practising in a town near you! Tell your clients what you will do for them, charge a fair price and deliver the service. Hopefully one day the public will be able to recognise the value of advice and be prepared to pay for it.

    Transferring a pension or other product from A to B in order to slap on an adviser fee charge of 1% is not advice, still good old churning as in the pre RDR days.

  8. Why all of this noi se about IFAs justifying there fees? I don’t see Lawyers, Dentists, Medical Consultants, Vets and Academics having the same noise about their fees?
    Surely the end Client(s) will decide whether what they receive as a service is worth the money they pay for it?
    If they think that a Govt body is going to decide on what fees are appropriate they will be very much mistaken

  9. In A Free Market, No Profit Is “Excessive”

    Authored by Ludwig von Mises via The Mises Institute,

    https://mises.org/blog/free-market-no-profit-excessive

    Profits are never normal. They appear only where there is a maladjustment, a divergence between actual production and production as it should be in order to utilize the available material and mental resources for the best possible satisfaction of the wishes of the public. They are the prize of those who remove this maladjustment; they disappear as soon as the maladjustment is entirely removed. In the imaginary construction of an evenly rotating economy there are no profits. There the sum of the prices of the complementary factors of production, due allowance being made for time preference, coincides with the price of the product.

    The greater the preceding maladjustments, the greater the profit earned by their removal. Maladjustments may sometimes be called excessive. But it is inappropriate to apply the epithet “excessive” to profits.

    People arrive at the idea of excessive profits by confronting the profit earned with the capital employed in the enterprise and measuring the profit as a percentage of the capital. This method is suggested by the customary procedure applied in partnerships and corporations for the assignment of quotas of the total profit to the individual partners and shareholders. These men have contributed to a different extent to the realization of the project and share in the profits and losses according to the extent of their contribution.

    But it is not the capital employed that creates profits and losses. Capital does not “beget profit” as Marx thought. The capital goods as such are dead things that in themselves do not accomplish anything. If they are utilized according to a good idea, profit results. If they are utilized according to a mistaken idea, no profit or losses result. It is the entrepreneurial decision that creates either profit or loss. It is mental acts, the mind of the entrepreneur, from which profits ultimately originate. Profit is a product of the mind, of success in anticipating the future state of the market. It is a spiritual and intellectual phenomenon.

    The absurdity of condemning any profits as excessive can easily be shown. An enterprise with a capital of the amount c produced a definite quantity of p which it sold at prices that brought a surplus of proceeds over costs of s and consequently a profit of n per cent. If the entrepreneur had been less capable, he would have needed a capital of 2c for the production of the same quantity of p. For the sake of argument we may even neglect the fact that this would have necessarily increased costs of production as it would have doubled the interest on the capital employed, and we may assume that s would have remained unchanged. But at any rate s would have been confronted with 2c instead of c and thus the profit would have been only n/2 per cent of the capital employed. The “excessive” profit would have been reduced to a “fair” level. Why? Because the entrepreneur was less efficient and because his lack of efficiency deprived his fellow-men of all the advantages they could have got if an amount c of capital goods had been left available for the production of other merchandise.

    In branding profits as excessive and penalizing the efficient entrepreneurs by discriminatory taxation, people are injuring themselves. Taxing profits is tantamount to taxing success in best serving the public. The only goal of all production activities is to employ the factors of production in such a way that they render the highest possible output. The smaller the input required for the production of an article becomes, the more of the scarce factors of production is left for the production of other articles. But the better an entrepreneur succeeds in this regard, the more is he vilified and the more is he soaked by taxation. Increasing costs per unit of output, that is, waste, is praised as a virtue.

    The most amazing manifestation of this complete failure to grasp the task of production and the nature and functions of profit and loss is shown in the popular superstition that profit is an addendum to the costs of production, the height of which depends uniquely on the discretion of the seller. It is this belief that guides governments in controlling prices. It is the same belief that has prompted many governments to make arrangements with their contractors according to which the price to be paid for an article delivered is to equal costs of production expended by the seller increased by a definite percentage. The effect was that the purveyor got a surplus the higher, the less he succeeded in avoiding superfluous costs. Contracts of this type enhanced considerably the sums the United States had to expend in the two world wars. But the bureaucrats, first of all the professors of economics who served in the various war agencies, boasted of their clever handling of the matter.

    All people, entrepreneurs as well as non-entrepreneurs, look askance upon any profits earned by other people. Envy is a common weakness of men. People are loath to acknowledge the fact that they themselves could have earned profits if they had displayed the same foresight and judgment the successful businessman did. Their resentment is the more violent the more they are subconsciously aware of this fact.

    There would not be any profits but for the eagerness of the public to acquire the merchandise offered for sale by the successful entrepreneur. But the same people who scramble for these articles vilify the businessman and call his profit ill got.

    The semantic expression of this enviousness is the distinction between earned and unearned income. It permeates the textbooks, the language of the laws and administrative procedure. Thus, for instance, the official Form 201 for the New York state income tax return calls “earnings” only the compensation received by employees and, by implication, all other income, also that resulting from the exercise of a profession, unearned income. Such is the terminology of a state whose governor is a Republican and whose state assembly has a Republican majority.

    Public opinion condones profits only as far as they do not exceed the salary paid to an employee. All surplus is rejected as unfair. The objective of taxation is, under the ability-to-pay principle, to confiscate this surplus.

    Now one of the main functions of profits is to shift the control of capital to those who know how to employ it in the best possible way for the satisfaction of the public. The more profits a man earns, the greater his wealth consequently becomes, the more influential does he become in the conduct of business affairs. Profit and loss are the instruments by means of which the consumers pass the direction of production activities into the hands of those who are best fit to serve them. Whatever is undertaken to curtail or to confiscate profits impairs this function. The result of such measures is to loosen the grip the consumers hold over the course of production. The economic machine becomes, from the point of view of the people, less efficient and less responsive.

    The jealousy of the common man looks upon the profits of the entrepreneurs as if they were totally used for consumption. A part of them is, of course, consumed. But only those entrepreneurs attain wealth and influence in the realm of business who consume merely a fraction of their proceeds and plough back the much greater part into their enterprises. What makes small business develop into big business is not spending, but saving and capital accumulation.

    Originally Published in Planning for Freedom, Featured in The Mises Reader

  10. Grey area makes a great point – The advice market is very uncompetitive. It is very unlikely clients will try 5 advisers before picking one. There are no price comparison sites and generally the various charging structures are incomparable. As a result most advisers are in a pretty nice place, knowing that their clients are unlikely to leave, even with the occasional 0.25% increase in charges.

    The only thing that will drive any change here is a competitive increase in the market, until that happens advisers are holding all/most of the cards.

  11. Nicholas Pleasure 18th January 2017 at 1:51 pm

    Correct me if I’m wrong but what I see is this:
    1. The FSA increased the bar to membership of our profession and refused grandfathering during RDR. This meant that lots of advisers retired and many left.
    2. The FSA/FCA still hasn’t addressed the many issues that make becoming a financial adviser generally unappealing. I’m thinking of things such as the weight of regulation, the constant wondering whether you might be doing something wrong, the retrospective reviews, the unending liability, the FSCS levy and the £3K plus a year that it costs to remain regulated.
    3. These factors mean that there are many more clients than there are advisers.
    4. Then the FCA worry that advisers are charging too much. Advisers will charge what the market will stand and it will stand a great deal because there is pretty much nowhere else for clients to go.

    FCA – if you want low fees make financial advice an appealing profession with clear rules, boundaries and liabilities. Until this happens we can and will charge what we like, even if most of our profit goes on FCA fees, FSCS levies and compliance consultants. What a waste.

  12. Matthew & Grey Area – you have this spot on. All of the ‘vital signs’ within the market indicate that consumers do not shop around and compare prices when choosing an adviser. Until that happens then there is no way of knowing whether adviser firms are charging too much or, indeed too little. The challenge for the regulator is to find an effective way of enabling consumers to compare prices and services offered.

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