The FSA recently attacked an IFA for charging his services at £150 an hour, which appeared at first sight to be a bridge too far in the world of financial services regulation.
I do not believe the FSA will be telling us how to charge our clients in a fee-based environment as this is a matter of discussion between the adviser and the client and I cannot believe the FSA would want to involve itself in what is a commercial negotiation.
The real issue is to ensure that a client understands what he is likely to be charged on a fee basis and that this is clearly stated, either in the form of quoted hourly charge rates or as a fixed fee.
I am often asked by IFA firms who want to move to a fee basis what steps they should take. The simple fact is that there is no quick fix. Any IFA running a commission-based business, unless they have been working on the basis of very restrictive commission levels, is going to find that their remuneration level will drop dramatically. However, this is really just a trade-off between more income now or more income and an increase in the value of your business over the longer term.
We are all aware that commission levels have reduced and will reduce further. This is inevitable in an environment where product providers are struggling to make ends meet as product charges have fallen.
As a result, it is clear that IFA businesses which have relied on old-style commission models carry little intrinsic value other than any annuity income stream. The idea that the owners of such businesses are building up an asset which they can sell on is misguided. Those organisations which have acquired IFA firms at inflated values can testify to this fact.
What are the benefits of moving to a fee basis on the assumption that the FSA's comment on hourly rates was just an isolated incident?
I believe there are significant benefits although I should make it clear that I am not one of those who believe that fee-based advice is better than commission-based advice. The quality of advice will depend upon who is delivering it.
It is worth making the point that many fee-based advisers will give clients the option where a product sale is involved to use commission to pay fees. Given that this can result in VAT savings and, where investment in either pensions or VCTs are involved, you could say that the fees have been subsidised at the rate of up to 40 per cent through tax relief, this must be in the best interests of most clients. On the other hand, most corporate clients who can reclaim the VAT and set fees against profits will prefer commission-free terms, particularly where staff benefit arrangements are concerned.
What do I see as the principal benefits of running a fee-based IFA organisation? First, there is the discipline involved in ensuring that all our consultants, paraplanners and admin staff complete monthly timesheets so it is easy to identify how they have spent their days. This is a significant management tool in assessing levels of activity and ensures true accountability.
It is easy to establish whether the work you are doing for particular clients is profitable. It enables you to weed out what I refer to as the “value-destroyer client”. Most businesses will have such clients who are effectively driving profit out of your business and the old 80/20 rule – that 20 per cent of clients contribute 100 per cent of profitability – is true in most IFA businesses.
Having identified such clients, it is important that consultants are encouraged to take action either to make them more profitable through perhaps paying retainer fees or by suggesting to the client it is unprofitable for the firm to continue to act for them.
In terms of identifying profitability, we often believe that those advisers who are generating the most commission income are contributing most to the bottom line. Often, this is not the case. What is not factored in to the profit equation is the cost of support staff to deal with the work that is generated. As higher business production is likely to result in bigger bonuses, the profit margin is often lower than for advisers with less significant levels of business production. Again, in a properly controlled fee-based environment, it is relatively straightforward to carry out such an assessment.
Fees also overcome one major concern for commission-based advisers – that they can spend significant time in putting together recommendations and can then be cut out of the equation by the individual dealing direct or perhaps through a discount broker. If you are advising on a fee basis, the client pays for the advice regardless of whether or not they proceed.
Finally, and certainly most importantly from the perspective of the IFA proprietor, a fee basis produces a genuine annuity income stream which adds to the value of the business. If this is combined with trail fees, say, from funds under management, which we are all seeking through increased use of wraps, the value of the business is significantly enhanced were the owner to make a trade sale at retirement.
I have concentrated on the benefits to the IFA but the client is also a major winner. He knows where he stands in terms of IFA costs and the scope of the advice he is receiving while benefiting from the fact that his relationship with that particular IFA firm can be a long-term one,as he will be dealing with a business which is well financed for the future.
Unless an IFA business is seriously under-capitalised, therefore, this is certainly one instance where I believe the short-term pain of reduced income levels is justified by the long-term gain.