Advisers have faced a number of challenges over recent years: reshaping their business models to a fee/trail model, reviewing their investment proposition and overhauling their back office systems among others. Answering these challenges has resulted in a cost model for some firms, which clients might find unsustainable.
The move to fee-based income began with a switch to trail commission, which has then been absorbed into adviser charging. Most fee models are now set at between 0.5 and 1 per cent a year, with upfront charges of fixed amounts or percentage based fees of up to 3 per cent of assets invested. In the past, adviser remuneration in the form of commission was absorbed into the overall product cost. Today it is explicit.
Investment propositions have moved in many cases to a discretionary fund management model, which can add 0.5 to 0.75 per cent a year to the clients’ costs on top of the underlying collective fund costs of another 0.6 to 0.75 per cent a year.
Adopting a platform to manage clients’ money and facilitate smooth running of the adviser’s back office can again add to the costs. Typical platform fees seem to be between 0.25 and 0.5 per cent a year.
By the time all these costs are added up there could be burden on the client of between 1.85 and 3 per cent a year. If a corporate bond fund is yielding, say, 4 per cent a year the net return to the client after all costs could be as low as 1 per cent. They would be better eschewing the platform, DFM and asset managers and buying dated gilts at 2.5 per cent yield to give a higher return at lower risk – or even a bank deposit!
This is a problem that has been masked in recent years by the performance of the underlying assets. Clients will not be as aware of, or interested in, the charges when returns are well above expectations and deposit interest rates. As we move towards what is likely to be the end of a bull market in equities in the UK, and with pressure mounting on fixed interest investments, we may be entering an era of increased client awareness of costs.
The issue of multiple layers of costs is only going to be compounded with the new pension freedoms in April this year. Those attracted by the option of drawing down their pension pot rather than buying an annuity will be made critically aware of the level of charges when considering the target level of income their fund can achieve.
A client with a Sipp of £500,000 looking to take an income will need to be made aware of the impact of charges on that income. Even at the lower end of the spectrum of costs at, say, 2 per cent, that is a £10,000 reduction in retirement income. Two per cent might not sound much but looking at it another way, £27 per day is quite significant. Treating customers fairly and communicating in a way that is “clear, fair and not misleading” requires the adviser to ensure clients fully understand the impact of charges. It might be time for some to revisit their business models.
The issue to be addressed is this: what can an adviser firm do to reduce the costs to the client without compromising service, while not going out of business in the process? The percentile charges of the various providers in the wealth management offering are clearly a big issue and moving from ad valorem charges to flat fees will be a big help.
A review of the business model and its operations would be a great place to start, questioning the current status quo. For example:
- Does the business need a platform for all its clients?
- Does the platform deliver value for money or is it duplicating the function of the back-office software?
- Is the investment proposition delivering a cost effective and value for money service?
- Are actively managed collectives really the answer?
- What should clients pay for and what should the business pay for?
- Which clients suit the business model?
- Where is the business profit coming from?
- What system is the administration team working on? Is it a helpful client-facing one or one sorting out provider problems?
Solutions will need to be found if clients are to be retained in a world of uncertain returns. A combination of efficiency, client-centric proposition and value for money investment management will be required.
Richard Leeson is chief executive officer of Adviser Advocate