Speaking to an old friend at an IFA practice the other day I opined that uncapped fees were under threat in the long term. My friend agreed and we wondered what could be done about it. You may be asking why uncapped fees are under threat. Let me answer that question by looking at a hypothetical client and a discussion they might have with their financial adviser.
Client: “Mr IFA, I am delighted with the work you have been doing for me and the way you have looked after my £250,000 investment in Isas and the Oeics you recommended. I have decided to transfer my pension pot of £750,000 and would like to invest it through you.”
IFA: “Great news, Mr Client. We would be delighted to help. Of course, we will need to go through all the paperwork, fact find, report writing and so on. We will continue to charge our 1 per cent per annum fee, which we will take from your platform.”
Client: “1 per cent of what?”
IFA: “1 per cent of everything you have invested through us.”
Client: “So that will be £1m at 1 per cent?”
Client: “That’s £10,000 a year.”
IFA: “That’s right.”
Client: “But at the moment I’m paying 1 per cent of £250,000, which is £2,500 a year. Why does it cost so much more to invest £1m?”
IFA: “Ah well. We have overheads, research, professional indemnity fees, FSCS levies, costs of being regulated and so on.”
Client: “But you were happy to do it all for £2,500 until now. Do your overheads really go up 300 per cent simply because I add more money to my investments? Or am I going to be subsidising smaller clients of yours if I invest £1m?”
This is an issue that some advisers are beginning to tackle. Some are doing so prompted by conversations with valued clients not dissimilar to the one above. Others are being more proactive and taking the view that they want to ensure their clients are getting genuine value for money. Many others have yet to address the problem.
In my conversation with my old friend I gave an example of uncapped fee levels. Imagine someone with a pot of £1m in their pension fund. Such a pot would purchase an annuity of about £27,500 for a 65-year-old male. If an adviser were to be taking a fee of 1 per cent a year from that pot (£10,000) it would represent over one third of the client’s net disposable income.
Would a client really be prepared to pay that amount of their income for the advice and service they are receiving? It brings in to question just how clear, fair and not misleading the communications are with the client about the level of adviser charging. In particular, it highlights the FCA’s concern about advisers expressing their fees in pounds as well as percentages.
What should advisers be doing about the problem? For some with a broadly similar client base and only a few ultra-high net worth investors it may be resolved by offering bespoke adviser charging. Other firms with a spread of clients with widely differing levels of investable assets might need a more structured approach. Smaller clients with, say, under £100,000 invested might need to be charged a minimum fee with other, higher net worth, clients having fees capped or tailored to their personal situation.
Understanding the financial dependencies of the business will be vital to the adviser in reaching a conclusion. Asking and answering questions about the costs of running the business and the profitability of different client segments and advice areas will be vital. In an uncapped fee world based on a percentage of assets, the fixed costs of client acquisition and client share of overheads can become obscured. Stepping back and addressing what the business spends money on and what value it receives and gives for that expense will lead to a clearer understanding of how the adviser charging model should look. This, in turn, should lead to a clearer explanation of the adviser charging model and fewer difficult conversations with larger clients.
Failing to address the issue of uncapped fees will eventually lead to client dissatisfaction, especially with the very clients that are profitable for an adviser. Client dissatisfaction can only result in regulatory intervention as the FCA is committed to positive outcomes for investors. As with so many changes in advisers’ lives it will be better to find a solution within the industry than wait for one to be imposed by the regulator.
Richard Leeson is chief executive of Adviser Advocate