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Richard Leeson: Uncapped advice fees are under threat

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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?”

IFA: “Yes.”

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

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Comments

There are 25 comments at the moment, we would love to hear your opinion too.

  1. We could all just move to SJP and still get paid commission

  2. paolo standerwick 20th August 2015 at 5:20 pm

    I don’t understand why advisers are being constantly being made to feel we have to work for a pittance.

    What nonsense about capped fees and for the following reasons:

    1) Clients won’t pay too much as the market conditions dictate fees
    2) If fees are capped then regulatory costs must also be capped – (Good bye FCA)
    3) One gets what they pay for, pay too little you probably get too little
    4) As a client said to me once, if you the adviser makes a profit, the provider makes a profit and I make a profit that’s good news all round. If one of those elements doesn’t, that’s bad news
    5) With regulatory fees constantly on the up, there’s no choice but to collect it from clients, otherwise advisers are out of business

  3. Insurance companies and investment houses have charged in this way for decades and will continue to do so and clients remain invested -plus I really think an annual charge of 1% too much-, perhaps you need to rethink your own charges!!

  4. The beauty of percentage-based fees is they are incredibly simple to understand and apply for both the client and the adviser. The client doesn’t need to worry they will pay more one year than they have previously unless their fund values increase (and if their fund values do increase they will keep the other 99% of the fund growth). There is an incentive to grow the client’s assets, but not such an incentive that the adviser’s priorities become skewed (I’m not going to risk telling my clients to invest in a fund that could return 50% or lose 50% next year just because my ongoing fees will be higher if the fund values go up 50%). The adviser is able to implement his business structure knowing he has a more secure level of income. Solicitors charge fixed fees and accountants charge fixed fees (sometimes alongside percentage fees) but they don’t contract to deliver a service on a fixed date in the future. How can I guarantee I will see x clients over the next y months, and put that down in a written client agreement with each of those x clients, if half of the clients don’t turn up on their scheduled appointments or pay their fee on time? My staffing costs don’t alter if clients don’t turn up. My regulatory costs and rent don’t alter. But the client will still expect to be fully serviced on whichever date he decides to turn up to his meeting and pay his fee.

    The downside of percentage fees is they are a blunt instrument, but they are still a blunt instrument that is effective. In reality the example above is more likely to end with the adviser offering to reduce his ongoing fee below 1%. If he doesn’t he should, in theory, lose the client’s business and the client will choose a new adviser who is less rigid in his fee structure. That’s how supply and demand works.

    Then in 5 years, or 25 years, when the client (or the late client’s relatives) complain the £750,000 pension fund was not managed correctly after they saw a solicitor’s advert on the TV, the new adviser will be able to look back and decide if cutting his fee still covers the countless hours he personally spends on his response, the 2 years he waits for FOS to respond, the excess on his PI policy and the resulting hike in his premium, the court fees when the client pursues him via the solicitor (after they have no luck via FOS), the disruption to his business and his family life…

    Anyway, clients have enough information, choice, protection afforded to them to let them decide who they want to be their professional advisers. If 1% of all their fund values is too much they can look elsewhere or the adviser can have a sensible look at his charging procedures.

  5. I agree with most of what is said… however I do believe that the article inferring that many charge 1% OAC is misrepresentative in the majority. I have never charged 1% OAC, normally I charge 0.5% and for larger clients 0.25%. If I had any clients with significant portfolios I would certainly consider capping it. Finally nothing is fixed with my clients and if portfolios should increase significantly due to windfall or inheritance then we can negotiate at that time…

  6. Dermot Brannigan 20th August 2015 at 5:33 pm

    And the moral of this one is – don’t bother reading the article, head straight for the comments as there’s infinitely more sense being talked about there

  7. Key point here is until the FCA and PI insurers move to capped charges we can’t amd probably shouldn’t make the move. However a flat 1% charge is not sustainable and HNW clients would be right to challenge it

  8. If the charge is fair in your own mind, then stick with it to the point where, if necessary, the client goes elsewhere (£10,000 a year for servicing a client equates to 60 or so hours of work per year; for that amount it is probably appropriate that the client should dispute things).

    If they trust you and value your advice and support and you charge a fair price (and feel that you can justify it in terms of the overall cost of running your business… regulatory fees, PI, petrol, the lot thrown in), they won’t leave! If they had to do their own research, convince themselves that their decisions were correct and do their own fetching and carrying, the cost would soon become clear (and if they want to do this, then just let them, I do…I’m not a charity!).

    However, it does stick in the throat when providers collect the business without liability for the advice and without payment for the same, but such is RDR!

  9. We should all have self imposed decency levels, and spend more time explaining the service we actually provide, and the infrastructure behind it. I personally think 1% of 500k for an annual summary amounting to one page and a quarterly magazine is obscene at one end of the scale, at the other 0.5% of 50k does not go very far.

    I believe I charge each client fairly, the main thing is that they trust me and value what I do, so for them cost is not perhaps an issue.

    • @Geoff – That’s what I have in my head “decency levels”, my quoted tariff mentions no discounts as it allows me flexibility to agree with the client WHERE to apply those discounts until the total remuneration is within my “decency level”

  10. For Paul Williams’ comment, thank you! – such perfect common sense and pragmatic approach… strangely, we use common sense and intuition, as you clearly do…if a client situation such as the example given arises, we immediately review and, if necessary, review ongoing service charges downwards in proper discussion with the client.

    Those that don’t or won’t do the above deserve to lose clients to those that do – as in any commercial situation.

    As other comment here, until the Regulators, PI insurers.. and even, dare we say, HMRC and VAT, move from percentage to fixed charging for what they do, why should we? – or anyone operating commercially for that matter, particularly when the client can see it, and control it… with his feet, if needed?

    It would be so nice if people would just stop trying to fuel potential hassle on this subject – those that want to go fixed charge route and their clients like it and buy it, please continue and here’s hoping it all goes well for you and all parties prosper – but don’t keep trying to ‘convert’ everyone else to your doctrine just because you’re convinced you’re right, please!!… shades of religious canvassing are really not needed here!

  11. In about 2007 i.e. pre RDR, we started to go fee based (I had planned to in 1993 but a business split and personal issues delayed it)
    We decided we needed to look at our break even point and establish monthly retainer fees to match it and called them a “Regulatory Premium Fee” to reflect the fact regulation COSTS a lot. This fee was worked out as F-pack fees + PI + Compliance Support costs + admin support staff costs + office costs = Total / number of clients willing to pay retainers / 12 = monthly fee.
    In doing so it meant we would advise people with small potsif they valued this quoted cost… wed make NO money on them at all as I would nto earn a penny and these were effectively at cost/pro bono. All clients were then charged 0.5% of FUM. For smaller pots, the monthly retainer plus FUM charge could equate to 1.5%. For about 25% of our client base, it equated to 1% and then most clients, it equates to about .6% I reckonNone of our clients have enough for us to start discounting the 0.5% on all their portfolio and what we tend to do is provide some advice on inherited individual plans with no dinoseur policy based adviser charge instead.
    The key point is it then is easy to relat to a client as being relative to what we are saying about increased FSCS fees. I haven’t increased the fees for sometime and will recalculate them on the same basis and see if my increased client numbers means the fee can remain the same or if the F-pack”s increased levies and Treasuries trousering of fines means I need to increase my fixed fees orphaning lower payers.

    • This is the method I agree with most, as long as there is logic and justification in the calculation and it is “sense-checked” there shouldn’t be an issue. However the FCA will probably then decide that high percentage fees (i.e. 1.5% for the smaller clients) are as unacceptable as high monetary costs (£10,000 per year for a £1,000,000 portfolio).

  12. Christopher Petrie 20th August 2015 at 9:26 pm

    The FCA couldn’t ban these charges even if they wanted to (which I don’t think they do). These charges are legitimate under EU law, which supercedes FCA rules.

  13. There’s also the factor that a PI claim for £1 million fund will have a far bigger impact by way of higher costs in the future, compared with a £250,000 fund, so you can easily justify any particular charging structure.

  14. The other unanswered question is when will platforms be able to accommodate tiered adviser charging in the same way that some of them apply tiered platform fees!

  15. The elephant in the room is conduct risk. Consider very cautious clients being recommended portfolios that after charges (adviser and the rest) are likely only to go backwards. Some clients are better off in cash, at least in the current environment. Do advisers have perverse incentives (to pay regulatory fees etc.)? In a few years we will be debating compensation for these folk. Be very careful if charging 1% in making sure the advice stands up.

  16. Really don’t get the comparison/analogy of the client using his £1M fund to purchase an annuity???? Following that route (annuity purchase) would require limited and potentially no ongoing advice but at the cost of receiving an investment return of 2.75% with complete loss of capital!
    It is largely due to the above paltry return that clients are prepared to pay for advice in order to achieve better returns.
    As others have pointed out a bit of a joke article.

  17. Paul Standerwick 21st August 2015 at 12:07 pm

    Surely, as with all things, the client is free to shop around? I agree that 1% x £1m is expensive, but there would be no compulsion for the client to remain with that adviser! To cap fees as a short term fix, would be very short sighted and would ignore the dynamic nature of our industry. A poorly written and thought out article.

  18. The issue I have with regulators questioning percentage based fees is how the FCA will apply any new rules or caps fairly across all firms.

    Example 1: Overheads
    Say Firm A works in an area with very high overheads (London is the best example of course) but they only aim to attract clients with £50,000 to £100,000 to invest. Their fees are 1% of assets for all clients. Firm B is in area with low overheads but also aims to attract £50,000 – £100,000 clients and also charges 1%. They both do the same work for the clients. Firm A makes less profit than B. But does this mean Firm B is in the wrong because his charges do not match his overheads?

    Example 2: Absolute vs relative client differences
    Firm A’s smallest client has £100,000 invested and their largest client has £400,000 invested. Firm B’s smallest client has £1,000,000 invested and their largest client has £4,000,000 invested. So Firm A has a relative differential of 4x but has an absolute differential of £300,000. Firm B also has a relative differential of 4x but has an absolute differential of £3,000,000. Both firms charge 1% of all client assets. Are they both in the wrong because a client 4 x bigger is getting charged the same % fee? Or is Firm B in the wrong because of the diference in £ compared to Firm A? What if we introduce Firm C with 1% fees and with its smallest client at £25,000 and its largest client at £100,000 (absolute difference of 4x but relative difference of £75,000) – is Firm A now in the wrong as well because it charges more in £ than Firm C?

    There is also Example 3: Number of clients, Example 4: Relative experience of advisers and support staff, Example 5: Business risk taken/services offered, Example 6: Firms which refuse all new clients vs firms which encourage as many new clients as possible.

    Based on these examples the FCA couldn’t set a maximum % cap, because then that would become the new fee for al advisers. The FCA couldn’t set a maximum hourly fee because this doesn’t account for overhead diferences betwen firms or experience/services offered.

    Basically there is too much variation between firms to set a consistent cap. The only one thing which links all of us is profit. So the only way to realistically set a cap is to set a profit ratio maximum. For example, adviser firms can’t make more than 30% profit in one year for their advice activities. Any other way will result in big winners and big losers.

    So if the FCA talk about capping fees, start to panic because the only logical approach is a profit cap.

  19. To my mind’s eye there is only one line in the whole article worth contemplating.
    “Client dissatisfaction can only result in regulatory intervention as the FCA is committed to positive outcomes for investors.”

    Excuse me…… what country are we living in….. North Korea ? its the only place I can think of where a “positive outcome” (which I believe is only found under the pillow of the unicorn !) is strived for by the total disregard and en-slavery of others !!

    So all this bull squirt about 1% this 0.5% that, is nonsense, what you really what to say is……… buckle under and blindly accept everything that comes out of Canary Wharf, because woe be tide if you don’t.

    Not on you Nelly old chum !

  20. Douglas Baillie 22nd August 2015 at 9:21 am

    A significant part of my firm’s costs are incurred in ‘information mining’ trying to accurately discover exactly what existing investments and pension assets the new client actually has. This can take months before pension administrators respond accurately.
    Hardly anyone knows what they already have and woe betide the adviser who doesn’t take the time to find out before offering advice. Does the client want to pay me for all of this work and the subsequent analysis?
    You tell me.

  21. Just as a final comment on this matter, I recently received my home insurance renewal in the post. There has been no change to my cover, I now have 1 more year of “no claims” and yet my premium has increased from £22 to £29 per month (a 32% increase). My insurer actually needs to do less work this year than they did last year as I don’t need to change any details with them (so they just keep collecting the money from me). Obvious answer: I will shop around.

    So why can an insurer put up their charges by 32% in one year without justification and I can be expected to “shop around” but advisers can’t set their charges under the assumption clients will also “shop around”? Market forces apparently drive all areas of the market except with advice fees.

  22. The article was written to highlight a threat to advisers. That threat is exemplified in Investors Chronicle 3 September, Your Money, Portfolio Clinic.

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