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Robert Reid: The problems with percentage-based charging

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The architects of the RDR made it clear one of its key objectives was to move the power in the market from the manufacturer to the distributor. Given the bulk of the market is still charging on a contingent basis on assets under their advice is it unreasonable to suggest this be revisited by the FCA?

The ongoing focus on the fairness of percentage charges is underlined by comments from regulators that this method of charging is likely to come under scrutiny in the near future. However, as long as the FCA charges on a percentage basis its case is somewhat weakened.

The great benefit of the current and undoubtedly dominant system is that it saves the advice firm the complicated work of setting appropriate fees for each individual client. Just how would you explain the new fee structure to existing and potential clients?

Some will point to the fact the assets under management charge for advice contains a built-in escalator clause, which grows your remuneration as clients add more assets to their portfolios and/or the markets rise. However, the greater workload emanates from a falling market just as the revenue follows suit, so it is easy to argue the AUM method is anything but intuitive.

As we strive to communicate the value we add, being paid on assets alone can lead to a misunderstanding as to where that value really lies. When clients agree to an adviser managing their assets, they will discover that for no extra cost they get a full financial planning service with recommendations they can claim on should they turn out to be unsuitable in hindsight. So zero charge for that element but maximum risk for the adviser.

The problem with this arrangement is best illustrated where an adviser explains his AUM fee structure to a high net worth prospect. The prospective client listens carefully and then says: “So, if I let you manage my £500,000 portfolio, you’ll charge a percentage of the assets and provide financial planning services at no extra charge?”

So far so good. But when the prospective client then asks: “What if I give you just £100,000? Would you still give me financial planning advice at no extra charge?” As the adviser says yes with a grimace he then finds the prospect asking: “Suppose I give you just £50,000?” That is the risk of bundled contingency charging, as providing extras for free leaves you vulnerable.

There are also some glaringly apparent inequalities built into the AUM model. Unless the fees reduce with larger portfolios the clients with the most assets are effectively subsidising everyone else. Is that fair? The trend to a flat 1 per cent will prove to be a major error for many firms and one that is hard to disconnect from.

Charging solely based on assets also has the potential to introduce conflicts of interest where liquidating investments could be the right call but it is at the expense of revenue.

The AUM model creates a dangerous countercyclical mismatch between remuneration and workload. When the markets drop, your phone rings. The harder and faster the plunge, the more your clients need reassurance. At the same time, your remuneration falls. Revenues going down while internal costs head upwards is never a good combination.

Robert Reid is managing director of Syndaxi Chartered Financial Planners

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Comments

There are 22 comments at the moment, we would love to hear your opinion too.

  1. I could not agree more. Commission never stopped in this industry, they just call it a fee nowadays.

  2. Oh dear oh dear… Charging for managing assets is a charge. Charging for a financial plan and ongoing financial planning is a separate charge. Implementation has a charge. Not that complicated. If you offer anything for free you aren’t running a business but a charity. Price your work and deliver value beyond the charges. Your approach only seems to get you in knots.

    Charges have always been a % – commission was a %. How much “extra work” did you do setting up a £300 month pension against one for £100? yet the commission refelcted rather more… The issue is transparency not the amount, that is a commercial decision for the firm and failing to demonstrate value will result in failure.

    Fairness is a relative term and based on perception, but it would seem logical that fees are at least matched by value provided. I fail to understand why you are still struggling with this in 2015.

  3. Good observation. I have always felt that a percentage charge was unfair on both client and adviser. A percentage charge is inequitable for all clients.

  4. Christopher Petrie 26th June 2015 at 10:26 am

    No chang here. Somebody telling us everyone else how they should run their business.

    The client will either agree to your fees or they won’t.

    Meantime, fund managers, estate agents, probate lawyers, some tax accountants, property rental agents, the FCA and FSCS will still charge by % basis…as is done the world over.

  5. Neil Liversidge 26th June 2015 at 10:35 am

    We use a well worked out combination of a basic advice fee with a percentage charge and have the facility to charge additional advice fees if necessary. It all works out very fairly and we have no shortage of clients. Our average case size is circa £150k and our average initial charge circa 1.5%. I do not, however, seek to impose this on anyone else and I am REALLY bored with others trying to impose their systems on me. What I do know is that if the FCA is ever so idiotic as to insist on direct invoicing then the credit control costs will send advice and service costs soaring and make financial services much less affordable to most of the population. Nobody should be telling advisers how to charge. If a client does not like our system they can go elsewhere. That’s called a free market. I don’t like the FCA’s system but I cannot go elsewhere. What do we call that?

  6. If customers are happy with the charging structure they will remain as clients. If they are not happy with it, they will take their business somewhere else. It’s called a “market”.

  7. Neil Liversidge 26th June 2015 at 10:44 am

    Precisely Ken. Over the last ten years I’ve had umpteen nitwits, some compliance people, some employees of other firms, some – a few – business owners, all telling me that I should do this or that differently or we would not survive etc etc etc. But they are still all employees / compliance people / less successful owners (and nitwits!) and we are doing very nicely thank you.

  8. Brendan O'Ciobhain 26th June 2015 at 10:51 am

    Charges can be flat fee, time based or % based. Other professional services have similar differing methods of charging: flat fee, time based or a % of whatever sum they project they will save the client at some point in the future.What matters is that a service is being delivered to a client commensurate with what is being charged and the added value can be demonstrated to the client. I would expect that firms would have more than one service level (unless they are really focused on providing a particular level of service to a particular type of client).
    The firm should be able to clearly explain the services they offer, what the charge is in pounds and pence and how the charge will be taken and why the firm charges in the manner that they do. The client is then free to instruct that firm or not.
    The method of payment is a secondary issue. The primary issue lies in the firm being able to explain CLEARLY what they do, what it costs and what the benefits are to the client. That allows a client to better compare one firm against another and decide who they want to work with.

  9. This is a very interesting article. Can I add a comment from the perspective of a SIPP provider? Most ‘real’ SIPPs (not platform-based quasi SIPPs) charge flat fees that are intended to reflect the amount of work involved, which is not related to the value of the transaction or to the value of the assets under administration (AUA). However, the FCA’s new capital requirements for SIPP operators are based on AUA. This means that there will be pressure on SIPP providers to introduce an element of percentage-based charging solely because of the FCA’s fundamentally flawed and misguided approach to SIPP capital requirements.

  10. ” 2 key comments I’ve taken from above:

    1. ‘Meantime, fund managers, estate agents, probate lawyers, some tax accountants, property rental agents, the FCA and FSCS will still charge by % basis…as is done the world over’….to which I’d add: so do the Inland Revenue & VAT and their equivalents the World over – no chance whatsoever of them ever changing…..

    So how about ‘leave this subject alone, and let individual businesses and their clients and the market forces get on with it’ ?.

    2. ‘Charges can be flat fee, time based or % based. Other professional services have similar differing methods of charging: flat fee, time based or a % of whatever sum they project they will save the client at some point in the future. What matters is that a service is being delivered to a client’….

    As above, how about ‘leave this subject alone, and let individual businesses and their clients and the market forces get on with it’ ?.

    Oh!…and I love Neil’s comment! : Over the last ten years I’ve had umpteen nitwits, some compliance people, some employees of other firms, some – a few – business owners, all telling me that I should do this or that differently or we would not survive etc etc etc. But they are still all employees / compliance people / less successful owners (and nitwits!) and we are doing very nicely thank you.

  11. It amazes me that we have the same arguments here that we used to have with the old commission v Fees debate, ‘my clients are happy with it so there’. It most cases the clients trust their adviser and thrust them to have a fair pricing policy. Most advisers that advise on a percentage/commission have a minimum amount that they will deal with, as the ‘fees’ paid from anything less will not be enough. However how many have a cap? That is the ‘fees’ get so great that the adviser could not justify the fee with the time spent on the client? It is all about maximising profit, doing less for more. I am not against profit, but I am against exploiting the trust clients have to extract more fees than the services provided are worth.

  12. Just because everyone does something the same way, does not mean that it is right and fair.

  13. Neil Liversidge 26th June 2015 at 1:28 pm

    Quote: ‘However how many have a cap?’
    We do for one, Nigel, applied according to circumstances. I can honestly say I’ve never charged a client too much. I do rue charging a few too little, who then, as per sod’s law, turned out to be right royal PITA’s. But one lives and learns!

  14. Nigel, and just because someone doesn’t do it ‘your’ way doesn’t make your way right or fair either. I run model portfolios for my clients and my largest client has the same investment strategy as one of my lowest value clients. In the past 12 months to date, having just checked, my largest client has made 7.92% after all charges are taken into account whilst the other client has made 6.98% (differential caused by large value discounts etc.) I charged exactly the same advice fee in percentage terms to both clients, only my largest client paid me £11,191 more for what I did for him compared to the other client. The research involved in fund selection was broadly equivalent. Sure there was a bit of extra tax planning work for my largest client, but essentially, in all truth, the work involved was largely the same. Clearly unfair in some eyes I know – but then again my numero 1 client made £154,579 after all charges compared to £1,003 for the other one. Strangely enough my biggest client isn’t unhappy and neither is the smaller one.

    I don’t tell others how they should run their lives or businesses and I greatly resent being told that my way is wrong when theirs is so right. We all have to run our businesses within the rules and our clients have complete freedom to choose their adviser. If your system is that much better than mine, I’m sure far more clients will migrate to you so don’t worry. Really if you think about it, better to leave the charlatan’s (like me) as they are and benefit from your USP. Simples! This time next year Rodney and all that.

  15. Trying to draw a distinction between were financial planning starts and ends and separating it from “investment management” is no foundation on which to build this argument. You can’t do a cashflow model without making assumptions around performance returns and risk – these things are intertwined and shouldn’t be switched on and off as stand alone pieces of work.

    I think the article is well written but more from a perspective of how to manage your business and income and offer fair value to clients during market volatility. I disagree that the FCA have an issue with % charging, their issue is around delivering a service for that % or £.

    The comment that % based is actually still commission is both laughable and arrogant, clear communication of costs with clients is what this is about, its not how MUCH we are paid but HOW we are paid.

  16. Robert Reid highlights issues we should all consider from time to time and review against our client demographics and way we work. We may then decide what we are doing works for us or our client or needs tweaking. Mine works pretty well, but can always do witha little tweak, but the cost of tweaking in time (Money) can exceeed the improvement.

  17. Christopher Pitt 27th June 2015 at 11:54 am

    Robert, great article and great timing. I suspect the FCA are starting to realise that widespread use of a % of AUM charging model is the result of consumers having no effective mechanism for shopping around. Transparency is one thing but being able to compare value between different suppliers is another.

  18. Check out page 1 of this from Robert’s own firm….http://www.syndaxi.co.uk/downloads/SOFAC_2014_April.pdf

    • Ha ha, gun & hole in the foot springs to mind, if Robert reid does not like a system of charging clients he can change his but just keep his nose out of my business. I charge a % based fee both initial & ongoing, on top of that there are many occasions where I do things for clients without charge, and that cost me more than a measly .50%. This is my business and I will run it as I please, subject to COBS/FCA/FOS/RDR etc etc etc. Perhaps he is trying to get a job with the FCA!

  19. Now I am completely confused. Rob Reid raised some good issues that we need to consider and address with each of our own methods of charging. I think what my firm has works for us and our clients. How does Rob Reid address these problems in his own firm when his principle (Raymond James) has a charging structure at odds with the problems he has posed?

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