The who, what and when of financial advice fees
Financial and investment advisers who want to maximise their revenues must have a deep understanding of their clients’ needs and may have to consider hybrid advice fee models. This was one of the messages that emerged during a recent Morningstar Investment Management ‘Costing and Fees’ webinar; a discussion that was expertly steered by Morningstar SA, Director: Portfolio Specialist, Debra Slabber. “Your clients are becoming more specific about their needs, what they are willing to pay for and how want to pay you,” she said, before conceding that ‘how to best bill clients’ was a controversial topic.
Charge more clients for your services
Alan Moore, CEO and Co-Founder of US-based XY Planning Network and Jaco van Tonder, Advisor Services Director, at Ninety One Asset Management spent the next 60-minutes being ‘interrogated’ on which of the myriad advice fee models make most sense in reaching the widest possible market demographic. Should you only charge using everyone’s favourite assets under management (AUM) model, or should your practice offer clients and potential clients a choice of flat fee; hourly fee; retainer; and / or project-based fee models? The discussion kicked-off with an assessment of current trends in the South African and United States markets.
“The average [South Africa based] advice business, independently focused on investments, is still very much implementing the AUM fee model, which works and has worked for a very long time,” said Van Tonder. He identified a clear correlation between client type and the preferred advice fee structures, explaining this in the context of clients and AUM on the Ninety One platform. The average advice practice using the asset manager as the practice’s primary platform had around ZAR500 million in client assets invested, with the average client size being between ZAR1.2 and ZAR1.5 million. Typically, these clients are charged a fee of 60 basis points on AUM. “These [stats] immediately tell you that you are looking at a slightly older client base, with the current average age being over 50-years,” he said.
AUM fee model remains popular
The AUM fee model is popular because it has been in use for a long time; is easy to calculate and present to the client; and is similar to the fee structure used industry wide for both investment and platform fees. “There is lots of operational efficiency in the AUM fee process, and because the fee is a percentage of assets … your fee goes up with inflation without you having to get the client to sign on a piece of paper,” van Tonder explained. The major drawback to this fee model is that it does not accommodate prospective clients who are asset poor. This is one of the main reasons why more and more advice practices are exploring alternative advice fee models. Advisers need more arrows in their fee ‘quivers’.
Moore, who opined that the South African and US financial advice markets sounded similar, said that the vast majority of financial planning firms in the United States had exposure to the AUM billing model. “We have, however, seen the rise of fee-based billing whether that be hourly, retainer or project-based … we are seeing a lot of ways to implement ‘fee for service’ in financial planning,” he said. Most importantly, he observed that it was not an ‘either or’ debate: advice practices need not choose one fee model over another. Many firms adopt both, leverage the models in different ways.
In Moore’s assessment, the average age of a financial adviser in the US market was 56-years, with the average client being of similar age. Working with established clients that had USD1 million or more in assets made the AUM fee model attractive; but it meant that swathes of potential clients were uneconomical to service.
Leaving asset poor clients ‘out in the cold’
In the US, the need for alternative advice fee models became apparent as more and more advisers and advice practices declared: Hey, we want to work with a different type of client. Moore explained the problem and solution set as follows, with some paraphrasing from FAnews. “It comes down to being clear on the type of client you are trying to serve, what services you want to offer these clients, and what problems you want to help these clients solve. Armed with this information you can start scanning the market for other fee models, other business structures that allow you to offer the identified solutions to your clients in a way that allows you to operate your business sustainably”.
Moore co-founded XY Planning Network out of a need to service the growing cohort of clients that did not have enough assets to support an asset-based advice fee model. “These are clients that have enough income to support a fee if they can pay out of cashflow instead of paying out of assets, they just sort of work that advice fee into their monthly or quarterly budget,” he said. The need for alternative to the AUM advice fee models was confirmed by the 1700-plus advisers who are now affiliated with the platform… PS, Moore pointed out that although charging an advice fee for working with clients was becoming part of the mainstream, over 80% of advisers on the XY Planning Network also charged asset-based fees.
The size of the South African market presents some unique challenges, not least of which the difficulty in developing and implementing the support infrastructure for different advice fee models. Van Tonder pointed to the cross-subsidisation inherent in the current AUM fee models, with asset rich investors to some extent subsidising their asset poor peers. “If you compare the rand fee, your large client is still paying significantly more than the smaller client; removing that cross subsidy as you start moving to a different fee type can become quite painful for the business in the short term, from a cash flow perspective,” he said. Advice practices are also concerned about the operational implications of moving to an advice fee solution, because it could mean building and maintain a billing and collections system similar to a law practice or medical professional.
SA household assets / incomes lagging US peers
The similarities between South Africa and the United States evaporated when the panel discussion turned to the ‘peg’ for a once-off or single advice fee. In the US, according to Moore, it was common to ‘sell’ a financial plan for USD2 000,00 to USD3 000,00 with this amount begin equivalent to around 1-2% of the typical client’s annual income. Van Tonder reckoned that a local equivalent single advice fee would be around ZAR25 000,00 against a combined household income of ZAR1 million. The reality check for financial advisers: you are dealing with a shrinking mid- to high-income market who are noticeably poorer than their global peers. Whatever the case, it seems income-based fee models are gaining traction.
“On the client acquisition side, firms who are using a single fee model are overwhelmingly the fastest growing firms in the US in terms of adding client headcount … the average advisory firm in the US is adding something like eight new clients a year [whereas] the average member of XY Planning Network added 30 clients in 2022 … they are adding more clients because they have a much broader market they can serve,” concluded Moore.
Hybrid advice fee model is inevitable
It will be a matter of time before local financial planners cotton on to the potential in alternative advice fee models. “Your current target market, who you would usually sign up on a 50 or 60 basis points per annum model, are increasingly going to approach you to deliver a financial plan for a set fee,” concluded Van Tonder. In this context, financial advisers and advice practices will have to start thinking about how to charge clients who take your advice only, or use you for both the advice plus the ongoing financial plan implementation.
Writer’s thoughts:
The cross-subsidisation that Van Tonder mentions in the Assets Under Management (AUM) advice fee model has long concerned this writer. Do you feel that wealthy clients are paying too much versus poorer clients with smaller portfolios? If yes, how should the industry solve the issue? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts [email protected].
Comments