It has been two years since the implementation of the retail distribution review (RDR) and most advisers have by now finalised their fee models and service propositions. Yet the discussion over whether to charge a fixed fee, hourly fee, or a percentage of assets, continues. Indeed recently, BBC journalist, Paul Lewis, dropped a grenade into the conversation by announcing advisers are still hooked on commission. Is he right? Has the RDR seen the end of potential conflicts between adviser pay and consumer outcomes? Has it made it easier for customers to compare and understand costs? As a potential customer, what should I look for when it comes to fair fees?
The predominant emerging fee model is to make an annual charge based on a percentage of assets under advice, with the adviser managing the client’s portfolio. This is perhaps the simplest route in the post-RDR world, but in whose interest is it? Fixed and hourly fees are task based. Although they may repeat, the norm is for each piece of work to be agreed before a commitment is made. Annual percentage fees recur without re-engagement. For advisers considering the eventual sale of their business this stickier income stream adds value.
One objective of the RDR was to unhook adviser pay from the need to sell a product thus eliminating the biases that can creep in where product providers set the rate of pay rather than the adviser and client. Another was to come up with a system that allowed potential clients to compare the costs of advisers and hunt around for the best deals.
Both objectives are undermined by percentage fees, but then the clarity and usefulness of cost comparisons was always doomed to fail.
The point at which a fee becomes a commission or a commission a fee is blurred hence the potential confusion and statements by commentators that advisers remain commission junkies.
Commissions have the following characteristics. Firstly, they are set by the provider and built into the cost of the product or service. This can lead to the impression that the advice element is free. Where linked to pay as is often the case, the payment can influence the adviser’s decision. A second feature is that commissions are generally based on a percentage of the amount invested and not therefore linked to the actual amount of work undertaken. Even worse, where the payment is annual it is not necessarily linked to the delivery of a quantifiable service.
A fee based on a percentage of funds being managed therefore looks very much like a commission especially when linked to individual pay. A common commission structure, sometimes called on-target earnings, links commission rates to the achievement of specific targets that have been agreed upon between a firm’s management and the adviser. Commissions and percentage based fees can create a strong incentive for employees to invest maximum effort into work that generates this type of income and sell services where the income recurs. For business owners increasing assets under management to enhance profitability and the eventual sale value of a firm is an obvious conflict. The disclosure of the potential conflict of interest is one way to protect customers although in practice customers will not see the disclosure until the advice is given and at a time when the commitment is all but made.
Perhaps the biggest criticism of a percentage based fee is that it bears no relationship to the amount of time taken to deliver the service, nor for that matter the quality of service delivered. To deliver advice the firm will have to have set up systems and controls. Advisers gather client details, undertake research and produce documentation evidencing why the recommendation is suitable. These tasks take time but the work is essentially the same whether the client is investing £250,000 or £1m. So why is there such a big difference in the amount paid? At 1% £7,500, almost the cost of a small car. Of course the work on a larger portfolio may add to the time but there is no logic for a large difference in costs based on value rather than time.
It is true that the risks are higher where larger investments are made. But the increased risk that the client is paying for relates to the cost of the adviser’s incompetence ( a potential compensation claim). Assuming the adviser meets the standards set by the regulator and acts professionally, it seems odd for the client to underwrite the potential costs of negligence. It would be laughable if a firm of solicitors put forward a proposition where the juniors cost more than senior partners on the grounds that, unsupervised, they would cause more claims against the firm.
Either wealthier clients are cross subsidising the less wealthy (which was a feature of payment through commission) or the adviser is potentially profiteering from one group of clients. Wealthy clients should consider carefully any proposition where they are paying a percentage fee. While poorer clients should take advantage of this model (the adviser will be losing money).
Advice to clients is to obtain an estimate of how much work is being done in terms of hours. Divide the percentage fee by hours worked and draw your own conclusions.
The advice to firms continuing to charge on a percentage fee basis should be to be clear about disclosing conflicts of interest, be clear in justifying why a percentage fee works for all clients and remove income generation as an incentive from the pay structure if they are to win the trust of consumers and other professionals.
Comparing Adviser Fees
A further objective of the RDR was to allow those seeking advice to easily compare costs. In addition to being fair to clients this ought to promote competition. Open disclosure should in theory drive down charges as customers shop around.
Percentage based fees are impossible to compare unless the amount invested is know at outset. Even then, the FCA rules at disclosure relate to the adviser fee alone, which for clients is only part of the real cost. Product and platform fees are equally important but not disclosed until the advice is delivered. A customer sensitive to fees would want to know the total cost not simply a part of the cost. Accordingly, the disclosure as envisaged by the rules does not meet the test of being true, fair and not misleading. Is a cheap adviser recommending expensive solutions better than an expensive adviser recommending efficient cheap solutions?
Hourly fees of course suffer from the same drawback and are not without faults either. It is one thing to see a cost per hour in a disclosure document but it is, by and large meaningless, unless the client is able to understand not only how much time a task will take but also the quality to which it will be delivered. The latter is only measureable after the event and the former can be difficult to pin down. The FCA has tried to make comparisons easier by asking firms to disclose examples of total costs for sample tasks where hourly rates are used. This is a futile exercise where times taken to do the same tasks can vary widely between advisers and firms (depending on experience and support) and the quality of the outcome is not necessarily the same. In other words, the product is never going to be the same. Paying £350 per hour might be cheaper in the long run than paying £150 per hour.
The same is true of the fixed fee based on a task. Advice is often about opinion and opinions vary. The nature of a task will often vary depending upon not only delivery but the eventual recommended solution.
If tasks cannot be compared on a like for like basis, the fee disclosure for comparison purposes is meaningless. Hence the conclusion that disclosure can be misleading.
Is There a Solution?
The truth is there is no easy solution. In selecting an adviser, fees are interesting but not the only one factor. After deciding if independent or restricted advice is required, our recommendation would be to look at the culture of the organisation. Though in practice there are no good measures, there are clues.
In assessing culture qualifications are key, the higher the better. Rogues generally do not invest the time in seeking anything but the passport to trade. However, do not rely on these, there is the odd exception to the rule.
Very small firms can be well meaning. Leaving fees aside, if independent, do they really have the resource to undertake fair and comprehensive review of the whole market place when making a recommendation? Good due diligence involves detailed questioning and understanding. It makes it very expensive for a small practice and therefore the client. How does the adviser approach this task?
The way staff are paid is central the culture of an organisation and helpful in making judgments. In larger firms, how are advisers incentivised? Beware of anything other than a salary and a realistic bonus (small relative to salary). Firms that pay advisers “uncapped” earnings based on a percentage of fee income are, as Paul Lewis suggested, addicted to commission. They have not been able to make that jump of putting the customer at the centre of the proposition. Target earnings is a strong indicator that the firm simply wants revenue. Its interests and the customer’s are unlikely to be aligned.
How do I pay is also an indication of culture. Are fees invoiced? Is there an opportunity to write a cheque? Does the client see and agree the bill before it is extracted from a product? Ask the adviser, is it in my best interests to have the money taken out of the product? In many cases, if cash is available in current accounts, this should be used to pay fees. Cashing in funds where initial costs have been incurred or would be incurred if that cash is invested later is easy for the adviser (hides the pain), but not necessarily in the customer’s best interests. Money coming out of tax free funds (Pensions and ISAs) to pay bills is generally not efficient. Without an invoice or regular clear statements the culture is wrong.
Ask too, what am I paying for? If your adviser comes to your home, how much is that costing you? If they write you a birthday card, is that professional and do you really want him or her spending your time doing this? Time is money. Percentages are commission.