Robo-Advisors And Fiduciary Change Heap Pressure On Financial Advisors' Fees

by: SA Gil Weinreich

Summary

Changes in technology and in industry regulation both serve to keep the pressure on financial advisors’ income.

New fiduciary requirements could spell doom for advisors reliant on commission income and even those who are not commission-based will face costly new compliance burdens.

Robo-advisors can do an advisor’s work for a lot less in fees, placing heavy new competitive pressure on FAs.

One estimate of the cost of these regulatory changes to advisors totals $600 to $1,500 per client, enough to wipe out an advisor’s entire business.

Dalbar recommends bypassing the regulations through discretionary accounts, while a new report by SEI Advisor Network counsels FAs on what kind of model can help them justify their fees.

How, and how much, financial advisors charge their clients may be the most persistent item on investment professionals' agendas, never going out of fashion.

That is likely the result of the constant changes in technology, and the constant changes in industry regulation (and maybe also the inherent preoccupation business people have with their potential earnings).

So, for example, the deregulation of commissions back in the 1970s led to the establishment of discount brokerages, the emergence of no-load mutual funds and the ultimate birth of fee-based models as a response to pressure on traditional commissions.

And, similarly, in our times changing regulations requiring advisors to adopt fiduciary responsibility for client accounts joined with pressure from robo-advisors (who are compliant with fiduciary rules) are forcing advisors to look for sensible and permitted ways to charge for their services.

While epitaphs written for financial advisors have time and again proven to be premature, they are nevertheless a regularly recurring feature of advisors' lives.

Thus, for example, Seeking Alpha contributor Bruce Miller recently crunched the numbers and determined that adoption of fiduciary requirements (which he sees as unstoppable) will bury much of the financial asset management industry, and that investors should flee now or see their dividends sharply cut.

Specifically, Miller argues that asset managers with a high proportion of asset-based fee income have some staying power but those whose revenues largely derive from product commissions and third-party revenue sharing agreements are in for a world of pain.

Miller, a former advisor himself, takes Waddell and Reed as an example of a company in the latter category, since 42% of its revenue stems from distribution agreements and product commissions. A crippling loss of 12b-1 fees would wreak havoc with the company's finances and force a dividend cut, he argues.

Meanwhile, Morningstar's vice president of research John Rekenthaler reckons that the same dynamic that has squeezed mutual funds' asset-based fees may soon start pressuring advisors' AUM fees.

The veteran fund commentator says, essentially, that advisors have long avoided the sort of pressure that is driving fund fees down because FAs are too apple-to-orange to compare one to another (unlike funds), having clients with different risk tolerances and portfolio constraints and operating without the same intense public disclosure as funds.

But whereas Miller sees regulation as the source of doom for asset managers and broker-dealers, Rekenthaler points to technology as the culprit, specifically robo-advisors.

"The robo-advisors want the traditionalists' clients," he writes in Morningstar's Rekenthaler Report. "They want those assets. Their campaign is only beginning. As it strengthens, as their businesses grow and they gather more media attention, their voices will be louder. The attack on financial-advisory fees will commence."

Dispelling the current crop of advisory fee gloom are two sources: Boston-based consulting firm Dalbar and Oaks, Pa.-based SEI Advisor Network, a separately managed accounts provider.

Dalbar, which provides self-study training programs for advisors, has figured out an angle that it believes will help FAs comply with and prosper through regulatory changes.

In a new post to his LinkedIn blog, Dalbar CEO Lou Harvey warns that "new federal regulations will require advisors to discover and document client's personal circumstances," meaning that advisors overseeing IRA, 401(k)s and the like will need to "sign a new contract with clients and then prove that recommendations are in the client's best interest."

Harvey estimates the cost of this tedious new compliance to range between $600 and $1,500 per client because of the need to understand each client's personal circumstances, find matching investments, recommend changes and implement them - all on a continuous basis since these circumstances constantly change.

"The cost could amount to as much as $450,000 for an advisor with 300 clients," which could "wipe out the advisor's entire business," Harvey writes.

His solution: "The new regulation does not apply if the client turns control of investments over to the advisor" through discretionary accounts, in which the client provides investing guidelines and the advisor acts on the client's behalf independently, reporting his decisions to the client.

Harvey believes this avoidance measure has the added merit of allowing the advisor to oversee the account as a true professional rather than be relegated to making recommendations that clients often don't understand.

Finally, SEI Advisor Network chimes into the debate and offers a broad, landscape view in its new 40-plus page report on advisor fees, arguing that advisors should consider a variety of fee models before adopting the one that most enhances the advisor's value proposition.

So, for example, an advisor for whom financial planning is part of a continuous process may be justified in using financial planning as a way to justify his or her AUM-based fee, typically 100 basis points. However, the report helpfully suggests that the advisor could variegate the charges - as a means of highlighting high-end planning - by breaking out fees into two streams: an AUM fee of, say, 25 basis points while earning the equivalent of 75 basis points through a financial planning retainer.

In contrast, advisors who perform a one-time comprehensive plan at the start of the engagement may be justified in charging a large upfront fee of, say, $10,000 for the plan. But the authors of the SEI report - the firm's John Anderson and Raef Lee together with independent advisory industry publisher Bob Veres - warn there are downsides to this model:

"It is a large expense to impose on a new relationship. Some advisors see that as a good test of a client's commitment, while others see it as a way to lose a prospect. Most advisors fold the ongoing financial planning fee into the AUM fee, but the tendency is to skimp on future planning once the initial comprehensive plan is complete."

This sort of micro-view of the range of different compensation models is characteristic of a report, available to financial professionals for download, whose overall purpose is essentially to determine what model best helps an advisor justify fees in the face of Darwinian competition from large asset managers and robo-advisors.

As the authors of the SEI report write:

"If Vanguard and Charles Schwab offer investors portfolio management for 30 basis points (bps) or less, it's not hard to imagine pressure for advisors to reduce their asset management fees or charge distinct fees for portfolio management, financial planning or other services. Clearly advisors need to be paid for their services, but what exactly is being delivered? And is it worth 100 bps?"

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Please delete disclosures as befits SA staff contributor.