Days of AUM-Based Fees (Slowly) Waning

The assets under management-based advisory fee model has stuck around mainly because financial services consumers don’t understand how advisers make pricing decisions or how much diversity actually exists in compensation models. 

A new report from the SEI Advisor Network, “Fees at a Crossroads,” asks whether industry professionals can continue to justify assets under management-based fees when the cost for investment selection, allocation and rebalancing has declined so dramatically thanks to automation technologies.

SEI on Monday put on a webcast exploring the report’s key findings, as compiled by John Anderson, SEI managing director and head of the practice management solutions team; Raef Lee, SEI managing director and head of new services and strategic partnerships; and Bob Veres, publisher of Inside Information. The three suggest advisers deserve to be fairly compensated for their work, but they also ask whether common industry practices and traditions have pushed the way advisers get paid away from the best interest of clients.

“Clearly advisers need to be paid for their services, but what exactly is being delivered? And does it have to be 100 basis points?” the researchers ask. “Shouldn’t transparency be the guiding force in client dealings no matter what the adviser’s certifications or designations are, or how an adviser charges for a service? And for that matter, shouldn’t all financial advisers be obliged to do the right thing for clients—not just those who are legally obligated to put clients’ best interests ahead of their own?”

Despite ongoing education and disclosure efforts, many consumers remain uninformed about the broad categories of advisory business models, SEI says. In fact, up to one in four investors still are not sure how even their own advice provider is compensated—let alone whether they are truly getting a good deal compared with similar or dissimilar fee models.

Acknowledging the difficulties of “educating our way out of the problem,” the SEI experts suggest it will have to be advisers themselves who step up and solve the problem. Participants cannot widely be expected to learn and understand the different fee models, in other words. Part of what has made this job difficult for consumers, SEI says, is that the focus of many advisory practices has “straddled the world of advice and portfolio management.”

Today’s financial advice landscape therefore ranges from “pure money managers to wealth managers, with various hybrids emerging across the spectrum,” SEI’s report explains. “Pricing for these services runs the gamut from commission-based to fee-based, fee-only, retainer, flat fee, or a combination of some or all of these arrangements.”

NEXT: ‘Is it any wonder that investors are bewildered?’

SEI goes on to suggest there is “general agreement that the commission model—which still represents the most common compensation arrangement for financial advisers—is the least desirable arrangement and, going forward, may be the hardest to justify.” (See the latest PLANADVISER Practice Benchmarking Survey for additional insights on the industry fee landscape.)

Industry practitioners will be familiar with this warning already. As SEI explains, advocates for greater transparency and reduced conflicts of interest have for years been arguing against the AUM-based fee model, especially for institutional investors such as retirement plans or foundations/endowments. These investors often grow hugely during the course of their lifetime with a given adviser or service provider—so when fees are tied to the level of assets under management it’s actually easy to “grow from a good deal into a bad deal.” Indeed, it’s not hard to see how a 1% of assets fee might be a good deal for a retirement plan first trying to get off the ground with only a handful of people, but that same fee is likely too high once a plan has achieved any significant scale.

“Meanwhile, new pricing strategies, including variations on retainers, flat fees, hourly billing and lower asset fees are emerging,” SEI says, further upsetting the traditional AUM-based outlook. Another big part of all this is the “decoupling of investment advice and portfolio management,” giving consumers yet more ways to price and purchase investment services. 

SEI’s explanation points out that the cost of doing business for advisers has increased in recent years, “with expenses for compliance, recruiting and retaining talent, rent and technology,” making those advisers relying on AUM-based fees more reluctant to try a new approach. “Based on our survey responses, some advisers are worried,” SEI says. “However, most are not.” Many, instead, are enacting strategies to get ahead of the shift from direct-to-client offerings in favor of automated adviser platforms.

“Advisers with great technology are incorporating automated investment services, particularly for younger investors, while the robo-advisers are realizing that clients need and want the advice, guidance and behavioral coaching that only a human adviser can offer,” SEI concludes. “The trends may be relieving fee pressures but continue to call into question the value of advisors’ asset management advice.”