ADAPTING TO CHANGE
Adviser remuneration has changed significantly since the millennium – and stands to adopt a whole new model again, writes Clive Waller
Advisers have proven better survivors than many commentators have predicted. One of the reasons for survival, which Darwin would have recognised, is their ability to adapt to change.
There have been a number of changes over the last 20 or 30 years of enormous significance: portfolios of funds replacing investment bonds managed by life companies; retail platforms moving the sector into the age of IT and, more recently, pension freedoms changing the way both advisers and their clients look at retirement.
Arguably, the greatest change has been in adviser remuneration. Remuneration has been changing constantly over my lifetime in the financial services sector and continues to do so today.
If one goes back to the millennium, standard practice was indemnified commission. This meant that IFAs could make huge amounts rebroking personal pension schemes every three or four years (and many did). Investment bonds were the lifeblood of smaller businesses. Life and critical illness typically paid 150% of the first premium and kept the big, BMW in the heated garage.
It was at this time that the more professional planners changed the nature of the game. Rather than taking high initial commission with front-end loading, they opted for a smaller initial of 3% with a 50 basis points trail – the new model adviser was born. Good businesses were soon to be valued on recurring income rather than potentially sporadic windfalls.
THE KING’S NEW CLOTHES
In 2012, we published a study, The King’s New Clothes, looking at adviser intentions post RDR. At this time 60% of advisers intended to charge 3% initial and 55% of advisers intended to take 50 basis points (or less) ongoing.
However, the old model survived RDR. On 1 January 2013, the vast majority of advisers charged fees at the same rate as the commission they had received. This tended to be factored via the platform and RDR came and went relatively peacefully.
This soon changed. I clearly remember an adviser saying to me in 2013: ‘When a client is moving his portfolio of £500,000 to you, you just can’t ask him for a cheque for £15,000.’
To many, this statement appears crazy. Yet the way of the world, pre-RDR, was that the provider paid you 3% of client monies paid into their funds. Of course, at the start of the millennium, it would typically have been 7% or even 8% from a life company.
Thus, the first major impact of RDR was a reduction in initial remuneration. At the same time, however, many advisers found they could charge 100 basis points for ongoing service. Many did so; the average in our surveys in 2015 and 2017 was 93 basis points. The average initial fee is now only 1.29%.
NEVER MIND THE QUALITY
In our recent study, Never Mind the Quality, Feel the Width 3, we asked advisers whether they anticipated change in the most contentious area – decumulation – and 90% anticipate no change or minor change.
This is unlikely. Change has been a constant over 50 years and there are good reasons for more.
Ad valorem is being questioned. It was thought that the regulator was keen to ban it, but that was a misunderstanding. The concern was where charges were contingent on a transaction.
However, there is now broad acceptance that the work of the financial planner or the wealth manager does not correlate with the size of the portfolio. A complex retirement scenario for a client with a small pot is far more costly to the adviser than a client with a few million looking for a return of inflation plus cash on his portfolio with little intention of ever amortising it.
We are now seeing 38% charging flat fees some of the time for initial work and 22% for ongoing work. More are looking at this model as they themselves question ad valorem.
The contentious issue is where advisers are charging 1% per annum for a decumulation portfolio where the objective is to provide income. Based on amortisation at 4%, this represents 25% of the client’s income and that is before investment and platform charges. A defense for this model is that the cost includes financial planning work. This invites two questions. Will the client tolerate such charges when fully aware of the impact on income? And what is the relationship between the retirement portfolio size and the volume of financial planning work?
CRYSTAL BALL Looking at my crystal ball, here is what I think I can see through the smoke:
• The move away from ad valorem fees will gather speed. At the same time, many will retain percentage charging for running money as there is a level of justification and, importantly, of client acceptance.
• The 1% model for drawdown funds where the objective is income will be challenged. The outcome will be a combination of a more efficient drawdown investment proposition and lower adviser fees.
Looking at macro level, the direction of travel is for greater transparency and lower cost. This is due to three main factors: regulation, digitisation and competition.
Firstly, MiFID II plus the FCA’s asset management review both major on transparency of charges, believing this is good for competition and customer outcomes.
Secondly, full robo advice will struggle in the shorter term, but will be a test bed for smart use of technology. At the same time, wealth managers and financial planners will incorporate digitisation in their firms to increase efficiency and lower cost.
And thirdly the entry of Vanguard’s direct-to-consumer proposition into the UK has caught the attention of the media. If it launches its personal advisory service, the impact will be even greater. Others, such as Schwab, have advisory propositions in the US with costs that look like rounding errors in the UK.
These drivers will impact on asset managers, wealth managers (especially those that are vertically integrated and have opaque charging), financial planners and platforms.
History tells us that advisers are great survivors in the face of change. Ultimately, the world is getting more complex especially in areas such as taxation.
With political parties growing further apart, legislative swings may be quicker and more extreme. For those advisers that adapt, as most have done and will continue to do, it is easy to see them building practices with the requisite specialisms resembling solicitors and accountants and charging in a not dissimilar way.
The one certainty is that the current model won’t survive long. It never does!
is managing director of CWC Research
AVERAGE ADVISER RENUMERATION
||Flat fees only
||Flat fees only
Source: Never Mind the Quality, Feel the Width 3, CWC Research/the lang cat 2017