The financial advice profession is undergoing unprecedented disruption. With so many models competing for clients’ money, current and future advisers need to stay on top of their game to remain relevant and in business.
This isn’t just speculation. Disruption is happening today; for example, Vanguard Personal Advisor Services drew more than $100 billion in inflows in the US last year alone.
This shows people will vote with their feet and with their money. A line in the sand has been established – at 30 basis points (bps), capped – for what a portfolio can cost. Anything above that is the extra cost for an advisory relationship.
This has laid down a marker for advisers who have historically charged 100 bps of assets under management. How will they articulate the value they provide for that extra 70 bps they charge for advice and ongoing services?
For those who can meet that challenge, no problem! For those who can’t, we are already seeing the consequences. They will face a significant squeeze on margins and major disruption.
As Charles Darwin wrote, “It is not the strongest of the species that survives, nor the most intelligent that survives. It is the one that is most adaptable to change.”
ARTICULATING VALUE
There is good news, too. Despite headlines about fee compression, some firms are managing to increase fees by 10-25 bps because they are getting better at articulating and demonstrating to clients the value they bring. In other words, firms that offer more comprehensive and holistic services find they can charge more.
Research by Peloton Partners, an Australian business-to-business consultancy specialising in adviser pricing, found firms are typically working on gross margins of 77-85 bps (not that Peloton recommends AUM-based fees).
My view is that more advice businesses will move towards a flexible fixed-fee structure aligned directly with each client’s level of complexity, service needs and expectations. For their part, clients will accept and recognise that fees will ebb and flow as their circumstances change. As a result, their understanding, trust and connection to their adviser will deepen.
This scenario will mark a significant change in an industry where the proxy has remained at 100 bps of AUM, despite increasing evidence that this tired benchmark has failed to keep pace with the rising costs of delivering a full-service offering.
Peloton Partners managing director Rob Jones says fixed costs in the average wealth management practice have increased by 12-15 per cent in five years and are still rising.
“This additional cost is directly related to compliance,” Jones says. “With ongoing regulation and general inflation, we will soon see further increases as employee costs rise in line with mandatory minimum qualifications.”
As he points out, the problem is that few fee models permit firms to pass these additional costs on to their clients, particularly under a percentage – AUM model.
REVIEWING THE MODEL
It may be a tough adjustment, but my view is that advisory practices, more than ever, need to review their businesses, including their fee models. The alternative is that complacency and resistance to change will cripple good businesses.
A way of approaching this is understanding the clear and symbiotic relationship between client segments, client services and pricing.
The best analogy, and one we all experience, is how airlines separate passengers into first class, business class, premium and economy. Different people perceive value in those different classes, for different reasons, at different times. If you are rolling out business-class pricing for your clients, you had better be delivering business-class service. Similarly, if you are rolling out a business-class service for people buying an economy ticket, you’ll go broke. Get this right.
So the message is to segment your clients. Look at who is paying what. More importantly, look at the profitability.
Italian 19th-century economist Vilfredo Pareto developed the Pareto principle. It states that in many events, about 80 per cent of the effects come from 20 per cent of the causes.
In our business of financial planning, it means that about 80 per cent of your clients will bring in 20 per cent of your revenue and vice-versa. This principle, if you grasp it, can open all sorts of conversations and opportunities.
These conversations should focus on identifying and developing a clear idea of your ideal client, your value proposition, your service model and pricing that suits your client segment but is also profitable.
When you start from this perspective, you’ll begin to see the rationale for my view that more advice business will move towards a flexible fixed-fee structure aligned directly with each client’s level of complexity, service needs and service expectations. Perhaps part of this fee will be for portfolio management and part for advice and the ongoing relationship.
To sum up, the advice industry is changing quickly. The scale of disruption puts more pressure on advisers than ever to remain relevant and articulate their value beyond what commoditised services can supply.
Pricing models need to be flexible, with a clear value proposition attached. More clients will be looking for flexibility and value.
The question is whether they’ll be heading your way.