R.I.P. AUM Fees?

(Illustration by RIA Intel)

(Illustration by RIA Intel)

The longstanding approach is riddled with challenges while newer approaches are seeing greater adoption.

More than four decades have passed since regulators did away with fixed-rate trading commissions. Trading fees have been falling ever since, all the way down to the unexpected price of zero.

In fact, price erosion is everywhere you turn these days in the financial services industry.

Low-cost exchange-traded funds (ETFs) are taking market share from higher cost mutual funds; Robo-advisors put low-cost portfolio management within reach to a whole new swath of the investing public. And the major discount brokers are pitching financial planning services through a growing horde of captive CFPs.

Against that backdrop, clients are starting to question the longstanding asset management fees, which can exceed 2% of assets when all costs are tallied. That’s created a clear challenge for broker-dealers and hybrid advisory firms that live and die by the AUM (assets under management) approach.

For RIAs, the challenge is more nuanced. Many RIAs more squarely focus on financial planning these days, and not just wealth management. And a growing number of them are carving out those services apart from the AUM fee umbrella. Even for RIAs that aim to stick with the AUM fee approach, the conversation with clients needs to evolve.

Make no mistake, technology, regulation and changing consumer demands will lead to profound shifts for our industry in coming years.

“The industry is in flux,” says Rob DeHollander, a Greenville, SC-based advisor. “Even though the fiduciary rule fizzled, advisors are still feeling whip-sawed,” he says, adding that “we will need to get more granular in explaining what the client is paying for.”

Bob Veres, who publishes a popular newsletter for financial planners, completed a landmark industry study of fees in 2017, with data collected from 956 firms. Fully one-third of respondents operated under a strict AUM-only model. A growing number of firms now offer AUM as well as fixed retainer fees. Just 10% of respondents offered retainer, hourly or a combination of both, without any sort of AUM offering in place.

In his 2017 study, Veres concluded his report by noting that “the financial planning profession is moving away from a pure AUM revenue model.” Yet he added that “the destination is, as yet, uncertain.”

Curiously, the 1% AUM fee has remained the most popular price point, whether a client has $250,000 in assets or $1 million, according to Veres’ research. Clients with larger portfolios tend to negotiate a fee discount, down to 0.75% or even 0.50%.

Of course, the real cost to clients can handily surpass the 1% headline figure. Turnkey asset management platforms (TAMPs) will take their cut, as will transaction costs, fund fees and custodial services that can tack on an average 50 more basis points on top of the AUM fee.

Veres found that among clients with $500,000 to $1 million being managed, a stunning two-thirds pay between 1.4% and 2.4% in total fees. Studies have shown that clients of hybrid advisor firms tend to pay the most in fees. Veres found that “fee-only planning firms appear to be the most cost-conscious among the different firm types.”

To be sure, the various AUM fees can lead to sticker shock, especially for wealth managers that would rather eschew any sort of financial planning. For that matter, even wealth managers that do provide planning in tandem with portfolio management are being pressed to justify their costs.

Mark Tibergien, CEO of Advisor Solutions at BNY Mellon, says that “25-30% of all firms have already broken out distinct pricing for their planning services. It’s become a major issue for clients.”

Tibergien says that advisors are now rising to the challenge of greater fee disclosure. “Advisors are starting to create a better alignment between their fees and the services they provide,” he says. Still, transparency in pricing “has thus far been more of an issue for ultra-high net worth clients than the rest of the market.”

These days, the notion of standalone portfolio management seems almost quaint. Consumers have come to understand that investment strategies can’t be done in a vacuum, and instead must underpin a broader set of financial goals. And that has led to a shift in how firms market themselves.

In his report, Veres notes that “There is a trend toward either supplementing AUM with hourly or retainer fees, or replacing AUM altogether with these alternative fee structures. But as yet, the trend appears to be in its early stages.”

In a recent follow-up interview with RIA Intel, Veres says that there has been little movement on pricing structures since his 2017 report.

“A lot of advisors are waiting for a sign or a trend that will signal that they must make changes,” he says. Thus far, regulators aren’t providing much guidance. “They still suggest that AUM is the best way to charge clients,” says Veres. For that matter, “there isn’t a lot of pushback from consumers just yet either.”

Yet as standalone financial planning is increasingly being sought by some consumers, especially in the growing area of fee-only planning, a shift in industry pricing policies appears inevitable.

Lisa Kirchenbauer, President of Arlington, VA-based Omega Wealth Advisors saw this trend more than a decade ago. That’s when she started steering her practice in a new direction.

“Our clients began to see that the financial planning piece was even bigger than the investment management piece, and we had to price that accordingly.”

Over time, her pricing model has evolved, and she now charges a modest 35 basis points for assets under management. The bulk of her firm’s net income comes from planning fees.

There’s a clear merit to that pricing approach. While AUM fees may rise and fall in tandem with stock market levels and an individual clients’ asset deaccumulation phase, planning fees offer greater pricing power and more predictable income streams.

“We’ve raised our planning fees as needed over time to reflect the value that we create,” says Kirchenbauer. She notes that advisors can help clients save tens of thousands of dollars through savvy tax and estate planning, along with other wealth-preserving moves.

Still, the onus is on the advisor to justify their fees.

“We have to articulate exactly what we are delivering to clients,” she says. And she aims to be transparent by keeping her AUM fees low. These days, it simply doesn’t cost as much to deliver portfolio returns in line with goals and benchmarks, as fund fees and transaction costs have slid.

Even as advisors like Kirchenbauer and DeHollander have moved to break out their AUM and planning fees separately, not all clients will appreciate that level of transparency. DeHollander notes that for some clients, “bundling all of that together is easiest for clients to understand, and for advisors to bill.”

Still, the recently deceased Fiduciary Rule is bound to spring back to life at some point. And that will likely entail far greater transparency—and perhaps unbundling of—wealth management and financial planning fees.

Tibergien suggests advisory firms take a look at industry regulations that have taken root in the United Kingdom and Australia to get a sense of where we are headed.

“In those countries, you have to declare all of your fees upfront. The first year is demonstrated and the subsequent years are estimated,” he says.

That dovetails with consumer demand for the ability to shop around and compare prices and levels of service. “If you’re still operating with past models, then newer clients will bring that into question,” says Tibergien.

Instead of worrying about fee pressures, advisors simply need to make a clear-cut case of how they are bringing deep value to clients. “It’s not defending your price, it’s demonstrating your value,” he says. “This is where the puck is going.”

In recent years, there has been growing discussion around potential conflicts of interest in the AUM approach. “Advisors have an incentive to retain and enhance portfolio assets,” says Tibergien. “So how can you help provide unbiased advice around charitable giving, debt reduction and other moves that may reduce a portfolio?” he asks.

In response, some advisors are shifting towards a broader model that focuses on net worth or income, and not just on assets under management. Veres thinks the shift could greatly expand the pool of potential clients. “Right now, the financial planning approach, using AUM as a basis, ignores 85% of the population that lacks enough assets to attract advisor attention,” Veres says.

Industry thought leader Michael Kitces takes that thought one step further. In a blog post, he predicted that “the untapped market potential for using retainer fees to expand the reach of financial planning is so large that, in the long run, while the AUM model may still survive, it could become a niche for high-net-worth clients, while most consumers access financial planning through various retainer or fee-for-service alternatives!”

So how will this all play out? Veres speculates that “the journey will entail a smaller percentage of total fees charged by AUM, and a correspondingly larger percentage of flat fee or hourly.” In fact, he adds, “it may lead to an eventual abandonment of AUM altogether.”

How advisors re-configure their pricing strategies—without suffering a drop in income—represents a clear challenge for the years ahead.