Francis Klonowski explains why he has implemented a fixed fee model in his business and how it benefits his clients.
I first discovered the percentage fee idea – the so-called assets under management (AUM) model - back in 1994. At the time it was a revelation : no more reliance on high up-front commissions, instead an ongoing income from the client’s investments.
Over the years, though, I have come to realise that it may be a flawed model.
Proponents of AUM charging will argue that it is simple, that fees increase as portfolios grow, etc. [except they don’t always, but we’ll leave that for now...]. Maybe it suits those firms where investment management is perceived as the main offering. But I’ve found several reasons for believing it no longer suits my own practice.
- Post-retirement investment values will, by definition, go down - not through stockmarket fluctuations but because the clients are drawing and spending. Isn’t that why they had saved in the first place? The adviser’s income, therefore, will also go down.
- What about those large withdrawals they make to cover special holidays or family projects? Or the client who withdraws most of the trust fund to buy a property for one of the beneficiaries?
- Then there are the clients who don’t have investment portfolios to manage. Like the couple who need in-depth pre-retirement advice, including cash-flow planning and lifetime allowance implications. Investable assets are minimal, their pensions are mainly defined benefit, but the advice is invaluable – and they are willing to pay.
- There are others still in the accumulation phase. Should I follow what appears to be the trend among my peers and turn such people away? Do I insist on a “minimum portfolio size”? [Strange how no-one says what happens when it drops below that level……..]. Either way, the AUM model doesn’t work with these clients.
I have other reasons for believing the AUM fee model may no longer work.
- Some clients need considerable planning but don't have substantial assets to manage; while others with significant assets had fairly simple requirements but were paying a lot more.
- Most firms who use this model seem to somehow throw in the financial planning for free, yet surely it is the planning which provides the real value. How, for instance, do you deal with estate planning if your fee income is derived from the investment or SIPP portfolio?
- There is a danger of being judged on investment performance – which I can’t control – rather than on whether I am really addressing the client objectives.
That’s why I now prefer a "fee for service" approach, because financial planning is where I add the real value : it is far broader than investment management and therefore more reflective of my main business. Basing my fees on the client’s investment does not seem to reflect the value I am providing, and may even detract from the main purpose of the engagement. A fixed fee for financial planning suits my practice well : that way I work with the client in all aspects of their financial life and provide them with (I hope) appropriate advice. Setting fees on the basis of value to clients rather than the portfolio value can also deal with the different effects of having clients in accumulation or in drawdown.
The transition isn’t easy because there are still several legacy accounts on AUM fees, although new clients can go straight on to a fixed fee - or hourly charges if appropriate. So is the AUM fee model on its way out, as many commentators suggest? I don’t know : I only know what works for me.