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Fee Compression And Why Alternative Investments Matter

Richard Hillson, 30 March 2020

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With some parts of wealth management there's a "race to the bottom" on fees while firms are also trying to prove their added value propositions, including those alternative investment areas such as private credit, equity and types of hedge fund.

Fees have been compressed in parts of the world’s asset management sector, so much so that it has driven mergers and acquisitions in certain quarters. Charles Schwab and TD Ameritrade and Morgan Stanley and E*TRADE, are two examples from the US. The rise of “passive” funds, regulatory changes and technologies are pushing fees down. A question is how far this can run; even providing “passive” investing does not come out of thin air – someone has to set these entities up and run them. There are no free lunches in capitalism. Wealth managers must now consider how they can add value, and where those "alternative investment" sectors fit into this story? 

To talk about these issues is Richard Hillson, a figure who has worked in the wealth and investment management space for many years. The editors of this news service are delighted to share these views; we invite responses and debate. (More on the author below this article.) The usual editorial disclaimers apply. Email tom.burroughes@wealthbriefing.com or jackie.bennion@clearviewpublishing.com


In a world of fee compression, avoid the race to the bottom. It is evident that fee compression is an escalating trend in most global industries. Much of this is due to advances in technology, replacing certain human elements and the cost associated with “man hours”. In some cases, this automation can be a direct benefit to consumers where the associated cost savings are passed on. In other cases, the end result can be inferior service, or improved margins for businesses, rather than benefitting customers.

This takes me back to my 15-year-old self, sitting in my Business Studies and Economics class - you either compete on quality or cost. It’s time to show your quality through high level thinking to bring in those high net worth clients.  

History has given us giants of the game at either end of this spectrum, from a low-cost juggernaut such as Sam’s Club, to a luxury retailer such as Rolex. The wealth management space is no different. With pressure to compete on price, the race to the bottom is rampant in modern wealth management.

We have seen Schwab, TD and Fidelity eliminate commissions on online trading. It would be impossible to see how any of their competitors can buck this trend without being wiped out. A T Kearney estimate that the robo-industry managed roughly $30 billion in 2017 and is expected to top $2 trillion this year. We know that the low cost robo-options can be priced at less than a third of a full-service advisor fee. What a tragedy this is!

There are various ways in which an independent advisor can maintain the quality and level of service without reducing their fee. I have heard the phrase “a robo-advisor won’t come to your kid’s birthday party”. This certainly sums up the service and personal relationship element in a practice. Clients are willing to pay for a more personalised service and someone they can always call when they are concerned. This is even more so in tougher market conditions and when there is a life event such as a birth, inheritance etc.

Performance is clearly important in the world of wealth management. Relationships and service are equally important. I pay additional fees to be able to speak directly to a person at my bank or credit card company rather than plod through an automated system. I would give up my first born to avoid the torture of an automated system when dealing with my cable and wifi company. 

Nausea sets in when I am connected to an overseas call centre. I long for the good old days when you could sit down with your bank manager and talk about a business loan or mortgage, receiving personal service rather than an algorithmic response. 

I am not devaluing the impact of great client relationships and the personal service; however, it is not the crux of this discussion piece. Today, I want to talk about justifying your fee by focusing on what can differentiate you from competitors through your product offering.

Let’s use the theoretical 80/20 split here for the purposes of this discussion. 80 per cent of an HNW accredited investor portfolio in traditional allocation vs. (up to) 20 per cent in alternatives. (I am not referring to the 60/40 stocks/bonds portfolio here. That split would be addressed within the 80 per cent traditional investments in the pie chart above.)

Unless an advisor displays Bobby Axelrod stellar levels of performance with his/her mainstream parts of the portfolio, it is very hard to differentiate here. The difference in performance between an average asset manager and an exceptional asset manager, when limited to traditional assets classes is marginal at best. The difference between average and exceptional when using more complex structures and alternative investments takes us into “multiples of” territory.

Time for an NFL analogy here. Back in the day, some coaches would call all of the plays on both sides of the ball; act as head coach; and act as general manager. In fact, the legendary Bill Belichick still holds that HC/GM hybrid role. It is unthinkable nowadays for a head coach to do everything. If he is not surrounded by a great GM, offensive coordinator, defensive coordinator, special teams’ coordinator and the plethora of data analysts and position coaches he will fail.

The modern head coach does not do any of the jobs himself, he holds everything together. In financial terms, he is the strategic overlay.

An advisor with confidence delegates like a head coach would. There must be trusted partners with individual expertise and outsourced solutions working alongside the advisor. The outsourced investment manager may never have met the client and is working to a remit set out by the advisor. The advisor has the detailed knowledge of the client’s circumstances and valued relationship with the client and must manage the overall investment process and relationship.

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