In my article last week, I gave five reasons why the asset-based fee model is unlikely to survive. Here are five more:
- The conflicts are pervasive
An article posted on November 27, 2011 in Investment News by Bert Whitehead set forth additional conflicts of interest when fees are based on a percent of assets under management. These included:
- Advising whether to rollover a pension plan or leave it with a former employer;
- Advising about charitable contributions;
- Advising about gifts to children to avoid estate taxes;
- Advising about annuities, including charitable annuities;
- Advising about purchasing a larger home and investing generally in real estate.
- If the fee is different for managing stocks and bonds, the advisor’s self-interest may result in an over allocation to stocks.
Asset-Based Fee Model
In the first five examples, a conflict arises because the suggested action (e.g., a pension rollover) would decrease the AUM and the advisor’s fees.
Whitehead concludes: “If fee-only advisors want to hold themselves out as being the most ethical practitioners of their profession, they should commit themselves to adhering to the highest possible and least conflicted standard.”
- It’s not equitable
As noted on the web site of Litovsky Asset Management, charging a high-net worth client a multiple of the fees charged to a lower net worth client “can hardly be justified.” It doesn’t take many multiples of the amount of work required to manage a $10 million portfolio to manage a $5 million portfolio.
Mr. Litovsky, an engineer and mathematician, concludes: “Our conclusion is that AUM fees cannot be justified on any basis, and that a flat fee is the only type of fee (along with other fees for work such as hourly and per-project) that would be fair to the client and would compensate the advisor adequately for their work.”
- The premise is flawed
There’s no doubt a competent advisor can add meaningful value on the investment side by helping to determine an appropriate asset allocation, making sound investment recommendations based on peer-reviewed evidence, keeping the client disciplined and adhering to a carefully crafted investment policy statement.
However, as a fiduciary, you have an obligation to do all of those things regardless of how you calculate your fees.
The argument that an asset-based fee aligns your interest with the interest of your client has no merit. Your interest is already aligned by well-established law.
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By Dan Solin, read the full article here.
