Asset-based fees long ago replaced commissions as the preferred method for paying wealth managers, but the financial crisis may have shown the need for a scheme that rewards both investors and advisers.
* Asset-based fees may not reflect adviser's worth
* Fortigent's Welch says hedge fund scheme worth studying
* Says should establish fees for achieving account goals
Asset-based fees long ago replaced commissions as the preferred method for paying wealth managers, but the financial crisis may have shown the need for a scheme that rewards both investors and advisers.
Fees based on account assets are supposed to align everyone's interests -- adviser revenue rises only if the customer gets richer. Such fees are easy to explain and calculate.
Yet the crisis drained trillions of dollars of wealth from investors and eroded income for money managers, even those who did the right things for their clients.
Scott Welch, Fortigent Inc's senior managing director of investment research and strategy, suggests wealth firms may want to take a page from the hedge fund playbook.
"A model that charges an appropriate fixed fee, combined with an incentive-based fee that rewards the adviser if objectives are met or exceeded, is very interesting to consider," Welch told Reuters in an interview.
Hedge funds typically charge a 2 percent management fee plus 20 percent of fund profits. The formula is often criticized as too pricey, but Welch contends it is a step in the right direction.
Wealth managers could assess a fixed fee to cover operating costs, and then negotiate performance awards for meeting a series of goals, including investment performance, said Welch, whose firm provides asset allocation models, portfolio manager selection and other outsource services for banks, trust companies and investment advisers.
Asset management fees ignore other valuable services, he added.
"When applied to wealth management, where investment performance is one component of what you're doing, you start to disconnect," Welch said. "It ties the value of the adviser solely to investment portfolio performance."
During the turmoil of 2008, many advisers moved clients out of some high-flying assets or employed hedging strategies that limited losses. Yet many accounts are still below their peaks, and adviser income remains depressed.
Debates over fees have come as wealth managers work to regain the trust of investors stung by massive losses as well as frauds like the Madoff scandal.
Meanwhile, Congress is close to imposing new rules that would require brokers to always place client interests first, putting conflicts of interests and fiduciary standards into the national spotlight.
"There are conflicts in the way we price services," said Welch, who sees pros and cons in asset-based fees as well as other alternatives such as fixed-fee and retainer plans.
"In a shattered trust environment, can we do better?" he asked. "We should think about a better way to price our services, to bring us into closer alignment with investors."
To be sure, advisers may find it difficult to convince investors they are better off in a plan that would boost pay for advisers in a falling-market environment. Welch, though, said good firms deserve to be rewarded for sound advice.
"When assets dropped precipitously in '08 and '09, that may have been when you (the adviser) were most valuable," Welch said. "Maybe you prevented them from panicking, did some tax-loss harvesting or bought some defensive stocks. Yet your fee for services probably dropped by 20 to 40 percent."
By: MayorTimo I Source: Joseph A. Giannone & John Wallace
Copyright 2010 by Reuters. All rights reserved.
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