Wealth managers covet hedgies’ pay

By Felix Salmon
July 14, 2010
pay them more!


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People, we have a problem: financial advisers aren’t being paid enough. But there’s a chap named Scott Welch who has a solution: pay them more!

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…

“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.”

Advisers typically get a fixed percentage of assets. Which means that if adviser income dropped by 20% to 40%, so did the assets they were managing. Which doesn’t seem to me like the kind of performance which should carry enormous rewards.

Structuring an incentive-based fee for financial advisers is, I think, a very bad idea, because it’s very hard to quantify objectives. You don’t want to set a benchmark to outperform, since that’s just a way of asking your adviser to take on more risk. If you want your adviser to do something like preserve real wealth for multiple generations, it’s hard to measure that on an annual basis and pay a condign bonus.

In fact, the current system is quite a good way of doing things, I think. If you manage to smooth out volatility in wealth during a time of volatility in markets, then you get rewarded with a less volatile income. And if you build wealth steadily over time, then your income goes up steadily over time as well. And, of course, if you impress your clients with your work, they will stick with you and recommend you to their friends.

The alternative — where advisers get huge paychecks in boom years and then feel aggrieved when those paychecks fall sharply after a bust — does no one any favors. So while the “hedge fund model may be good for wealth firms”, in the words of the story’s headline, I don’t think it’s good for their clients. And that’s where the conversation should end.

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Comments
9 comments so far

The fundamental assumption seems to be that good decisions by a financial planner lead to good performance of their clients’ portfolios. But don’t you think there’s a lot more randomness involved? The financial planners whose primes were in the 1990s make tons of money, while the planners in the oughts or the 1950s make much less. Why not just pay them all by the hour?

Posted by PopEconomics | Report as abusive

“Why don’t we just pay them by the hour?”

Simple, they don’t put many hours in to an individual client’s account. They generally spend a little time researching and thinking, or just rely on outside opinions, and put all their clients into similar things. The actual work for the trades are done by glorified secretaries.

These “financial advisors” are the most overpaid people in the U.S. job market. Their success or failure generally revolves about relationships, and getting high-end clients to trust them.

Posted by TaxLawyer | Report as abusive

Here’s how to tell if your financial planner is worth the money… Was he suggesting that you buy more stocks in the fourth quarter of 2008? Was he demanding that you ignore the fear-mongering in March 2009? Or was he moving you to a “more defensive position” during that time?

The time to get defensive is BEFORE the market collapses. Advisors who do that have my respect. Those who accede to panic AFTER the bottom falls out of the market have my ridicule.

If your retirement portfolio was worth less on July 31, 2009 than on October 10, 2008 then FIRE YOUR ADVISOR. The only way to lose money over that period would have been to sell in panic.

Posted by TFF | Report as abusive

The absurd part is that when we were in a bull market and everything rose, these same advisors were raking in higher – undeserved – fees every year. Did anyone complain at that time?

http://blog.mdwoptions.com/options_for_r ookies/

Posted by MarkWolfinger | Report as abusive

To get a perspective on this, you need to know that many (and certainly a lot more over the last 2/3 years) leading wealth managers / financial planners are ex-investment bankers. And what they are really complaining about is that the pay of wealth managers is much more like “farmers” (ie – long haul, month by month, relationship, etc…) than “hunters” (ie: IBs who would make a couple millions out of working on 1 or 2 IPO/M&A per year)

The problem of course is that a lot of IB nonsense have got into wealth management – the poaching to begin with. So that average tenure has gone down – and that makes it harder to follow clients through thick and thin.
Then the products: essentially, the industry is product pushing. They love HFs and active managers – not because of alpha, better risk diversification or anything sensible thing, but because of the kickbacks, for lack of better words. Those are paid by the investment managers to the wealth managers for bringing clients in.

And of course, having sell side types into what is (or should) be a fundamentally buyside function is a recipe for disaster in my view. But then again, while I think it’s essential to protect the vulnerable from predatorial banking practise (see subprime crisis!), i dont feel quite that strongly for HNWIs, who by definition will have 7 figures cash as investables assets. With that sort of money, you ought to find the time/advice/etc to be able to handle the wealth management sirens.

The other thing wealth managers hate with a vengeance is cash. Because the fees are not worth their work. So they’ve come to create structured deposits, multi deposit products and the likes – mostly a way of getting a few basis points extra from clients, while (at least in the UK, and subject to limits) most would be better off buying saving directly from the National Savings & Investments, which is gov operated and backed.

Posted by fxtrader14 | Report as abusive

There’s another fundamental problem here…

The global economy was booming from 1950 through 2000, with rapid gains in productivity, efficiency, international trade, and the rise of a wealthy middle class. (Your parents were raised in a 1200 sq ft house and all their toys fit into a single cabinet.)

Real returns are likely to be much more subdued going forward. As an off-the-cuff estimate, I use 4% real returns for the stock market and 2% real returns for long-term bonds. (And even those might be generous at any given point in time.)

If your “wealth advisor” is charging you 1% annually, while buying funds that charge another 0.5% to 1.0% annually, how much real return remains? Wall Street ends up with half the money that by rights belongs to YOU.

Your “wealth advisor” isn’t going to help you beat the market. He might help you appropriately balance your portfolio and hedge risk, but he’ll take such a large bite out of your earnings that your downside is just as bad as if you blundered through it on your own — with much less potential for upside.

If you have $500,000 in savings, then you could easily be paying $5,000 to $10,000 annually for advisory services. Instead, put in the (minimal) time to read a few books and educate yourself. Is there anybody here who COULDN’T use another $10,000 a year for a few hours of work each quarter?

Posted by TFF | Report as abusive

As the “chap” referenced in this posting, allow me to respond:

1. If the title of the posting, “Wealth Managers Covet Hedgies Pay”, implies that I suggested that wealth managers should be paid as much as hedge fund managers, then Mr. Salmon quotes me out of context. I specifically stated in my article to NOT focus on the LEVEL of compensation, but rather on the compensation MODEL — some level of fixed fee plus an incentive fee based on the wealth manager meeting or exceeding mutually agreed upon objectives, which might be performance-based or might be based on some other aspect of the relationship. Clearly that objective needs to be both mutually agreed-upon and measurable in order to be feasible.

2. The broader point of the article was that, post-2008, wealth managers are operating in a “shattered trust” environment and need to take proactive steps to maintain or regain the trust of their clients. One of the several steps I discussed was to rethink the pricing model, with an objective of coming up with a model that brings the respective interests of client and advisor more closely into alignment.

All pricing models have inherent conflicts. A %-of-AUM model, the most commonly used in the WM business, explicitly links the value of the advisor to investment performance. That works well for an asset manager or investment consultant, but if “wealth management” means more than that — which to most people it does — then this model minimizes the tangible value linked to those other services.

A fixed retainer fee — another common pricing model — carries a different set of conflicts. One is the risk of “scope creep” in terms of services provided versus fee receive. Another is simply human nature: the client is incented to maximize the services received in order to maximize value for what was paid, while the advisor (even if implicitly) is incented to minimize services provided in order to maximize profitability.

The hedge fund pricing model — a fixed fee plus an incentive fee — has its own set of conflicts, which were pointed out by Mr. Salmon and the other commentators to the blog posting. I never claimed it was the best answer — I simply stated that it was worth asking the question of whether it does a better job of aligning the interests of advisor and client.

Though quoted out of context, I am glad, at least, that my comments sparked a discussion — one I believe is critical to the continued success of the wealth management industry.

Thanks,
Scott Welch

Posted by Islanders78 | Report as abusive

Mr. Welch, what is wrong with paying wealth managers an hourly fee for their services? If they give good advice, you’ll come back and refer your friends. If you have complex needs, the wealth manager gets paid more. Paying a percentage of assets or a percentage of gains only makes sense if the difficulty of the advisor’s job is proportional to the size of the portfolio. And if that *is* the case, then you can simply bill more hours.

Posted by TFF | Report as abusive

In my experience, the primary issue with an hourly fee (or, as in the legal profession, a retainer fee that is drawn against as services are used) is the “ticking clock” syndrome. That is, clients often are reluctant to call their advisors because every time they do, “the clock is ticking”. Of course, there is also the temptation for the advisor to stretch out the time spent on a project in order to drive up revenue.

Unfortunately, no pricing model is perfect, and I suspect the best answer is that each advisor should use a pricing structure that best fits their particular business model. Perhaps the more important point is that advisors should give serious thought to(and discuss with their clients)the pricing structure they use, so as to (a) fit their fees more closely to their tangible services, and (b) maximize alignment of interests between client and advisor.

Thanks,
Scott

Posted by Islanders78 | Report as abusive
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