Wealth managers covet hedgies’ pay

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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