The investment advice industry in the US is growing. It has, so far, avoided a regulatory probe into fees. But the lack of clarity surrounding fees, which sparked a review in the UK, is significant, finds Nick Fitzpatrick.
The financial advice industry in the US has seen the number of registered investment advisers (RIAs) grow. According to Cerulli Associates, the number of advisers practicing as RIAs increased at an annualised rate of 8% between 2004 and 2012, while every other adviser channel declined.
An RIA is a firm or individual allowed to offer investment advice about funds or securities.
So far, the US industry has avoided the type of regulatory probe seen in the UK, where the history of financial advice is less than illustrious.
Even putting aside the catastrophic pensions mis-selling scandal of the early 1990s that could have affected two million people, the UK advice industry has been dogged by more everyday problems, chiefly opaque charging structures that include fund manager “rebates” – a murky system of commissions from investment managers to financial advisers that the financial regulator worried could distort an adviser’s fund choices.
Rules implemented a year ago following the UK’s retail distribution review (RDR) cover independent financial advisers (IFAs) and those tied to an institution. Under the RDR, advisers must agree how much a client pays, what the client gets, and fund manager commissions are finished.
Similar rules are on the horizon for the rest of Europe.
At present in the US, the tied advisor is far more common than the independent adviser, says Bing Waldert, director at Cerulli Associates in Boston.
“Around 40-45% of assets under management are with advisers working for the big banks,”
he says, though he adds that advisers employ open architecture – that is, offer funds from other institutions.
However, the concept of the IFA in the US is on rise and IFAs are taking market share away from the banks, Waldert says.
Historically, the banks focus more on mass affluent customers – people with between $1 million (€726 million) and $5 million – and high-net-worth individuals.
The typical blue-collar worker, says Waldert, with perhaps $100,000 to $500,000, represents “the Big Middle” and is more likely to access an IFA.
In broader terms, the adviser battleground is in the $100,000 to $2 million range.
But just because there has been no large focus on adviser fees does not mean there is no need for one. Adviser fees are a source of confusion in the US.
Waldert, who says little has happened in comparison to the UK’s RDR to clarify fees in the US, adds: “A lot of people think the service is free.”
The misundertanding about fees is leaving investors unaware that there is action they can take to save money by choosing between charging structures.
“There is a trend in the US towards asset-based fees rather than commissions,” says Waldert. He defines an asset-based fee as a one-time fee based on a percentage of portfolio.
The unfortunate irony is that the commission structure is probably cheaper then the asset-based fee, Waldert says.
Research in 2013 by JD Power, a market research firm, into charging by full service investment providers showed 51% of investors paid an “annual account fee”, and of those, 49% paid their annual fee as a percentage of the portfolio.
Those who did not pay an annual account fee usually paid a per-trade fee (31%).
The research does not point to a trend towards asset-based fees, though. “These values have been fairly consistent over the past three years,” says Craig Martin, financial services director at JD Power.But it does signal that customers do not realise that asset-based fees may be disadvantaging them.
“We do see that a relatively high proportion of customers indicate a lack of clarity on fees,” says Martin.
“Only 38% of full-service investors indicated they completely understand their fee structure and 30% of clients indicated their adviser did not explain the fee structure.”
Andrew Power, the RDR lead partner at Deloitte in the UK and who has also worked in the US, says: “[The US] still has a plethora of fees that are difficult for retail investors to understand.”
But what about the commissions paid to fund managers, which the UK regulator finds so worrying?
Waldert says: “The payments will usually be from the asset manager to the platform or broker, and then to the adviser. A lot of fees are set out, but an asset manager might benefit from preferred access or attractive speaking slots at conferences.
“However, you can argue payment for distribution drives more assets and this increases scale and lowers costs.”
Martin says: “The argument could be made that because the advisor’s performance is linked to the success of their customer’s portfolio that this should reduce incentives to recommend investments that are not in the best interest of the client.”
But he also adds: “While we don’t specifically capture all the detailed fees in our study, the challenges with customers understanding the fees charged could point to the potential of firms having bias in their recommendations [and having a lack of customer awareness].”
Martin says there are a number of smaller firms that promote their independence from the investment funds as a demonstration that they provide unbiased advice.
Meanwhile, on a broader industry level, there has also been a shift to offering many services to clients on a fee basis rather than the more traditional commission, which further separates the advice from the product selection.
While the US has avoided the kind of wide regulatory scrutiny that was seen in the UK, Martin says that anecdotally there is a high level of focus and scrutiny on this topic in the US.
“Many of the industry groups that provide certifications and the like are working to define the requirements and criteria to help address the underlying concern
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