The client experience on phones and computers is steadily improving at wealth managers and “bifurcating the financial advisor landscape.” As a result, one group of advisors might need to rethink its business and compensation models.
There are, increasingly, two types of financial advisors, according to a recent report published by Aite Group, a research and advisory firm focused on financial services. Some wealth managers are “hunters” that cater to high-net-worth and ultra-high-net-worth clients, and others are “administrative farmers” focused on serving the mass affluent (generally considered households with $100,000 to $1 million to invest). Organizations, regardless of size, might have one or the other, or both.
Hunters don’t have it easy. Investors are “increasingly demanding vis-à-vis what they should pay for,” especially the wealthiest ones, Aite says. For example, if a client has millions of dollars invested passively and their advisor is no longer being charged commissions to trade (potentially saving a lot of money), that client might start asking, why are they paying the same 1% fee?
Those wealth managers to the rich could face fee compression. But they can also do a better job explaining their value proposition, and improve their operating models while still having the resources left over to invest in technology and their business overall. They can also evolve compensation plans to incentivize hunters to grow their own practices and work with wealthier clients.
But the Aite-dubbed farmers are facing bigger changes.
“The mass-affluent and mass-market segments will increasingly find themselves doing business with digital players, whose staff are paid standard salaries and bonuses,” according to Aite.
As the financial services delivered to clients through electronic devices improve and become “more mainstream,” salary-based compensation plans for the humans they work with will standardize. In addition, bonuses those advisors receive will not just be dependent on new assets they bring in. Performance will be judged by qualitative factors, such as client satisfaction. There are already examples of this model in practice such as Schwab Intelligent Portfolios and other robo-advisors.
To be sure, this hybrid advice approach to wealth management began years ago following the global financial crisis and is still in its infancy. As of year-end 2019, the hybrid model accounted for only $298 billion in the U.S. — less than 1% of total professionally managed assets, according to Aite.
However, Aite expects the Covid-19 pandemic will accelerate adoption of the hybrid model. The sharp market downturn and economic turmoil “identified certain flaws in current assets under management (AUM)-based compensation models,” the report said. “Post-crisis, wealth management firms and advisors will need to reevaluate and expand their compensation plans to include planning and subscription fees to better align client needs with the full range of services and value provided by the advisor.”
What the hybrid model adoption means for independent RIAs is unclear.
RIAs that don’t cater exclusively to the rich could be vulnerable if investors reconsider the asset-based fee model. Asset-based fees accounted for 82% of revenue at independent RIAs as of June of last year, compared to 66% at the so-called wirehouses, and 58% at independent broker-dealers, according to Aite. However, independent RIAs might also be best-prepared to transition to new fee models. “Consulting and advice fees” accounted for 10% of revenue at RIAs, compared to 2% at wirehouses and 6% at independent broker-dealers.
“Although U.S. financial advisors continue to focus on advisory/fee-based models, we see only marginal use of advice-based compensation, as there is a lack of consensus on the best approach to structure it. New entrants into the market are driving growth toward advice-based compensation, evolving with the emergence of hybrid advice solutions and next-generation advice,” Aite says.
Assuming investors take to the hybrid model as predicted, which companies they gravitate toward is unknown. For example, Goldman Sachs only began developing products and services intended for the mass affluent in recent years; Other companies might consider and pursue that client segment, too.
Although, McKinsey & Company expects only a handful of big wealth managers will reach the necessary scale to be everything to every customer. All others will have to remain focused on the wealthiest investors.