Custodians ponder charging RIAs asset-based fees

A new pricing model has RIAs and custodians in reevaluation mode

Aug 9, 2018 @ 2:15 pm

By Jeff Benjamin

The fee arrangement developed over the past 20 years between registered investment advisers and custodians might be about to change dramatically.

As custodians reevaluate the value of their services to RIAs, and RIAs reassess their fiduciary duty to clients, there are growing discussions about whether it makes sense to start charging advisers a fee based on total client assets.

The proposal, detailed earlier this year in a blog post by Pinnacle Advisory Group director of wealth management Michael Kitces, would upend the current practice of custodians earning revenues from RIAs' clients and letting RIA firms ride for free.

Even in the earliest stages of the discussion, with no custodian having yet come forward with an official plan to change its pricing model, lines are being drawn and heels dug in.

Pressure from the likes of Mr. Kitces, who comes to the argument from a strong fiduciary position, is forcing custodians to take a closer look at the numbers.

"If you think about how custodians are paid, we have the same challenge advisers do; their assets-under-management fee is tied to the value of the portfolio and we know they do a whole bunch of work beyond just investments," said David Canter, head of the RIA segment at Fidelity Clearing & Custody Solutions.

With that in mind, Mr. Canter said Fidelity is doing a lot of research around the "custody value stack."

Citing such chores as shareholder servicing, tech support and marketing support, Mr. Canter said, "We do a whole bunch of things beyond pure custody."

"There has to be a lot more dialogue between advisers and custodians, because it cost money to place trades, send out confirmations, and look out for dividend payments," he added. "We're at the discovery stage with this."

But a lot of RIAs prefer the status quo.

"Advisers are so used to getting custody for free that I've already heard a lot of resistance that they don't want to pay for it," Mr. Kitces said. "Of course, the reality is they already pay for it, just indirectly through all the ways that custodians skim dollars on the back end."

Most custodians would likely take issue with the reference to "skimming dollars" off clients, but there is no denying that clients represent the primary revenue stream for a custodian.

There are basically three ways a custodian makes money: on asset balances, interest spreads and trading. The first two involve leveraging investor cash and cash-equivalent balances for significant revenues.

Last year, for example, Charles Schwab Corp. generated over half the company's revenue from interest spreads in client accounts, according to Mr. Kitces.

The third revenue stream for custodians is shrinking fast as trading becomes a discounted commodity.

"What's clear is that there needs to be a reevaluation of the price-value-cost dynamic," said Gabriel Garcia, head of relationship management at BNY Mellon's Pershing Advisor Solutions.

"For custodians, the cost of doing business is increasing, and productivity gains alone are not sufficient to offset costs," he said. "RIAs, on the other hand, are experiencing pricing stability and growing profitability. There's a need to reconcile this dichotomy, as it is hard to imagine why custodians would continue to provide technology, invest in compliance and regulatory requirements, and provide safety and security of assets in a cyber world without a reasonable return on investment."

Rush Benton, senior director of strategic wealth at Captrust, said falling trading costs are part of the reason that changing the fee model is a "bad idea."

"It doesn't move the needle for clients or firms," he said. "Trading fees are going to zero anyhow, and custodians are making their money on deposits, margin balances and activity fees."

Kashif Ahmed, president of American Private Wealth, said asking RIAs to pay a custodian fee based on assets is "most certainly a bold idea," but "the time for this change might not have arrived yet."

"If the end client is not complaining about this arrangement now, then why change anything?" he said. "Perhaps if the RIA is picking up the cost, they may gravitate to a cheaper custodian, but that custodian may not be better overall for the RIA's business, and/or the end client."

But Steve Lockshin, principal at AdvicePeriod, said custodians charging fees at the RIA level can't happen soon enough.

"There is one component necessary to make this work and it's oddly simple — transparency," he said. "If custodians would offer tiered pricing based on size and not try to make any additional profits from a negotiated spread on margin and money markets, but instead charge their cost plus a reasonable margin for profit, then the simple business-to-business arrangement would take hold between the consumer and adviser, and adviser to custodian."

From Mr. Kitces' perspective, and maybe in an ideal world, nobody's fees or revenues would change much if custodians stopped charging clients fees and started charging advisers a few basis points pegged to client assets on the platform.

He proposed the idea of 5 basis points, but admits the asset-based fee would have to be set to make financial sense for all parties, whether higher or lower.

"I find it supremely ironic that RIAs push clients to pay fees and not hidden back-end commissions on products, and then resist the suggestion that we should pay fees and not back-end commissions on custody," Mr. Kitces said.

The second argument against an asset-based custodian fee is more nuanced, he explained.

"Some RIAs are much better at playing the game of minimizing the custodian's profits than others, because they manage trades efficiently with rebalancing software, minimize cash balances, etc.," Mr. Kitces said. "For those RIAs to pay a custody fee, they may actually end up paying more than they do today because they're really good at minimizing the custodian's profits."

On that point, Mr. Kitces said, "custodians have really painted themselves into a corner, because their best and most vigilant advisers will view this as a fee increase, while the most ignorant, who don't pay attention to all these hidden costs, would get a fee decrease when the custody fee equalizes the costs. Basically, the compensation system from RIAs to custodians is so broken that the worst and least client-centric advisers are subsidizing the best ones."

For the pricing model to work to the satisfaction of fiduciary purists, custodians will also have to rethink their use of no-transaction-fee platforms and the use of funds charging 12b-1 fees that generate various forms of soft dollars.

"There are too many games being played with hidden profit centers, soft dollars, and unnecessary negotiations for what is otherwise a commodity service," Mr. Lockshin said. "This is all likely to change significantly in the coming decade with the advent of blockchain and the simplification of data flow. As I often say, as soon as moving your brokerage account is as easy as moving your phone number to a new carrier has become, we can expect to see a very different landscape for the financial service industry."

0
Comments

What do you think?

View comments

Recommended for you

RIA Data Center

Use InvestmentNews' RIA Data Center to filter and find key information on over 1,400 fee-only registered investment advisory firms.

Rank RIAs by

Upcoming Event

Oct 23

Conference

Women Adviser Summit - San Francisco

The InvestmentNews Women Adviser Summit, a one-day workshop now held in four cities due to popular demand, is uniquely designed for the sophisticated female adviser who wants to take her personal and professional self to the next level.... Learn more

Featured video

INTV

What it took to win an Excellence in Diversity & Inclusion Award

Editor Fred Gabriel and special projects editor Liz Skinner explain how InvestmentNews chose the winners of our inaugural Excellence in Diversity & Inclusion Awards.

Latest news & opinion

10 highest paid professions in America today

These are the top-paying jobs in the U.S., according to Glassdoor.

Ameriprise to pay $4.5 million to settle SEC charges that five reps stole more than $1 million from clients

Agency censures firm for not protecting clients from thieving brokers.

SEC slaps Lockwood with $200,000 fine over unseen trading costs to clients

Clients were forced to pay fees in addition to the usual wrap charges, the regulator maintains.

Gotcha! 10 lessons from brokers gone bad

These cases show why regulators nabbed reps and firms, and how to avoid their fate.

Tax-credit investigation may trip up Wells Fargo

Justice Department is investigating bank's dealings in tax credits for low-income housing, sources say.

X

Hi! Glad you're here and we hope you like all the great work we do here at InvestmentNews. But what we do is expensive and is funded in part by our sponsors. So won't you show our sponsors a little love by whitelisting investmentnews.com? It'll help us continue to serve you.

Yes, show me how to whitelist investmentnews.com

Ad blocker detected. Please whitelist us or give premium a try.

X

Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print