Why some brokers stand by commissions

LPL adviser Sharon Joseph of Joseph Financial Partners knows she could make more money if she moved her clients onto a fee-based platform with a recurring annual charge of around 1%, but after three decades in the industry, she said that the math doesn’t add up for her clients.
She said that for her approximately 700 clients, all of whom have assets below $2 million, a commission-based model works best.
“I am not afraid of much, and certainly not afraid of the way my pay would change if I moved to fee-based,” Ms. Joseph said. “I stay commission-based because it is the right thing for my clients.”
That puts Ms. Joseph, whose firm manages around $163 million in assets, in the minority of advisers. For more than a decade, firms such as LPL Financial have been encouraging advisers to go fee-based, meaning that they derive a majority of their business from charging clients around 1% to 2% of assets under management annually. Around 57% of all advisers are fee-based, according to the most recent Cerulli Associates data from 2013.
Meanwhile, broker-dealers continue to push for more fee-based business. Morgan Stanley Wealth Management, which reported it had around $724 billion — or 37% — of assets under management in fee-based accounts as of the end of March, has said that number could rise to around $1 trillion if growth continues at a similar pace.
Firms market fee-based accounts as more transparent and having less conflicts of interest than charging on each transaction, but in reality there is a lot of gray area around what makes sense for the client, said Brian Hamburger, president and chief executive of MarketCounsel, a legal and regulatory consulting firm focused on registered investment advisers.
“We have a tendency to look at this as black and white as commissions are wonderful, or commissions are evil; fees are wonderful, or fees are evil,” he said. “But when you peel back, you start to see the reasons they look at it differently is because clients have different needs.”
CRUNCHING THE NUMBERS
From an expense standpoint, it might be hard to justify a fee-based relationship on a smaller portfolio, such as those Ms. Joseph manages, or on a long-term retirement investment that does not require frequent changes.
The compounding effect of a 1% annual wrap fee on a $1 million retirement account over 20 years is more damaging than an upfront commission and a quarterly 12b-1 marketing, or “revenue sharing,” fee that usually runs around 25 basis points, or 0.25% of assets, Ms. Joseph argued.
She said she put one of her wealthiest clients who sold a small business for around $2 million into a well-known fund family with a low expense ratio that will allow her to shuffle assets around different funds in the family free of charge.
“Except for capital gains tax, they’ll have no other sales charge for the rest of their life,” she said.
If she had charged a fee on those assets as well, it would have taken out another 1% to 2% of their annual return in addition to the fund’s annual operating expenses.
Overall, around 49% of Joseph Financial Partners’ assets are in mutual funds; 38% is in insurance and annuities and another 13% is in brokerage.
Still, the math can be complicated and depends on what is being offered, said Ned Van Riper, a former financial adviser who now counsels advisers going independent through his firm, Finetooth Consulting.
A 1% annual fee may still be cheaper if the client is going into low-cost equity or fixed income ETFs, for example, which have expense ratios well under 1%. A total charge of 1.3% on a wrap account invested in ETFs may be well below what some mutual funds charge just on annual operating expenses.
TRANSPARENCY
While he acknowledged that fees may not make sense on smaller accounts, Mr. Hamburger warned that clients may be willing to pay more for advice that they know will not be influenced by the size of the commission.
“You’re not really giving them holistic investment advice,” he said, “You’re giving them advice as to which security is most useful. That’s different.”
But the holistic financial advice may come with its own conflicts of interest, even in the fee-based world. Advisers have an incentive to recommend against drawing down assets or taking out a mortgage, for example, as both would decrease the overall AUM, both Mr. Hamburger and Ms. Joseph agreed.
Ms. Joseph added that she did not believe that being fee-based would “deepen” the relationships with clients because advisers still have to spend time prospecting and making up for lost assets. Advisers can lose an average of 20% of assets each year because of clients dying or moving away, she said.
“It’s a nice theory to think you have more time to spend hand holding, but we’re always still out selling more,” she said.
Ms. Joseph refers her clients to an estate planner for broader financial planning questions.
There’s also the possibility that advisers who receive both fees and commissions will start offering extraneous products under the guise of holistic advice.
“People will think you’re fee only and trust you,” said one commenter in response to an InvestmentNews article earlier this year about why more advisers weren’t fee-based. “Then you can sell them all kinds of expensive stuff on the side.”
Regulators have been more closely eyeing the potential conflicts of interest around fee-based accounts, which could be susceptible to “reverse churning,” Mr. Hamburger said.
“This industry has gone full circle,” he said. “Now they’re taking a look at fee-based accounts and where there’s no activity; they’re questioning, ‘why is this a fee-based account?’”
Ms. Joseph said that a good adviser will be providing holistic advice whatever the model. She said her job is focusing on how the investments fit into the total picture. Commission-based advisers still have an incentive to follow up with clients after the sale and monitor investments because they usually still receive a small recurring commission or charge from 12b-1 fees or commissions on insurance products.
“If he’s the kind of adviser who is going to take care of you, he’s probably going to take care of you under either system,” she said.