Karen Van Voorhis wants to transition her financial advisory clients away from an asset-based pricing model, but she knows that is easier said than done.
Ms. Van Voorhis, a vice president at Sapers & Wallack in Newton, Mass., is like a growing number of advisers in that she recognizes the limits and challenges associated with asset-based pricing models.
"It's becoming difficult to charge a fee that is exclusively tied to an investment account, when work on the account is only a fraction of the work we do for clients," she said. "The current fee structure has led to conversation with clients, that they initiated, asking what they are getting for that 1% fee."
Whether it's the influence of the Department of Labor's fiduciary rule and a push toward more transparency around fees or the pressure on fees coming from low-cost robo-advice platforms, asset-based pricing models are being challenged like never before. Critics claim they don't reflect the scope of an adviser's services and leave advisers vulnerable to market downturns. And they also limit the universe of potential clients, many of whom are not willing to pay a percentage of their assets each year for financial advice.
"They don't understand what the fees are for," Ms. Van Voorhis said. "As an industry, we haven't done a good job of evolving the value proposition we put forth for clients."
But not everybody is ready to write off asset-based pricing. Proponents continue to tout the symbiotic nature of an adviser's income being pegged to the size of a client's investment portfolio.
Michael Kitces, a partner and director of wealth management at Pinnacle Advisory Group and co-founder of the XY Planning Network, comes down firmly on the side of asset-based pricing for his own $1.8 billion advisory business and any other firm that can make it work.
"I've been pounding the table for a long time saying the AUM model is not going away," he said. "AUM works fine. It's not broken. The interests of advisers and clients are relatively aligned. You have very good client psychology. And the fee bills automatically, so clients don't have to write a check."
Ever since the late 1990s, when asset-based pricing started gaining appeal over sales commissions, the independent financial advisory space has leaned heavily on a fee structure pegged to the size of a client's portfolio.
That fee typically starts at around 1% but is often discounted as portfolios grow.
According to an analysis of fee structures by InvestmentNews Research, 86% of registered investment advisers charge asset-based fees, although many of those firms also charge other fees, including commissions on some insurance products or one-time fees for financial plans.
When broken down, asset-based fees represent 76% of the total advisory firm revenue.
Although asset-based pricing might put the adviser on the same side of the table as the client, it can unintentionally de-emphasize everything an adviser does for clients.
"The problem with AUM fees is the value proposition if you're doing financial planning along with the investment management," said Scott Bishop, the executive vice president of financial planning at STA Wealth Management.
Asset-based pricing can also make the adviser vulnerable to extreme income volatility.
"A market correction is in the back of everyone's mind," Ms. Van Voorhis said. "Ask anyone who survived 2008 and they'll tell you the market went down 30% but we didn't do 30% less work. There's a need to have the fee be commensurate with the work involved."
Then there's the big-picture perspective of the ultimate need for and value of financial advice.
By decoupling financial advice from client assets, the universe of people willing and able to pay for financial advice becomes much larger.
Even though he supports an AUM model, Mr. Kitces recognizes its limitations.
"Right now, the whole industry is fighting for the same 7 million high-net-worth households. But if you're not charging based on assets, there's an enormous untapped market out there," he said.
The so-called subscription fee model, also known as a flat fee or retainer fee, is a foundation fee model for members of the XY Planning Network, largely because it vastly expands the market of potential clients for advisers who are newer to the business.
"Today, the number of households paying a subscription fee for financial advice is zero or negligible, but in five years I would expect it to reach 20 million households," Mr. Kitces said.
For some advisers, the growing influence of robo-platforms has triggered concerns over fee pressure and a move away from fees tied to investment management.
So far, those concerns have not had a measurable effect on asset-based fees, said Matthew Sirinides, senior research analyst at InvestmentNews Research.
"Advisory firms might be talking about lower fees, but over the past seven years, the average fee has only shifted a basis point or two," he said. "Average asset-based fees have been between 73 and 78 basis points for the past five to seven years."
Mr. Kitces also shrugs off the notion that robo-platforms are driving the increased focus on fees.
"After six years, the robos have attracted a total of $25 billion, and at 25 basis points, that is equivalent to a single $6 billion RIA," he said. "Robos have had a negligible influence on fees. It's the general focus on transparency that has people focused on fees."
But it may be a while before a significant shift occurs away from asset-based pricing. In May, the consulting firm of Simon-Kucher & Partners published a research report titled "The Future of Fees: Real life pricing innovations in wealth management."
The report, which identified eight variations on advisory pricing models, essentially concluded that it will take a tectonic shift to get the industry to move in a significant way away from asset-based pricing.
"If you look at the history of wealth management, before AUM, it was the broker commission fee that was dominant, and that [became less popular] because people realized the brokers' commissions were not aligned with clients' best interests," said Wei Ke, co-author of the report. "So, AUM became a nice compromise because fees grew with portfolio assets."
For advisers already charging AUM fees and seeking to switch, like Ms. Van Voorhis, the focus needs to shift toward comprehensive planning and services beyond just investment management.
"I'm overwhelmed just thinking about it because the hardest thing to do is convert current clients," she said. "It's much easier to say we're just going to do this going forward. I think there's going to be some hard conversations."
One of the strategies Ms. Van Voorhis and her colleagues are considering is explaining to clients that their current asset-based fee will be frozen for two years.
After that, the fees will convert to a subscription fee that more closely reflects the services they are receiving.
"Nobody wants to have those conversations with clients," she said. "But it is an opportunity to talk to them about our value prop. We're not just rebalancing portfolios."