New fee models could open up pricing choices

Fees took center stage last month as executives from Fidelity Investments and Charles Schwab Corp. squared off over the merits of so-called free custodial platforms that pass on fees to advisory clients.

While many advisers enjoy the free service, the complex revenue streams used by custodians are forcing many advisers to rethink how and where they hold client assets. Many RIA custodians sweep cash into interest-earning accounts, or even loan it out through affiliate banks at significantly higher rates, and don’t pass those revenues on to clients. The practice has forced some advisers to look elsewhere for higher returns on holdings in cash.

Pressure from the likes of industry thought leader Michael Kitces, who comes to the argument from a strong fiduciary position, is also forcing custodians to take a closer look at the numbers. Instead of the status quo, Kitces has suggested a model that would charge registered investment advisers an asset-based fee somewhere around 25 basis points, requiring almost a full redesign of the business model.

Kitces’ vision of a more straightforward approach to revenue generation might make sense. A simple fee based on AUM would open new business relationships and pricing plans, and theoretically allow advisers to pick and choose the services they want to pay for and at what cost.

During an InvestmentNews keynote discussion last month, Fidelity’s David Canter and Charles Schwab’s Bernie Clark took Kitces to task over his calls for a reconfigured model, challenging him to debate the topic in an open forum.

“I am going to make an offer right now; I’m happy to come on and talk to Michael Kitces in a debate, because I think he’s asking the wrong question,” said Canter, executive vice president of the RIA segment at Fidelity Institutional. “One of the things we could do, and maybe educate Michael on a little bit more, is make more transparent how we make money.”

Historically, custodial fees are paid in a third-party payer model where the investors pay fees based on the way the investments in their accounts create revenue, Canter said. He suggested Kitces is oversimplifying the models for custody fees and the services custodians provide.

Charles Schwab, too, is adamant about maintaining its current fee structure, according to Clark. “That is not the direction we’re going … So we have no intention of raising any fees as per our pledge,” he said during the event. “I will commit to the fact, and I have in our pledge that’s been public, that there will be no custody fees in the future at Charles Schwab [or] TD Ameritrade.”

RIA service providers are certainly notching strong growth in both clients and assets under custody, according to the annual InvestmentNews Custody & Clearing survey. The breakneck pace of RIA growth has allowed new players to enter the landscape with newer revenue models, even as the largest incumbent players have so far maintained their relative dominance.

While these so-called free services are offered at very little cost to registered investment advisers, they do pass on fees to clients through revenues on commission, trading and for brokerage services on those assets. A revamped model could offer new options for advisers who want to pay a more straightforward fee and would also make explaining those charges to clients easier.

Rethinking custodian fee models could open choice and transparency around pricing, which is almost always the best option for advisory clients.