Waning revenues may mean more fees

Advisers could face new charges for services such as practice management and technology.

If the profitability of the relationship between registered investment advisers and custodians doesn’t improve, more advisers could soon find themselves paying an assortment of new fees to custodians.

InvestmentNews hosted a roundtable of top executives from the leading custodians to learn more about the major issues they face.

One of the most pressing is the need to generate profits when traditional revenue sources are drying up and advisers’ demand for services is rising, according to participants.

“At some point, I don’t know when, there will begin to be a retooling of the revenue engine” for custodians, said Mike Durbin, the former president of Fidelity Institutional Wealth Services.

Late last month, the firm’s broker-dealer clearing unit was combined under the moniker of Fidelity Clearing and Custody. Fidelity spokesperson Nicole Abbott said in an email that since then, the firm no longer breaks out clients in each channel. But as of last August, Fidelity’s custody unit served about 3,000 RIA firms.

In a follow-up statement to the roundtable, Mr. Durbin — who as part of the reorganization was named president of Fidelity Wealth Technologies, a new group — attributed the potential shift to an “increasing divergence between [the industry’s] traditional sources of revenue and our evolving areas of investment spend … such as practice management solutions, that provide added value to advisers.”

ECONOMICALLY FEASIBLE

In other words, it has become much harder for custodians to serve advisers in an economically feasible way. That’s because custodians traditionally have relied on three revenue drivers: trading volume, income from interest rate spreads on cash and asset growth.

Two of those, trading volume and interest income, have withered over the past six years, making it more difficult to turn a profit in the adviser-custodian relationship, the roundtable participants said.

“Since 2008, asset value is the only thing that has gone up,” said Mark Tibergien, chief executive of Pershing Advisor Solutions, in a follow-up interview. Pershing serves 517 RIA firms.

In fact, trading volume — the amount of stocks, bonds and other securities bought and sold by advisers’ clients — is going down both in sheer volume and in profitability.

Advisers are trading less on behalf of their clients, and more of the trading they are doing involves passive investments, which tend to be less profitable than active investments.

Morningstar data show that while assets in actively managed funds stood at $9.87 trillion on Aug. 31 compared with $3.98 trillion in passive funds (including index funds), passive funds had an 11% growth rate over the previous year versus just 2% for active funds.

“The more that people go to passive [investing] … it’s less revenue-rich,” Mr. Durbin said during the roundtable discussion. “We’re very mindful of that custodial mixture that’s on the way.”

He said that a decade ago, about 80% of industry revenue was based on trading fees.

“Now, 20% is trading and 80% is spread,” Mr. Durbin added.

That’s not good, especially in an environment in which interest rate spreads for custodians have been squeezed because the overnight federal funds rate has been stuck near zero for the past five years.

The pressure on revenue generated by lower trading volume and interest rate spreads comes as custodians are being asked to provide more services to advisers. In recent years, the major custodians have worked to ingratiate themselves with advisers by expanding their offerings in practice management, compliance and technology — all of which cost money.

It remains to be seen how advisers will react if custodians start tacking on fees for some of those services.

For his part, Ron Carson, founder and CEO of Carson Wealth Management Group, expects to take it in stride — especially if such fees become commonplace.

IMPORTANT PARTNERS

“We all get that we’re in business to make a profit,” said Mr. Carson, adding that custodians are important partners to advisory firms.

“My clients don’t want me not to charge enough, and we don’t want custodians not to charge enough, because then it wouldn’t be an investment in the future of our business,” he said.

In addition to basic asset safekeeping, custodians provide services including technology solutions, continuing education, webinars and conferences.

Some, including several represented at the roundtable, already charge fees to advisers whose assets under management fall below a certain threshold.

Matt Enyedi, an executive vice president and head of RIA Solutions at LPL Financial, said it has moved toward fee arrangements with “business models that aren’t profitable, especially at the lower end.”

The firm has 322 RIAs on the platform.

In a statement provided later, Mr. Enyedi said, “While in our case only a very small number of firms are charged a fee, it should be noted that the practice of customized fee structures based on the size and complexity of a relationship with a firm is very common in the industry.”

Pershing, which actively targets RIAs with at least $100 million in assets under management, said it has some fee arrangements, determined case by case, for advisers whose assets under management are lower than the target market.

Meanwhile, Fidelity said that roughly 10% of its client base gets charged an asset-based fee for custody and related services, with either the end-client or the RIA paying the fee.

The firm began charging such fees in 2010 for clients that don’t meet a $15 million minimum.

Schwab Advisor Services eliminated custody fees to advisers with less than $10 million in assets under management two years ago.

About 7,000 RIAs custody assets with Schwab.

FOCUSED ON GROWTH

Like Schwab, TD Ameritrade has no minimum AUM.

“When we do engage advisers at the lower end of the asset spectrum, we make sure they have a business plan and are focused on this as their primary occupation and are focused on growth,” said Tom Nally, president of TD Ameritrade Institutional, in a phone interview.

About 5,000 RIAs use TD’s custody platform.

Almost everyone in the industry is examining the potential for fees’ becoming the norm at some point, according to Mr. Tibergien. He said he envisions the emergence of a fixed fee or of a la carte payment for services.

“No one has decisively acted on it, because there are so many variables,” he added. “Anytime you change pricing, clients get upset. So to do it, you have to offer added value.”

Sarah O’Brien is a freelance writer in Hampstead, Md.