With the rise of the robo-advisor – and FinTech more generally – all aiming to drive down the cost of investing for consumers, more and more have questioned whether the ‘traditional’ 1% AUM fee will even survive much longer.
Yet a deeper look at the history of the AUM fee reveals that not all costs based on assets-under-management are the same. While investment companies (i.e., mutual funds) typically have an expense ratio calculated as a percentage of AUM, and (registered) investment advisors have long charged AUM fees for investment advice, it’s only in recent decades that brokers have begun to earn AUM-like fees, either in the form of 12b-1 fees (an upfront sales commission paid out over time) or wrap fees (a AUM-based alternative to transactional trading commissions). In other words, some AUM fees are actually for advice, while others are really just a form of levelized commission for product sales or brokerage transactions.
The impetus for this shift does appear to be technology – not robo-advisors necessarily, but the ongoing impact of technology that has, for the past 40 years, brought down transaction costs and sales commissions, from the rise of discount brokerage to the availability of online brokerage accounts that allow consumers to buy no-load funds directly. Which means it’s increasingly difficult for brokers to get paid to broker transactions or sell products, driving them towards AUM alternatives instead.
The caveat, though, is that while there is a “great convergence” of brokers getting paid levelized commissions akin to AUM fees, and investment advisers that continue to receive AUM fees, the regulatory standards for the two are different. Accordingly, it is perhaps no surprise that the regulatory battleground for the past two decades has been about the distinction between brokers and investment advisers (and their suitability vs fiduciary standards) – because the two really are converging around a substantively similar business model.
From the perspective of the advisor, though, the significance of this trend is that the so-called “fee pressure” on the 1% AUM fee is primarily on the 1% distribution charge, not the 1% AUM fee for actual advice. In fact, brokers that struggle to justify their value proposition are increasingly getting their CFP marks and trying to add more value through financial advice, while investment advisers who already gave advice feel the pressure to step up and differentiate in an increasingly crowded marketplace. Which means overall, the real pressure is not on the 1% AUM fee for advice – at least, not at this point – but instead on how salespeople can shift the value proposition of the AUM fee from distribution to actual advice.
