The mode of compensation that most advisors use is broken. The system of charging clients based on the amount of assets they place under your management is fatally flawed. The AUM compensation often forces clients with simple financial lives to pay you more, while those clients with highly complex financial arrangements can demand more and get away with paying you less.
Left alone, this misguided pricing model will poison your business. Clients you overcharge will seek advisors with lower fees or a compensation structure better aligned with their needs, and your business will ultimately shift to clients with the most complex financial lives, who you are undercharging. It's not a prescription for financial success.
The AUM Time Bomb
The anti-consumer aspect of AUM pricing has gotten zero coverage in the consumer press and minimal attention in trade periodicals. It's rarely discussed in the professional membership groups or at conferences. That's because compensation discussions remain bound by the age-old arguments-first, whether to charge fees or commissions and then how to switch to a fee-based compensation structure without cutting your pay. But that battle, which began in the mid-1980s, is over now, and fees won.
Commissions are almost universally viewed as an ill-suited, conflict-laden way to charge clients for managing their wealth. But the victory for the fee advisors will be hollow unless they address the unfairness of AUM compensation. The focus of the conversation must now shift to fixing the inefficiency and irrationality of the AUM fee system, which is used by the vast majority of wealth managers, and which is ironically embraced by advisors calling themselves fiduciaries.
Let's face it: Advisors charging AUM know they have a problem. They know that their pricing scheme is not properly aligned with their value proposition. They know that some clients they charge only 1% a year call them every week or two because their attorney made them set up another trust, their partnerships are in trouble or one of their children is getting married or divorced and a will must be changed. Meanwhile, the same 1% fee is being paid by clients with simpler financial lives who the advisors never hear from.
Trouble is, the scariest thing for a business owner to confront is a change in price structure. It's risky. Even a small change could wreak havoc in your life. Some clients may get angry or leave. Who wants that aggravation? Nobody. So advisors have collectively ignored the issue. Fee-only advisors may continue to proclaim themselves consumer heroes for not accepting commissions, but it's only a matter of time before those in the naïve consumer press, who have for so long been the cheerleaders for fee-only advisors, wake up to the realization that they are recommending many consumers overpay for wealth management. And when that happens, the proverbial golden goose will have been cooked.
A Better Way
So let me introduce you to Chris Snyder, an extraordinary entrepreneur and economist with some big ideas. He has answers to numerous challenges facing advisors, including the thorny compensation question.
Snyder, 66, is CEO of Private Client Resources LLC (PCR), a Wilton, Conn., company he co-founded in 2000 with Joseph L. Dionne, 76, the retired chairman, president and CEO of The McGraw-Hill Companies who serves as director on the boards of several large companies, including AXA Financial (which encompasses Equitable, Alliance Capital and Sanford Bernstein), Harris Corp., Sprint and Ryder.
Snyder sold his first company, Loan Pricing Corp., in 1994 to Reuters for $30 million. A Ph.D. in economics, he's as adept at real-world business as he is at economic theory. He doesn't just understand the ideas fundamental to the capitalist enterprise, he lives them.
Snyder's latest venture, PCR, would seem to be an aggregation company serving the super-rich. But it's really an information company-information being a byproduct of the aggregation services. He's built such companies before. Loan Pricing Corp. gathered data about the cost of bank loans and published it, and thus fostered the creation of a market for the loans. Dionne, meanwhile, has run a giant information company (McGraw-Hill owns Standards & Poor's).
Together, the two are aggregating accounts, positions and transactions on assets owned by ultra-high-net-worth individuals and gleaning from that raw data much more useful and intelligent underlying information about these clients-trends, preferences, habits, patterns and needs.
The firm tracks the wealth of about 2,000 such individuals. Each client is an extended family, which is usually led by a patriarch or matriarch and may include their brothers and sisters and all of their children and grandchildren. The average extended family is tracking about $80 million of assets on PCR. This includes everything they own. Interests in private companies, boats, planes, coin collections, homes and all the other stuff they accumulate, including their debt-and, yes, their securities as well. PCR updates all the data daily by any means possible-using interfaces from aggregation companies, downloading directly from institutions that have direct feeds, and writing its own data feeds from institutions when needed.
PCR also uses good old-fashioned elbow grease to manually update accounts where needed. The firm employs about 20 people who seek hard-to-get data and make sure it's all scrubbed.
"There is nothing glamorous about PCR," says Snyder. With $1 billion of new assets being added to PCR's system every month recently (its clients include Northern Trust, U.S. Trust, Smith Barney and Citigroup ), not only is the firm gaining traction but its wealth of information is starting to be exploited. And among all the other things discovered in these pieces of information is a way to replace the broken AUM system of charging clients.
Like most great ideas, Snyder's solution to the AUM pricing problem is simple. He has invented something called a "wealth complexity unit" (WCU) to quantify the complexity of a client's financial life. "We originally thought that the richer you are, the more complicated you are," says Snyder. "But empirically, we've found no correlation between wealth and complexity. This is an important finding not just because it's interesting but because advisors add value to a client not based on wealth but based on how complex a client's financial life is."
It stands to reason that the value an advisor brings to a client is directly correlated to the complexity of a client's financial situation. But since the amount of complexity is not highly correlated with the amount of wealth, a better proxy for complexity is needed. Snyder has found that better proxy by calculating WCUs.
Snyder assigns these units to clients according to their number of tax entities, accounts, positions and transactions. Based on these and other factors, which are proxies for complexity, the clients are scored. This is how Snyder figures out how much to charge for aggregating each client's wealth on his system. And the same sort of system can be used by advisors.
A client complexity chart he's created shows that his clients' wealth is not correlated with their complexity. Some have great wealth but low complexity, others just the opposite, according to the quadrant of the graph. By creating a way for an advisor to benchmark the complexity of a client against peers, Snyder solves the AUM pricing challenge and, more importantly for PCR, unlocks the value of information in his database.
It's difficult to say whether you could best score clients this way using a financial planning, CRM or portfolio accounting system. But some professional client management application, it seems, should be able to collect this data, generate a report, and allow an advisor to sort and charge clients according to the amount of help they really need.
PCR in Perspective
Make no mistake about it, Chris Snyder wants to take over the world. He's an entrepreneur with a vision and his vision is big. He wants to become the aggregator for the financial services industry. "Think about how much money has been thrown at aggregation and high-wealth aggregation. And who is left doing it?" asks Snyder.
Once a sizzling hot idea, aggregation companies have been disappearing or dropping out of sight in recent years. ByAllAccounts, which was purchased by State Street Bank in 2004, has been sold back to its management. About two years ago, CashEdge, probably the leader of the group of aggregation companies seeking to work with advisors, sold the rights to AdvisorExchange to use the technology with financial planners. And Yodlee, which was a leader in aggregation about ten years ago, is no longer being distributed by any of the big three custodians and is almost never mentioned by advisors anymore.
Persistent problems with getting reliable data have dogged all these companies, and advisors who use these firms still report mixed results. Though advisors report some success, they say it takes patience and a good bit of work by their own staffs to make the aggregation of their clients' holdings work reliably and to keep the data flowing. Snyder, meanwhile, says PCR has figured out the business and that's why large institutions are hiring his company. "We've had to deal with enormous accuracy and scale problems, and we now seem to have a reputation for doing it reliably and at a reasonable price," Snyder says.
It has indeed been a long road toward success for PCR. The first time I spoke with Snyder was six years ago, when he called me to introduce himself and say that he liked my articles. He left an impression because he was so excited telling me how revolutionary his company would be. I didn't hear from him again until December 2003, when he showed up at my office with one of his investors and a business advisor, Herbert Aspbury, a former vice chairman of the board of trustees at Villanova University and the former group head of Europe, Africa and the Middle East at Chase Manhattan Bank.
I would soon learn that Aspbury was just one of the business luminaries backing Snyder. Not to be a name-dropper, but some of the investors listed on his Web site include: Richard Barton, founder of Expedia; Robert Friedman, former CFO of Goldman, Sachs & Co.; and Peter Gleysteen, former group head of global syndicated finance at Chase Manhattan Bank and the founder of Commercial Industrial Finance Corp. And that's only getting us through the G's alphabetically. Other backers include former top executives at AXA Financial, Fleet Boston Financial, Chemical Bank, The Rockefeller Foundation, Pfizer and Deutsche Asset Management. But don't hold it against Snyder that he is so well connected. He is down to earth, funny and impossible not to like.
Snyder loves ideas. It's obvious from speaking with him that building something new and great is far more important to him than the money it will bring him-although he seems to like money just fine. "I think we're profitable now but I'm not absolutely sure," he says. "Every time we get there, I invest more in the company."
PCR is now processing about 300,000 transactions a year. Typically, the firm charges about 5 basis points for aggregating the assets of a $100 million client of average complexity, and a small client with just $1 million of assets and average complexity pays 6 basis points. Creating peer metrics is the focus of the business because Snyder knows that these metrics could offer insights to money managers that revolutionize the financial services advice business. For instance, if PCR can tell an advisory what the average number of WCUs is for clients with $2 million, $20 million or $200 million, you can use that information to revise your firm's pricing matrix based on complexity. And that is just one of the peer metrics Snyder is collecting.
The Rich Really Are Different
One of the most significant findings Snyder is able to share so far is that the ultra-high-net-worth assets tracked on PCR's platform consistently perform better than their benchmarks. For instance, small-cap assets on PCR outperformed for the six-month period ended June 30, 2008-outperformed both the Standard & Poor's 600 index and the Russell 2000. And in the 12-month period that ended June 30, 2008, while the small-cap managers used by PCR clients lost 4.88%, according to PCR, the S&P 600 lost 15.54% and the Russell 2000 dropped in value by 16.22%.
The performance premium enjoyed by wealthy individuals holds up across other asset classes tracked by PCR, according to Snyder. PCR, he says, is reporting on peer metrics for large-cap stocks, international stocks and hedge funds, and reports on private equity and real estate are in the works. Across asset classes, Snyder says ultra-high-net-worth individuals are outperforming the indexes commonly used to benchmark their performance.
Why do super-rich people do better? "We're not sure," admits Snyder. "Is it skill? I don't know. I'm a scientist and I don't make statements that I can't prove.
"Maybe they are better advised, get better information or have a higher financial IQ than most people," he adds. Snyder says the pattern of outperformance has held steady for seven years.
Another noteworthy finding is in the style drift demonstrated by advisors to the super-rich on PCR's platform. According to the firm, small-cap managers for ultra-high-net-worth individuals using PCR have sharply changed their allocations at the expense of stocks to fixed income and alternatives over the past two years. Snyder says that while Morningstar's famous "style box" has led many advisors in the direction of finding pure plays for various styles, the managers of some asset classes tracked by PCR appear regularly to depart from their style and commit assets to other holdings. Among asset classes tracked by PCR, the drift of small-cap stock managers is most pronounced.
Another interesting observation is how quickly managers working with PCR clients dumped stocks starting in 4Q07. "Had you been a prisoner of the school of thought that says style drift is bad, you would have been trapped," says Snyder. "While traditional money managers adhere to the notion that style drift should be avoided, these guys do not."
In creating peer metrics, Snyder is hoping he can build an information database that will help advisors reprice their services, benchmark performance against peers and reveal other tends hidden by the opacity of the industry. He is doing the same thing he did at Loan Pricing Corp. I call it information arbitrage. He is aggregating hard-to-find information and publishing research about it. It's a formula that has worked before, and he just might pull it off again.
Andrew Gluck, a longtime writer and journalist, is CEO of Advisor Products Inc. (www.advisorproducts.com), a Westbury, N.Y., marketing company serving 1,800 advisory firms.