Like most RIAs, Nik Schuurmans is interested in offering clients conflict-free advice, full transparency and a fiduciary standard. Schuurmans, who until recently advised on $200 million in client relationships at U.S. Trust, launched the Portland, Ore.-based RIA firm Pure Portfolios in August to follow his vision of tying fees to performance for accredited investors. 

“One of the problems in wealth management is there’s no accountability for the investment performance,” says Schuurmans. “They charge their 1% fee or 1.25% fee if they do a great job or a terrible job. We’re trying to change that.”

Instead, Pure Portfolios promises to discount its account management fees for accredited investors by 25% in the next calendar year if returns on an investment objective fall below agreed-upon “hurdle rates.” Schuurmans borrowed the term from the hedge fund industry, which takes an additional fee if returns exceed hurdle rates. “We’re basically flipping that backwards,” he says. 

“If we get another market correction like in 2008, we don’t feel our clients should be paying full fee,” he says. Tying fees to performance would also protect clients if, he says, “we made a strategic asset allocation shift that turned out not to be the right move.”

For each investment objective, Pure Portfolios communicates to clients its hurdle rates, which Schuurmans says are based on its capital market assumptions and on historical market performance. In addition, there is a subjective component to the hurdle rates. “We want to discount fees during poor market environments, but want to leave some margin for error if the S&P 500 is down 20% while our balanced income portfolio is only down 3.5%,” he says. “Would discounting fees be fair and appropriate in this situation? These are the types of questions and scenarios we ran through as we developed our unique fee structure.”

Account management fees for Pure Portfolios’ performance-fee tier, open to clients with at least $1 million in portfolio assets, start at 80 basis points. Pure Portfolios offers a “Robo” tier for nonqualified investors for a fee of 55 basis points, which invests in exchange-traded funds and doesn’t link fees to performance. The expense ratios of the ETFs run an additional five to 11 basis points. 

A downside discount “really is a novel approach,” says Les Abromovitz, author of The Investment Advisor’s Compliance Guide and a senior consultant with NCS Regulatory Compliance, a Delray Beach, Fla.-based consulting firm for RIAs and broker-dealers. But he says he’d be uncomfortable discussing performance with prospective clients.

He points to a 2004 no-action letter from the SEC (to Trainer, Wortham & Co. and other advisors) that expressed concern that contingency fees—advisory fees that are waived or refunded, in whole or in part, if a client’s account doesn’t meet a specified level of performance—could incentivize advisors to take undue risks.

An advisor offering contingency fees, even without incentive to take risk, “has to argue to examiners that he has all these safeguards in place,” says Abromovitz. “It really is a facts-and-circumstances type of situation.” And although no-action letters are purely guidance, he’s seen advisors cited for not following them on other issues.

What also gives him pause is a new amendment to Rule 204-2 (known as the “Books and Records Rule”) under the Investment Advisers Act. It will require RIAs, among other things, to maintain records showing how they calculated performance and rates of return referred to in any written communications or performance-related communications.

First « 1 2 » Next
To read more stories , click here