10 FORUM JUNE / JULY 2012

PRACTICE MANAGEMENT

JUNE / JULY 2012 FORUM 11

here’s a growing movement inCanada’s financial landscape: ademand for increased transparen-cy. In particular, recent mainstreammedia has shone a spotlight on theissue of advisor compensation. Asa result, many savvy investors arenow seeking a higher degree of

clarity, not only from the products they hold, but alsofrom the advisors they work with.

Increasing AwarenessThese days, advisors carry a wide range of titles and des-ignations: financial planner, investment advisor, port-folio manager, CFP, CLU, CFA, CIM, FMA and FSCI.They offer a wide range of products and services, includ-

ing mutual funds, wrap accounts, financial plans, port-folio management, stocks, bonds, ETFs, segregated fundsand universal life insurance. Advisors are also compen-sated in a variety of different forms, including commis-sion, deferred and front-end sales charges, fee-only, fee-based, fee-for-service and salary.

It’s no wonder clients are easily confused. Rather thanshy away from issues regarding fees, commissions andmethods of compensation, here’s one more opportuni-ty for advisors to step up and educate their clients. Yet,while most would agree that clients should not be left inthe dark about how their advisor gets paid, some advi-sors are uncomfortable with questions about compensa-tion. Unfortunately, this can lead to a breakdown in anotherwise healthy line of advisor-client communication.

Of course this doesn’t mean clients need to know, ornecessarily should know, exactly how much an advisor

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With more clients wondering about the fees and commissionsthey’re paying, many advisors agree that it’s no longer a matter ofif but rather when a client will ask about how they are compen-sated. As Michael Callahan explains, there is no need to shy awayfrom the issue of transparency. If anything, it presents the perfectopportunity to demonstrate the value of your advice

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gets paid. Nonetheless, clients should understand how they’re pay-ing for the advice and services they receive. That is, an advisor’smethod of compensation should not be a mystery to clients.

One Size Does Not Fit AllThroughout the financial services industry, advisors have several dif-ferent compensation platforms available to choose from. Here’s wherechoice is generally a good thing — it allows both advisors and clientsto find a platform they’re comfortable with. Depending on an advi-sor’s service offering(s), one method of compensation may simplybe more desirable than another. Similarly, clients may choose to seekout advisors who work within a particular compensation structure,or offer a specific set of products and services.

FORUM spoke with several advisors, operating on various plat-forms, to see just how they’re managing client concerns over fees andcompensation. Let’s take a look at some of the more common waysadvisors are compensated, including fee-based, fee-for-service, andcommission.

Fee-BasedNot to be confused with fee-for-service, we use the term fee-based torefer to an ongoing investment management fee. Fees are typicallyexpressed as a percentage of the client’s assets under administrationand may vary according to account size and asset allocation. Forexample, some advisors may charge a 1.5 per cent management feeon equities and a 0.5 per cent management fee on fixed income.Others may administer a flat fee independent of asset class, but rel-ative to the total portfolio size, such as 1.5 per cent for accounts lessthan $500,000, 1.25 per cent for accounts from $500,000 to$1,000,000 and 1 per cent for accounts greater than $1,000,000.

“Our clients are charged a management fee structured as a per-centage of their assets under our stewardship,” says CameronPassmore, CIM, FMA, FCSI, and portfolio manager with PWLCapital Inc. in Ottawa. One of the benefits of operating a fee-basedpractice is the transparency of costs to the client. “We outline the feestructure in a written agreement — an Investment Policy Statementor IPS — which is developed with each and every client. As well asthe fee structure, the IPS spells out exactly how the client’s portfo-lio will be managed. We work with each client to determine an appro-priate allocation across various asset classes, and then implementthe portfolio accordingly,” he adds.

Of course, there are potential drawbacks to every compensationmodel, and a fee-based platform is no exception. In particular, someclients may find it challenging to pay an out-of-pocket fee for invest-ment management, and instead prefer an embedded fee structure.“The reality is that not every client is a going to be a good fit for everyadvisor,” says Passmore, “But if fees are going to be an issue, I’d muchrather address that concern up front than have it surface later.”

This raises a good point: Some advisors feel they may lose a clientover fees and subsequently shy away from the issue. Passmore thinksthat’s a mistake. If a prospective client isn’t willing to accept an advi-sor’s proposed compensation and fee structure, then perhaps theysimply aren’t a good fit for each other. “Failing to properly addresskey issues in the advisor-client relationship always tends to blow upsooner or later,” he adds. “We encourage an open discussion about

WHO’S INVOLVEDIt sounds simple enough, but as with any contract it’simportant that all parties be clearly identified. If thereare multiple clients, or an advisory team, all parties to thecontract should be named and all signatures obtained.

SERVICES PROVIDEDHere’s where advisors list all the wonderful things theyoffer their clients (e.g., a written financial plan thatincorporates aspects of tax and estate planning as anall-encompassing solution). Be sure to set realistic expectations of the services provided.

COMPENSATIONThe CSA should clearly indicate how the advisor getspaid. Whether the structure is commission-based, a flatrate for services or a fee-based platform related to assetsunder management, the corresponding fee structureshould be transparent. The advisor’s method of compensation should not be a mystery to clients.

ADVISOR-CLIENT CONTACTThis is where advisors can indicate the type and frequencyof contact with clients. For example, it may be desirableto meet in person only once a year, but schedule quarterlyphone calls for updates. It’s important that advisorsmake the commitment of regular contact, whatever thefrequency, and stick to it.

WORKING WITH OTHERSAdvisors can demonstrate how they interact with othercentres of influence — how other professionals areincorporated into the advisory practice. For example,advisors may work with an accounting firm for assistanceon taxation issues, or perhaps refer to a lawyer who special-izes in wills and estate planning. Any referral fees tooutside professionals should be disclosed to the client.

CLIENT RESPONSIBILITIESThe advisor-client relationship is a two-way street. Assuch, the CSA should map out not only what clients canexpect from advisors, but also what’s expected in return.For example, advisors may require reasonable financialdisclosure in order to develop an effective financial plan.

PRACTICE MANAGEMENT

CSA CHECKLISTKey Elements of an Effective ClientService Agreement (CSA)

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fees, services and our approach to investment management with ourclients. It helps flush out any concerns in advance and sets the stagefor a great relationship.”

CommissionOf all the different types of advisor compensation models, the com-mission-based platform is probably the most common. Advisors work-ing in this model get paid through the sale of products: insurance prod-ucts such as life, critical illness and disability insurance policies; andinvestment products such as mutual funds, stocks, bonds and GICs.

“We are compensated by commissions payable on a variety ofboth investment and insurance products,” explains RobertMcCullagh, CFP, CLU, CH.F.C, CHS, with Benefit Planners Inc. inCalgary. McCullagh makes sure it’s never a mystery to his clients asto how he is compensated: “I disclose my method of compensationwith all my clients. It creates legitimacy in my practice, and it’s sim-ply the right thing to do,” he says. “We meet with prospective clientsand explain exactly what we do, our service offering, and the valueof our advice. Our compensation is generated by the sale of what-ever products we use in order to implement the client’s plan.”

One potential pitfall to a commission-based platform is perceivedproduct loyalty. That is, some clients may feel the amount of com-mission payable on various products could sway an advisor to rec-ommend one product over another. But as McCullagh points out,the commission differs little from product to product. “We typical-ly get compensated a similar amount of commission whether we useproduct from Company A or Company B. We’re just interested in

using the best products we can find. And when we explain this to ourclients — that there really is no loyalty whatsoever to any specificprovider — clients are no longer concerned.”

Insurance commissions, for example, are typically calculated asa function of the annual premiums payable and can vary consider-ably across different product lines. However, the commissions oninsurance products are “baked in” and generally non-negotiable. Thatis, insurance policies have distribution costs and those costs areincluded in the price of the policies regardless of how they’re sold.

While most would agree thatclients should not be left in thedark about how their advisor getspaid, some advisors are uncom-fortable with questions aboutcompensation. Unfortunately,this can lead to a breakdown inan otherwise healthy line ofadvisor-client communication.[

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When it comes to investments, commissions are typically generatedthrough embedded fees associated with most mutual funds — eitherfront-end (FE), deferred sales charge (DSC), or low-load (LL) —trading commissions for stock trades and embedded trailer fees. Butagain, it’s a similar story on the investment side. “There may be someslight differences, but for the most part, similar investment productshave similar commission structures regardless of provider,” addsMcCullagh.

An interesting advantage to the embedded fee model is perhapsbetter explained by the field of behavioural finance. Recent studieshave shown that many Canadian investors prefer an embedded feestructure as opposed to paying an external fee for investment man-agement. Why? Perhaps it’s simply a case of “out of sight, out ofmind.” Just the thought of another out-of-pocket expense can dis-courage otherwise willing clients from moving forward. And thosewho become paralyzed by their own indecision often end up wast-ing precious time sitting on the sidelines, which can prove to be acostly mistake. Paying an embedded fee, on the other hand, may allowthese clients to move forward. Still, clients should be aware of thefees they’re paying — embedded or otherwise.

Fee-For-Service / Fee-OnlyAlso known as fee-only, a fee-for-service compensation model refersto a specific dollar amount charged for a given service or set of serv-ices to be provided. Fee-for-service advisors are not compensated bythe sale of products, but rather bill their clients either by the hour orat a predetermined flat rate for a given deliverable. For example, anadvisor may charge $250 per hour or a flat rate of $4,000 for a writ-ten, comprehensive financial plan. Hourly rates, typically between$100 and $500, can vary considerably depending on the experienceof the advisor and the services provided.

Unbiased and objective advice is often cited as the key advantageof a fee-only practice. Advisors in this role are, in theory anyway, ableto construct plans and portfolios without being swayed by achiev-ing sales targets, bonuses or other compensation that may arise fromspecific recommendations. But some say this is a hard sell. How areadvisors positioning themselves in this space?

“We run a fee-for-service practice, and our compensation is paiddirectly by the client,” says Scott Plaskett, CFP, who operates a finan-cial planning practice with his firm Ironshield Financial Planning.Plaskett is never shy about disclosing fees with clients: “We look for-ward to the opportunity to disclose all fees with our clients,” he says.“It actually helps serve as a differentiator and sets our offering apartfrom many others.” In addition to verbal disclosure, the structure ofPlaskett’s arrangement is documented in a letter of engagement witheach client. Both advisor and client signatures are obtained, and allparties receive a copy. “It’s only natural that clients may forget thingswe’ve discussed. This way, everything is documented and we havesomething to fall back on,” adds Plaskett.

One of the biggest challenges, however, with fee-for-service plan-ning is the implementation of an action plan. Whether it’s securinginsurance coverage, building or rebuilding an investment portfolio,or updating wills and estate plans, without professional assistancethis responsibility falls on the clients’ shoulders. “Sometimes clientsmay want a comprehensive plan, no more, no less. Others may want

to work with an advisor for the actual implementation of that plan,and to help with ongoing portfolio management. We accommodatethose clients as well,” says Plaskett. “I realize some advisors may findit awkward to discuss compensation, perhaps [because they are] con-cerned about a potential loss of business. But in practice we’ve foundthe exact opposite [to be true]. Whatever the nature of agreement,we opt for full, open disclosure. In my experience, it enhances ourrelationship.”

It’s All About ValueDespite advisors’ best efforts, some clients will remain sensitive tofees. Others may feel their advisor is being influenced by embeddedcommissions, or think the advisor is just too expensive. The solutionin this case would be to put the emphasis on value. “In my experi-ence, it rarely, if ever, becomes an issue of cost,” Cameron Passmorepoints out. “The real issue on the table is value.”

It all boils down to perceived value. Whatever the fee, commis-sion or compensation — does the client think it’s worth it? Are theygetting what they’re paying for? And is it a fair deal?

We know that most investors would be better off working with atrusted financial advisor, but unfortunately not all will come to thisconclusion. Talking to clients about the value of our advice certain-ly helps, but sometimes it’s just not enough. We need to demonstratethat value. Rather than just explaining the benefits of financial plan-ning, for instance, provide a prospective client with a sample finan-cial plan. This will help outline the specific benefits of the planningprocess.

One great tool to formalize your value proposition is a ClientService Agreement (CSA). (See sidebar on page 12 for tips on creat-ing an effective CSA.) Here’s where you lay out your commitmentto clients in writing. Serving as somewhat of a contract, a CSA canhelp advisors clarify exactly what they offer — and at what cost —thereby managing expectations for both the advisor and the client.

Bottom LineThe way an advisor gets paid is far less important than the quality ofservices provided. Whether we like it or not, today’s environment isone in which savvy consumers are focused on value. Clients need tofeel they’re in good hands and that they’re receiving adequate valuefor the fees they’re paying — regardless of how they’re paying. �

MICHAEL CALLAHAN is a freelance writer and can be reached atCallahan_michael@yahoo.com. If you would like a PDF of this article, please email FORUM editor Kristin Doucet at kdoucet@advocis.ca.

It all boils down to perceivedvalue. Whatever the fee, commission or compensation —does the client think it’s worth it?Are they getting what they’re paying for? And is it a fair deal?

PRACTICE MANAGEMENT

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