1. 1. 10 FORUM JUNE / JULY 2012 PRACTICE MANAGEMENT
2. 2. JUNE / JULY 2012 FORUM 11 heres a growing movement in Canadas financial landscape: a demand for increased transparen- cy.In particular,recent mainstream media has shone a spotlight on the issue of advisor compensation. As a result, many savvy investors are now seeking a higher degree of clarity, not only from the products they hold, but also from the advisors they work with. Increasing Awareness These 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 funds and 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. Its no wonder clients are easily confused.Rather than shy away from issues regarding fees, commissions and methods of compensation, heres one more opportuni- ty for advisors to step up and educate their clients. Yet, while most would agree that clients should not be left in the 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 an otherwise healthy line of advisor-client communication. Of course this doesnt mean clients need to know, or necessarily should know, exactly how much an advisor AreYou? How With more clients wondering about the fees and commissions theyre paying,many advisors agree that its no longer a matter of if but rather when a client will ask about how they are compen- sated.As MichaelCallahan explains,there is no need to shy away from the issue of transparency.If anything,it presents the perfect opportunity to demonstrate the value of your advice Transparent T ILLUSTRATION:JONKRAUSE
3. 3. 12 FORUM JUNE / JULY 2012 gets paid. Nonetheless, clients should understand how theyre pay- ing for the advice and services they receive. That is, an advisors method of compensation should not be a mystery to clients. One Size Does Not Fit All Throughout the financial services industry,advisors have several dif- ferent compensation platforms available to choose from.Heres where choice is generally a good thing it allows both advisors and clients to find a platform theyre comfortable with. Depending on an advi- sors service offering(s), one method of compensation may simply be more desirable than another.Similarly,clients may choose to seek out 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 theyre managing client concerns over fees and compensation. Lets take a look at some of the more common ways advisors are compensated, including fee-based, fee-for-service, and commission. Fee-Based Not to be confused with fee-for-service, we use the term fee-based to refer to an ongoing investment management fee. Fees are typically expressed as a percentage of the clients assets under administration and may vary according to account size and asset allocation. For example, some advisors may charge a 1.5 per cent management fee on 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 less than $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 Cameron Passmore, CIM, FMA, FCSI, and portfolio manager with PWL Capital Inc. in Ottawa. One of the benefits of operating a fee-based practice is the transparency of costs to the client.We outline the fee structure in a written agreement an Investment Policy Statement or IPS which is developed with each and every client. As well as the fee structure, the IPS spells out exactly how the clients portfo- lio will be managed.We work with each client to determine an appro- priate allocation across various asset classes, and then implement the portfolio accordingly, he adds. Of course, there are potential drawbacks to every compensation model, and a fee-based platform is no exception. In particular, some clients 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 every advisor,says Passmore,But if fees are going to be an issue,Id much rather address that concern up front than have it surface later. This raises a good point: Some advisors feel they may lose a client over fees and subsequently shy away from the issue.Passmore thinks thats a mistake. If a prospective client isnt willing to accept an advi- sors proposed compensation and fee structure, then perhaps they simply arent a good fit for each other.Failing to properly address key issues in the advisor-client relationship always tends to blow up sooner or later, he adds.We encourage an open discussion about WHOS INVOLVED It sounds simple enough, but as with any contract its important that all parties be clearly identified. If there are multiple clients, or an advisory team, all parties to the contract should be named and all signatures obtained. SERVICES PROVIDED Heres where advisors list all the wonderful things they offer their clients (e.g., a written financial plan that incorporates aspects of tax and estate planning as an all-encompassing solution). Be sure to set realistic expectations of the services provided. COMPENSATION The CSA should clearly indicate how the advisor gets paid. Whether the structure is commission-based, a flat rate for services or a fee-based platform related to assets under management, the corresponding fee structure should be transparent. The advisors method of compensation should not be a mystery to clients. ADVISOR-CLIENT CONTACT This is where advisors can indicate the type and frequency of contact with clients. For example, it may be desirable to meet in person only once a year, but schedule quarterly phone calls for updates. Its important that advisors make the commitment of regular contact, whatever the frequency, and stick to it. WORKING WITH OTHERS Advisors can demonstrate how they interact with other centres of influence how other professionals are incorporated into the advisory practice. For example, advisors may work with an accounting firm for assistance on taxation issues, or perhaps refer to a lawyer who special- izes in wills and estate planning. Any referral fees to outside professionals should be disclosed to the client. CLIENT RESPONSIBILITIES The advisor-client relationship is a two-way street. As such, the CSA should map out not only what clients can expect from advisors, but also whats expected in return. For example, advisors may require reasonable financial disclosure in order to develop an effective financial plan. PRACTICE MANAGEMENT CSA CHECKLIST Key Elements of an Effective Client Service Agreement (CSA)
4. 4. fees,services and our approach to investment management with our clients. It helps flush out any concerns in advance and sets the stage for a great relationship. Commission Of all the different types of advisor compensation models, the com- mission-basedplatformisprobablythemostcommon.Advisorswork- inginthismodelgetpaidthroughthesaleof products:insuranceprod- ucts such as life, critical illness and disability insurance policies; and investment products such as mutual funds, stocks, bonds and GICs. We are compensated by commissions payable on a variety of both investment and insurance products, explains Robert McCullagh, CFP, CLU, CH.F.C, CHS, with Benefit Planners Inc. in Calgary. McCullagh makes sure its never a mystery to his clients as to how he is compensated:I disclose my method of compensation with all my clients. It creates legitimacy in my practice, and its sim- ply the right thing to do,he says.We meet with prospective clients and explain exactly what we do, our service offering, and the value of our advice. Our compensation is generated by the sale of what- ever products we use in order to implement the clients plan. One potential pitfall to a commission-based platform is perceived product 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 use product from Company A or Company B. Were just interested in using the best products we can find.And when we explain this to our clients that there really is no loyalty whatsoever to any specific provider clients are no longer concerned. Insurance commissions, for example, are typically calculated as a function of the annual premiums payable and can vary consider- ably across different product lines. However, the commissions on insurance products arebaked inand generally non-negotiable.That is, insurance policies have distribution costs and those costs are included in the price of the policies regardless of how theyre sold. While most would agree that clients should not be left in the dark about how their advisor gets paid, some advisors are uncom- fortable with questions about compensation. Unfortunately, this can lead to a breakdown in an otherwise healthy line of advisor-client communication.[
5. 5. 14 FORUM JUNE / JULY 2012 When it comes to investments, commissions are typically generated through embedded fees associated with most mutual funds either front-end (FE), deferred sales charge (DSC), or low-load (LL) trading commissions for stock trades and embedded trailer fees. But again,its a similar story on the investment side.There may be some slight differences, but for the most part, similar investment products have similar commission structures regardless of provider, adds McCullagh. An interesting advantage to the embedded fee model is perhaps better explained by the field of behavioural finance. Recent studies have shown that many Canadian investors prefer an embedded fee structure as opposed to paying an external fee for investment man- agement. Why? Perhaps its simply a case of out of sight, out of mind. Just the thought of another out-of-pocket expense can dis- courage otherwise willing clients from moving forward. And those who become paralyzed by their own indecision often end up wast- ing precious time sitting on the sidelines, which can prove to be a costly mistake.Paying an embedded fee,on the other hand,may allow these clients to move forward. Still, clients should be aware of the fees theyre paying embedded or otherwise. Fee-For-Service / Fee-Only Also known as fee-only, a fee-for-service compensation model refers to a specific dollar amount charged for a given service or set of serv- ices to be provided. Fee-for-service advisors are not compensated by the sale of products, but rather bill their clients either by the hour or at a predetermined flat rate for a given deliverable. For example, an advisor 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 experience of the advisor and the services provided. Unbiased and objective advice is often cited as the key advantage of a fee-only practice.Advisors in this role are,in theory anyway,able to construct plans and portfolios without being swayed by achiev- ing sales targets,bonuses or other compensation that may arise from specific recommendations. But some say this is a hard sell. How are advisors positioning themselves in this space? We run a fee-for-service practice, and our compensation is paid directly 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 apart from many others.In addition to verbal disclosure, the structure of Plasketts arrangement is documented in a letter of engagement with each client. Both advisor and client signatures are obtained, and all parties receive a copy.Its only natural that clients may forget things weve discussed. This way, everything is documented and we have something 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 its securing insurance coverage, building or rebuilding an investment portfolio, or updating wills and estate plans, without professional assistance this responsibility falls on the clients shoulders.Sometimes clients may 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 accommodate those clients as well,says Plaskett.I realize some advisors may find it awkward to discuss compensation,perhaps [because they are] con- cerned about a potential loss of business.But in practice weve found the exact opposite [to be true]. Whatever the nature of agreement, we opt for full, open disclosure. In my experience, it enhances our relationship. Its All About Value Despite advisors best efforts, some clients will remain sensitive to fees. Others may feel their advisor is being influenced by embedded commissions, or think the advisor is just too expensive. The solution in this case would be to put the emphasis on value.In my experi- ence, it rarely, if ever, becomes an issue of cost, Cameron Passmore points 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 its worth it? Are they getting what theyre paying for? And is it a fair deal? We know that most investors would be better off working with a trusted financial advisor, but unfortunately not all will come to this conclusion. Talking to clients about the value of our advice certain- ly helps, but sometimes its just not enough.We need to demonstrate that 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 planning process. One great tool to formalize your value proposition is a Client Service Agreement (CSA). (See sidebar on page 12 for tips on creat- ing an effective CSA.) Heres where you lay out your commitment to clients in writing. Serving as somewhat of a contract, a CSA can help advisors clarify exactly what they offer and at what cost thereby managing expectations for both the advisor and the client. Bottom Line The way an advisor gets paid is far less important than the quality of services provided. Whether we like it or not, todays environment is one in which savvy consumers are focused on value. Clients need to feel theyre in good hands and that theyre receiving adequate value for the fees theyre paying regardless of how theyre paying. MICHAEL CALLAHAN is a freelance writer and can be reached at Callahan_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 perceived value. Whatever the fee, commission or compensation does the client think its worth it? Are they getting what theyre paying for? And is it a fair deal? PRACTICE MANAGEMENT [