Are You Oblivious to Fee Compression?

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Dan Solin Photo You are my friends and clients. I have great respect for the work you do and appreciate the value you add to the lives of your clients. That’s why it’s painful for me to see so many of you headed for trouble by denying the obvious trend in fee compression.

When I raise issues about your business model, some comment they “are not losing sleep” over the future because investors “will always need the guidance of a human advisor.” Sentiments of this nature recall this famous quote attributed to Upton Sinclair, “It is difficult to get a man to understand something, when his salary depends on his not understanding it.”

Pressure on fees will accelerate

A recent article in Morningstar by John Rekenthaler noted the impact of robo-advisors and made this observation: “On average, over time, robo portfolios will beat those created by human advisors by about 75 basis points per year.”

Many investors now understand the difficulty of attempting to “beat the market.” They also appreciate the effect costs and fees, including those charged by advisors, have on reducing returns.

Rekenthaler claimed the financial services industry will follow the lead of mutual funds in reducing fees “up to a point.” Wealthy clients, and those with complex issues, will be willing to pay more for professional advice. However, even these clients will “push for steeper volume discounts.”

Rekenthaler concluded, “robo-advisors have only just begun. They will not conquer all, but they will expand greatly over the next couple of decades.”

If he is right (and I believe he is), the market for your services is going to shrink dramatically, and those clients who continue to use your services are likely to impose demands for lower fees.

This conclusion is buttressed by a report from PwC. It found 30% of consumers plan to increase usage of “non-traditional” (i.e., “robo”) financial services providers. Only 39% planned to continue using traditional advisors.

Paolo Sironi, an IBM thought leader with Watson Financial Services, predicted more fee compression in a recent talk at the Advicent innovation Summit, as reported by a blog post in Financial Advisor Magazine. Sironi said advisors will be servicing more clients as margins continue to decline due to the “commoditization of investment management.”

As a consequence, he predicted market forces will compel advisors to switch to an hourly rate “because the value of advice is trending away from the product the client buys.”

If you’re not losing sleep over these developments, you should be.