Avoiding fee bias
All ways of charging, whether flat-fee or asset-based, introduce some kind of bias. Conflict of interests can be between agent and client or even between clients. Our solution to avoiding fee bias is to make the decision-making process objective and fully-informed which we do by allowing clients to interact directly with our modelling.
How we demonstrate freedom from fee bias
What is fee bias?
The conventional industry approach to charging fees for discretionary portfolio management or ongoing investment advice is as a percentage of assets. The principle is that value received is a function of, not independent of, the amount of capital being managed or advised. Value delivered is not the same as cost incurred by the service provider, so flat fees that reflect actual costs will make the value received, or the value proposition, much more widely dispersed between clients. You can read here how our charging approach has changed to reflect a changing business mix, incorporating both flat and variable elements.
Theoretically, the persistent dominance of asset-based fees implies that consumers do in fact associate value with the amount of their capital exposed to the service. The other implication is that they see fairness in terms of the size of base capital rather than the size of provider costs. But what many clients have also said to us is that they are quite comfortable with the idea of cross subsidies. This is partly because they are progressive, and see subsidising the less well off as a privilege of wealth, and partly because they believe they themselves benefitted at an earlier stage of their accumulation.
Whatever the theoretical and empirical arguments in favour of asset-based fees, they are unfortunately also riddled with conflicts of interest.
This is because the economic interests of the client and the agent arising from that link are different. The asset-based fee is often presented as a way to align both interests, on the superficial basis that client and adviser do well or badly together. But below the surface the differences in interests are real and influential.
To highlight the differences, we made a light-hearted video, contrasting what’s on and below the surface: what advisers may say and what they really think. Of course not all agents exploit clients as egregiously as the video implies. But it is important investors realise what the conflicts are, so they can themselves assert the dominance of their own interests.
Controlling the agenda
Computer-driven decision processes, without human intervention in their application or interpretation, are uniquely capable of ensuring that only a single set of economic interests drive decisions: those the model has to maximise or optimise. As long as the client gets to define what it is the model has to maximise or optimise, and as long as the engine really is designed to do that job, the client’s interests are paramount by design. How at Fowler Drew does a quantitative process deliver this objective? There are three elements:
- clients define their goals
- the model doesn’t lie and
- the interface doesn’t conceal.
This is best explained using an example of a goal-based portfolio, in this case for a retirement spending goal, and some outputs of the user interface.
The first job of the initial planning process was to identify objectives as a hierarchy of possible sources of ‘satisfaction’, working with the adviser using a shared interface to the Fowler Drew model, as illustrated in the first screen shot below
In this case, the primary objective was funding the couple’s retirement spending needs and wants but also a secondary objective of gifting to children, but only having met (at some agreed confidence level) the sustainable lifetime spending that is valued more highly than gifting. Gifting reduces the assets to which the manager attaches a fee and so in the video is one of the examples of how a perversely-incentivised and unscrupulous adviser might avoid telling a client they can safely gift now.
The model is by design objective and has been taught to abhor ‘inefficient capital’. Surplus resources, not assigned a role in balancing the plan, are inefficient. The second screen shot shows the position as the client would see it in a meeting or remotely.
The interface makes it impossible to disguise the fact that the spending objectives (thanks to achieved investment returns) are now over-funded (in this case, by a combination of the value of the portfolio assigned to the goal, employer pension contributions and a deferred final-salary pension). Gifts can be made without reducing the certainty of achieving the spending demanded by the client.
The impact on Fowler Drew’s fee income of making the gift, potentially a drop of about 12%, is no more a factor in the decision making than if fees were fixed independently of asset values. We are not indifferent but the decision process is. And is seen to be.
Here’s how one client saw it:
“We both want to thank you for urging us so strongly in 2015 to increase our spending – especially on the house. It cost about 50% more than we originally planned, but the results delight us every day. You were right – we would have been so aggrieved to have had more money but a house that was not as good as it could have been. Both the architect and builder have won multiple awards for their work, so we are not the only ones to be impressed. Your advice was unusual from a financial adviser. Even a flat fee-charging adviser might be tempted to recommend hanging on to the funds “just in case”. But it only had traction with us because you were able to demonstrate that you had already made provision for the future, so that this was a genuine surplus. We are far too cautious to have been swayed by anything less, so congratulations are definitely in order.”