Earlier this year, we surveyed over 1,000 registered investment adviser (RIA) firms about their technology usage, service offerings, and portfolio management styles, and then coupled the results with several different firm performance metrics. Previously we discussed how our survey revealed that RIA firms that aggressively adopt technology, offer financial planning services, and utilize a passive portfolio management style are growing assets under management (AUM) faster relative to their peers. This next post answers the question: What is the average annual client advisory fee charged by RIA firms and what factors impact that fee level?
According to our survey conducted in early 2015, RIA firms on average charge a 1.03% annual client advisory fee. As the chart below indicates, investment advisers most commonly charge between 75 to 100 basis points (bps):
Despite frequent industry chatter around fee compression, average advisory fees still appear to be holding steady around the 1% mark which has been a traditional financial advisor fee barometer. However, as technology advancements continue to drive down the costs of providing investment advisory services and investment advisory firms move more towards a passive portfolio management style, it is possible that advisory fees will decline over time. What's hard to predict is when and how rapidly such compression may take place. As such, fees will continue to be an area of increased scrutiny in future studies.
No Correlation to AUM Growth
Interestingly enough, our study found no correlation between advisory fee rates and assets under management (AUM) growth. Thus, advisory firms charging fees above industry norms continue to succeed along with firms shifting to lower cost fee models. However, in an era with increasing fee transparency and increased competition, we anticipate that firms charging significantly higher fees relative to pees may ultimately be forced to fall more in line with industry norms.
RIA Firms that Aggressively Adopt Technology Charge Lower Fees
In an earlier post, we discussed how RIA firms that adopted technology grew AUM faster than their peers in 2014. In regards to advisory fees, our study revealed that advisory firms that adopt technology charge a lower advisory fee on average. Specifically, firms that have not adopted any technology (defined as customer relationship management, portfolio management and reporting, and/or financial planning software) charge an average advisory fee 1.11%. On the other hand, advisory firms that have adopted 3+ technology solutions charge a 1.00% average fee which is 11 bps less than firms not utilizing technology. The chart below further illustrates the relationship between RIA technology adoption and advisory fee rates:
In the above chart, the maroon color represents the average advisory fee distribution for firms that have not adopted any technology solutions. This group could be defined today as tech laggards. Presently, this group of tech laggards seems to be successfully passing along higher average advisory fees to clients. However, if future fee compression does occur, this group may find itself in a difficult competitive position. It's possible that these firms' lack of operational efficiency due to not adopting technology may not allow them to generate significant profit margins at lower fee rates. On the other hand, advisory firms that are adopting technology are already operating successful RIA firms today at lower fee rates and will likely be better positioned to continue to adapt and succeed in the future.
RIA Firms that Offer Financial Planning Fees Charge Lower Fees
Advisory firms that offer financial planning services charge an average annual advisory fee of 1.03% compared to an average fee of 1.08% for advisory firms that do not. The chart below further depicts the relationship between financial planning service offerings and advisory fee rates:
At first glance, the above chart may seem a bit surprising since it would seem that firms offering financial planning services in addition to portfolio management services are likely to charge higher fees relative to firms just offering portfolio management. Perhaps some of the firms surveyed may be charging separate hourly or annual financial planning fees in addition to the advisory fee charged for portfolio management. We plan to further probe the frequency of advisory firms charging additional financial planning fees in future studies.
Yet, it should also be noted that our study showed that firms that offer financial planning services tend to also lean more towards a passive portfolio management style which may further shed light on why RIA firms offering financial planning services charge relatively lower advisory fees. The relationship between portfolio management styles and average advisory fees is further discussed below.
RIA Firms that Utilize Passive Portfolio Management Charge Lower Fees
Our study also revealed that investment advisers that adopt an exclusively passive portfolio management style charge an average annual advisory fee of 0.94% compared to the 1.10% average fee charged by firms that employ an exclusively active management style. The chart below further shows the relationship between an adviser's portfolio management philosophy and the average fee rate:
Compared to bucketing RIA firms based upon technology adoption or the offering of financial planning services, the above portfolio management style comparison chart reveals the largest discrepancy in relative fees. Investment advisory firms offering active portfolio management appear to be charging a 16 basis point (1.10% compared to 0.94%) fee premium compared to their peers utilizing passive management. Perhaps firms using active management are justifying this fee premium due to an impressive investment performance track record. Another reality may be that firms that offer active management may be spending more on internal portfolio management team staffing and need to charge higher fees in order generate attractive profit margins.
As we have discussed in earlier posts, selling investment performance is a risky RIA value proposition and a higher internal cost structure due to higher staffing costs compared to peers makes it difficult to still succeed in an environment with falling advisory fees. The eternal debate between active and passive portfolio management is not one we will try and tackle, but investment philosophy aside, it's possible that passive portfolio management may just be a better business model for RIA firms. In our observations, firms using passive portfolio management often have a more enduring value proposition that survives in good and bad market times and better positions the adviser as a holistic wealth manager rather than a portfolio manager solely judged by its latest performance track record. However, this is not to say that firms have to manage portfolios with a passive investment style in order to offer holistic wealth advice.
Be sure to check back soon as we release our full investment adviser industry report examining the key drivers of RIA firm growth.