In my article last week, I gave five reasons why the asset-based fee model is unlikely to survive. Here are five more:

  1. The conflicts are pervasive

An article posted on November 27, 2011 in Investment News by Bert Whitehead set forth additional conflicts of interest when fees are based on a percent of assets under management. These included:

  • Advising whether to rollover a pension plan or leave it with a former employer;
  • Advising about charitable contributions;
  • Advising about gifts to children to avoid estate taxes;
  • Advising about annuities, including charitable annuities;
  • Advising about purchasing a larger home and investing generally in real estate.
  • If the fee is different for managing stocks and bonds, the advisor’s self-interest may result in an over allocation to stocks.
Asset-Based Fee Model
Image source: The Blue Diamond Gallery
Asset-Based Fee Model

In the first five examples, a conflict arises because the suggested action (e.g., a pension rollover) would decrease the AUM and the advisor’s fees.

Whitehead concludes: “If fee-only advisors want to hold themselves out as being the most ethical practitioners of their profession, they should commit themselves to adhering to the highest possible and least conflicted standard.”

  1. It’s not equitable

As noted on the web site of Litovsky Asset Management, charging a high-net worth client a multiple of the fees charged to a lower net worth client “can hardly be justified.” It doesn’t take many multiples of the amount of work required to manage a $10 million portfolio to manage a $5 million portfolio.

Mr. Litovsky, an engineer and mathematician, concludes: “Our conclusion is that AUM fees cannot be justified on any basis, and that a flat fee is the only type of fee (along with other fees for work such as hourly and per-project) that would be fair to the client and would compensate the advisor adequately for their work.”

  1. The premise is flawed

There’s no doubt a competent advisor can add meaningful value on the investment side by helping to determine an appropriate asset allocation, making sound investment recommendations based on peer-reviewed evidence, keeping the client disciplined and adhering to a carefully crafted investment policy statement.

However, as a fiduciary, you have an obligation to do all of those things regardless of how you calculate your fees.

The argument that an asset-based fee aligns your interest with the interest of your client has no merit. Your interest is already aligned by well-established law.

Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.

By Dan Solin, read the full article here.