Robos, DOL Are Forcing Industry-Wide Price Discovery
The rise of digital investment advice and the Department of Labor’s new fiduciary rule are forcing universal price discovery and transparency on the wealth-management industry. This leads to a focus on the investor’s total cost of ownership — ultimately resulting in more industry consolidation.
In the long run, transparency is a positive trend for full-service advice. But in the short run — based on the assumption that the investor’s total cost of ownership will drift to the area of 100 basis points — it points to significant disruption and dislocation. And among independent, dual registrants especially, transparency will force aggressive price comparisons.
This points to more consolidation among firms.
For dually registered firms, the major costs in addition to the wealth advisory fee are custody and clearing, advisory platform costs — including operational support, client service and compliance — and investment-product costs. How these costs are allocated are subject to revision at the edges. But regardless of whether presented to advisors and clients as payouts, fee-sharing or pass-throughs, the net fee breakdown will be in an approximate range of 90 to 130 basis points. Roughly 30% to 50% of this will be the wealth-advisory fee.
In this environment, each constituent provider will be fighting for every basis point.
Custody and clearing costs to dually registered firms are mainly determined by the size of the order flow, although the services are often priced by an arcane Chinese menu of services offered by the custodians. Greater visibility into transactions, fees and flows should encourage more uniform pricing offered to advice platforms.
Custody pricing may start to be determined solely by volume— another nudge toward more consolidation among financial-advice firms. When every basis point counts, lower custody fees will be an important issue.
Platform costs are mainly the front-office components required to serve an advisory book. This is often referred to as the advisor workstation. This consists of some, if not all, of the following screens: home page, proposal generation, financial planning, client service to include client portal, access to research and product, and compliance and reporting.
Also included in platform fees are the middle- and back-office operations and client-service components.
As the industry starts to “sharpen its pencil,” these costs will start to play a bigger role in the investor’s total cost of ownership and will have a bigger impact on firm profitability.
To increase profits, the automation of operations and the client experience will have to increase dramatically. However, firms will still have to compete on the quality of their service and the robustness of their functional configuration.
This challenge is exacerbated by the forthcoming disclosure requirements forced on the industry by the DOL fiduciary rule. The intellectual and financial capital required for building this automation is yet another spur to consolidation.
Advice-platform services can be acquired in three ways: installing separate point solutions; outsourcing to a bundler of solutions; or levering services provided by the custodian. In addition, individual advisors need the flexibility to purchase additional services as their practice may require.
Regardless of how deployed, increased competition will likely provide more support options as well as clarity around pricing and functionality.
Finally, transparency will likely drive investment product costs down. This includes any markups that platform providers may add to product costs. These markups are likely to disappear entirely. Also gone will be misleading ADV’s and fund prospectuses — forcing among other things more clarity around transaction costs.
Clearly, the most elegant solution for cost savings is an integrated platform consolidated at the custodian. But so far, this has proven difficult for organizational reasons because the transactional and advice-oriented cultures at the custodians have traditionally been siloed. Also, custodians are reluctant to allow other custodians into their service mix. This is an important issue because for various reasons, many advice firms require multi-custody solutions.
This leaves two options: a flexible, robust and cost-effective outsourced platform that is custody agnostic, or an equally robust and cost-effective proprietary platform. But right now, buying these services can be expensive and building them can be even more so.
Both of these options could be realistic solutions for advice-platforms, but will require basic infrastructure modification if not redesign. The cost of these builds is yet another reason to think there will be more consolidation.
In sum, the ability of independent firms to compete for advisors and chart their own destiny will depend on the range of products and services they can provide at competitive prices. The advisors must be able to brand their own solutions and then mark this service up to a level that the various markets will bear.
Constructing an advice-platform with the right range of solutions at the right price will be a major product development challenge in the industry for the foreseeable future.