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| Best Practices: Bankers Agenda |
Performance Enhancers
Gayle B. Ronan
12/01/2005
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When wealth manager Tom Zachystal launched his firm, Individual Asset
Management in Pasadena, Calif., three years ago, one of his clients, an
international business executive, asked for a provision he had heard advisors
offer in Europe but which few in the U.S. brought up: He wanted his fees to be
calculated on the basis of the performance of his investments, rather than via a
traditional assets-under-management schedule or a flat retainer fee.
 After a
short deliberation, Zachystal decided it was a good idea. “We sat down, realized
his concerns made sense, and we worked to come up with a system that would be
fair to us and would ensure that no clients would ever doubt their interests
weren’t in line with ours,” he says.
Performance-based fees are only
marginally more common in Europe than they are here, and not every wealth
advisor will be amenable to them; however, in the current market, it may be to
the investor’s advantage to ask. Flat advisory fees or those based on AUM may
seem inconsequential when the market is generating double-digit returns. But
with financial gurus like Pimco’s Bill Gross warning that the most investors can
expect are single-digit annual stock and bond returns for the foreseeable
future, those costs have a greater impact on a portfolio.
Family offices
often successfully negotiate for performance-based fees, according to Robert
Zion, a principal at Hirtle, Callaghan & Co. in West Conshohocken, Pa. That
firm frequently asks advisors for such arrangements on behalf of its family
office clients. He notes that they encounter little resistance. “Generally, our
deals involve a base fee and a bonus for outperformance,” Zion explains.
“Sometimes a discount is attached for underperformance.”
| “We find that people who want other people to manage their money often
don’t want to think that hard about the fee structure.” |
The practice is
certainly well established in the world of portfolio management. According to a
2004 report from the Connecticut research firm Greenwich Associates, 43 percent
of institutional investors use performance-based fees in some of their manager
relationships, and 60 percent are interested in pursuing incentive structures
for a greater portion of their assets under management.
Yet for the most
part, ultra-affluent investors have not demanded performance-based compensation
schemes in advisory relationships. A recent study coproduced by the Investment
Adviser Association and National Regulatory Services found that just shy of 95
percent of registered advisors use the traditional AUM method to calculate their
fees. The absence of a demand for change is the oft-mentioned culprit for
keeping the status quo.
Transparent Arguments
But not all affluent individuals are indifferent.
John Noland, a private investor in Baton Rouge, has begun asking questions about
what he is getting for the fees he pays to financial advisors. “I’m happy to pay
for top performance, but not so happy to be paying the same fee for mediocre
performance,” he notes.
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