Fees Versus Commissions
Four reps debate why they prefer one style to the other, what’s best for clients and where the industry is heading.
By Dan Jamieson and Rick Weinberg
RR: The entire industry seems fixated on moving to fees. Are we really going to a 100% fee-based industry?
Mossa: I think the business wants to go that way. I’m really torn between which is better for the client. Why shouldn’t you be paid sometimes just for overlooking a portfolio rather than doing a transaction? But there are other instances in which clients are holding things long term. Should they be paying a fee for positions they might hold for many years?
Root: I don’t think you’ll ever see the commission business completely die for the reasons Joe mentioned. Clients are always going to have a portion of their portfolio that should be actively managed and a portion of their portfolio that is long-term buy and hold. There may be tax implications to selling. So I don’t think it’s appropriate to start charging fees on investments that clients are never going to get rid of.
Woolfolk: I agree. There are certainly accounts where a fee is appropriate. I manage some for the probate court for minors and infirm folks, and the court is used to dealing with trust companies. They want to pay a fee.
But then one of my biggest accounts is an attorney. I show him every year how much less he would pay me [under a fee], and he demands to stay on the commission schedule because he feels that when I call him, I’m calling because it’s the right time.
I think the rub with commissions is that there are people out there who have abused the commission system.
Trudeau: When I started in the business we used to charge our clients for trading securities, and we’d give our advice away for free. Now I find that my clients want me to charge for advice and give the trades away.
Frankly, I don’t know if it’s in the client’s best interest to charge on a transaction basis or have an inactively managed portfolio. I think it’s more appropriate, especially in these kinds of markets, to have a portfolio that’s looked after by a professional manager.
Woolfolk: Does that not happen under a commission arrangement?
Trudeau: Well, I think it’s more subjective under a commission arrangement. We’ve all seen transactions, if not in our own books, that might be considered a little bit superfluous. Charging fees takes that integrity question right out of the mix.
RR: What do you do with an account that just doesn’t make sense for you unless it’s under a fee arrangement? Can you begin charging them more with a fee account?
Mossa: I think you’ve got to be upfront with the client if you’re going to do something like that. If you turn your business around and say, “You know, I watch your fund, and I think that there are times when we need to make changes, and I need to actively manage it,” then you can probably justify that.
Root: If clients want good performance and access to good product, I think they’re willing to pay a little bit more for that.
Mossa: One negative with fees is that there’s a tendency to be lazy. You can get lazy by just putting assets in things that generate fees. Whereas, I think sometimes the commission person is at least actively looking at the account.
Trudeau: I think it’s exactly the opposite. The reality is fee accounts can be fairly large dollars. You need to provide consistent service. You need to be having quarterly performance reviews at a minimum. You need to have good client contact, or the client will go away.
The incentive isn’t to contact the client just because you need to make a move in the portfolio so much as it is to contact the client to make sure the portfolio is doing what we need it to be doing.
Woolfolk: One thing I’ve found with a few fee accounts I have is clients tend to believe that because they’re paying a fee, they can just trade willy-nilly. Their goals tend to evaporate. You almost have to bring them back to reality from time to time.
Root: The process we go through in initially establishing client objectives really helps us a lot in that regard. When we sit down with clients, we review what their original objectives are and make sure that those objectives are still in place.
RR: Joe mentioned the laziness problem. But is that unique to managed money? The same thing happens with, say, a load product, right?
Trudeau: My experience has been that certain people who enter into fee-based business can get lazy. They tend to spend time going after new clients. But that doesn’t work. You need to spend a great deal more time, I think, with fee clients. And you’re able, frankly, to spend more time doing the right things with your clients—doing the financial planning and proper asset allocation, and addressing a lot more of their needs.
Woolfolk: I don’t know that you’re going to spend any more time with your clients than I’m going to spend with my clients who come in and sit down with me. We cover their strategy and plan, and we target either a money manager or individual securities at the appropriate time. I think our goals are the same as yours. It’s just that our method of getting there is different.
Trudeau: I didn’t say it wasn’t, Rick.
Woolfolk: No, I understand.
RR: Do you all offer your clients the choice of both options for those of you who go both ways, so to speak?
Woolfolk: Yes, I explain it to them. I try to lay down the pros and cons. I give them some reading material. And I let them make the decision.
Trudeau: We believe that we can’t be all things to all people. So, especially with any new business we bring in, it is fee-based business exclusively.
Woolfolk: If you’ve got retail clients you want to get rid of, Rick can take ’em.
Root: I’m on the same page as Steve. When I have larger clients who come in, I just don’t have the time to research stocks and build portfolios, and then advise them on day-to-day changes. There’s just not enough time in the day for us to be able to do that with large clients. Most of the work we do is putting together an appropriate asset allocation. The money managers can make those day-to-day decisions and hopefully do it with a lot more expertise than I can bring to the table.
Mossa: I try to handle most people’s money on a commission basis. But I will put money out, either in a wrap program that I manage or in another program with an outside manager. And I do give clients a choice, and they can go either way. It always astonishes me the choices people make. Some of them you’re certain will prefer a fee would really rather do commission, and vice versa.
Managing the money yourself is more work. You’ve got to really like it. I’m not saying that fee-based brokers don’t do anything, but I’m saying it’s more difficult building your own portfolio. When you do that, you wind up being a bit more in tune with what’s going on day to day.
Trudeau: Are you saying that you present yourself as a portfolio manager at the same quality level as the premier portfolio managers in the country?
Mossa: We have a program here called Quantum that has a screening process. I’m a qualified portfolio manager for Quantum.
Trudeau: I’ve heard of that. It’s supposed to be really good.
Mossa: Yes, it’s a good program. And I do some of that, and I’ll also do individual securities. Sometimes I’ll use the stocks that I would normally put in a Quantum portfolio.
Trudeau: But doesn’t it make sense that the institutional-style managers who have tremendous staff and great experience will, over the long haul, outperform traditional stockbrokers with less risk?
Mossa: I think your theory is fine. It just depends on how involved people want to be. I don’t know that my performance has been outstanding on some accounts or at different intervals. But sometimes you see the institutional people who are so well ranked go through periods where they do terrible. I think it comes and goes.
Trudeau: One of the advantages of professional management is that if a private manager is underperforming substantially, we have the freedom to change that manager, and we can do it without having to charge the client any fees or commissions. We can upgrade the quality of their management.
Mossa: You can do the same thing with the stocks.
Trudeau: Not without cost.
Mossa: Well, wait a minute. You’re charging the client, whether you change it or not.
Mossa: We’re charging them money to make the transaction. The point is, it doesn’t really matter. The client’s got to be comfortable with the structure. And there’s got to be some performance.
Woolfolk: One of the problems I have with switching completely over to fees is that I think fee business came along at a favorable time in the market. The wind had been blowing not with just a little gust behind the sail, but with a great big wind.
We started seeing a change this past year when the market was down. Some of my friends who are in the fee-based business were bitching and moaning about how many clients were complaining. I had customers complaining about the down market, but they weren’t complaining about paying me a fee.
Root: For the clients who were pretty well spread out, last year wasn’t all that bad. Large growth was the one significant underperformer last year. Some international accounts on the value side and the bond side performed quite well. So actually, clients tended to be pretty happy, and assets were actually up a little bit last year.
Trudeau: I agree with Scott that if we do our job properly we get very few complaints about performance problems. The other nice thing about what we do is we’re able to provide consistent performance reporting on a quarterly basis and index it so clients understand what happened in the markets. For instance, the S&P was down over 9% last year, and most people don’t really know that.
RR: Wasn’t the worst period prior to last year, when asset allocation just didn’t work?
Trudeau: The oddest period of time I’ve ever experienced in the industry was the technology boom and what it did to our clients’ psyches. The idea was they could basically throw a dart at any dot-com or anything else technology-based and get 100% or 200% on their money in a couple of months. That was probably the most difficult period. Since then, we’ve been bringing in a lot of assets that were ‘traded-style’ assets at competitors or self-traded.
Root: Clients who felt they could do it themselves are finding they can’t. It’s not as easy as they thought. Asset allocation is important again.
Mossa: I’ve found the same thing. I don’t know that it matters whether you’re doing fee business or commission business. I think last year opened up a lot of eyes to people doing stuff on their own.
Pricing and Earnings on Assets
RR: For both commissions and fees, how do you set your pricing?
Mossa: On the commission side, it depends on how active clients are. The more activity, the lower percentage they’ll be paying. With long-term investments, you can charge your regular commission. With shorter-term stuff, you have to charge less to make it feasible. I look overall at clients’ accounts and how much they’re paying, whether it’s fee, commission or a combination of both, and try to make it reasonable on all their portfolios.
Woolfolk: I think it’s an individual thing based on the activity of the client. If I see somebody who needs to be considering a fee, we’ll look at what he or she has been doing and what the options are.
Root: I think the trend is going to continue moving both commissions and fees downward.
I think competition is going to continue to eat away at that. And I think performance is going to be more normal [lower]. So fees are going to be a more important aspect.
RR: What do you expect to earn off your asset base in percentage terms?
Root: Generally, it’s somewhere between 1% and 1.5% on managed assets. Of course, on larger accounts the fees come down. On fixed income, you might be talking about 50 to 75 basis points.
Mossa: On my book, I earn less than 1%. It’s more like 0.8% or something. There tends to be a larger group of people who don’t do a lot of trades, and then a few who are more active.
Woolfolk: I run between 80 and 90 basis points, depending on how much new money comes in.
Trudeau: We’re sort of in the same boat. I go somewhere between 0.7% and 0.8%, and I’ve done that consistently for years.
Root: My average is about three-quarters of a percent on all my assets.—D.J. and R.W.
Rookies and Fees
RR: Can a new broker today start off building a fee business?
Woolfolk: I have two sons who joined me in the business in the past 10 years. I’ve encouraged them to try to do more in fee business if they can, but I think to get started you’ve got to have a mix. Their mix is probably in the 50-50 range so they can put food on the table while they build their fee bases.
Root: I agree with that. I think the new guys today really have to do some transactional business and some A and B share mutual fund business just to be able to make the numbers they need to keep their jobs.
Trudeau: I sound like a Merrill Lynch commercial here, guys, so forgive me. But I think the firm does a great job of incenting trainees to do fee-based business. They give them over-credits for doing fee business so they’re able to survive.
Root: The larger firms are pushing fee business, and they want the younger brokers to do more fee business, so they are giving some incentives. They’re helping them out.
Mossa: Prudential extended rookies’ salaries for an extra year or two just so they can take the time to build a fee business. That’s the way the firm’s going. But they still support nonfee business, too.—D.J. and R.W.