The fee structure of the investment management industry—a percentage of assets under management—has been around for so long, and is so ubiquitous, that it almost goes unnoticed. Arguments can be made over whether the percentage is too high, or we can be amazed when some fund shops push it down low, but the fact that it is always a percentage of total assets is rarely questioned.
But just as financial advisors are beginning to experiment with different pricing models, such as hourly retainers or flat fees, one long-time investment strategist is challenging the price orthodoxy in the investment space.
Denver-based Scott MacKillop, former president of Frontier Asset Management, recently launched a new venture, First Ascent Asset Management. The pitch? He provides customized portfolio management services to advisors and charges 50 basis points for accounts up to $300,000, but then keeps the fee at a flat $1,500 for any amount larger than that. The investment management fee for a $1 million account, for example, would work out to the equivalent of 15 basis points, and for a $2 million account, 7.5 basis points. And so on.
“I looked at the percentage-of-assets-under-management fee that the industry uses universally, and I couldn’t come up with any good explanation why we were using a structure like that. With today’s technology, it doesn’t cost any more to manage a $1 million account than it does a $100,000 account,” MacKillop, 65, says. “So it didn’t seem fair or logical that larger accounts would pay more than smaller accounts.”
“At a certain point I just realized there was a company there if I had the courage to step out and create it.”
The Ascension of First Ascent
MacKillop started out as an intern at the Securities and Exchange Commission in 1975, while attending law school. He practiced securities law in Washington, D.C. for about 15 years before joining one of his clients, ADAM Investment Services in Atlanta, in 1992. He became president of the firm in 1997, the same year it was acquired by Denver-based Portfolio Management Consultants (PMC). Since then, MacKillop has worked for various turnkey asset management providers (TAMPs), or third-party strategists as they’re now called, building outsourced portfolios for independent financial advisors. The latest was Denver-based Frontier Asset Management, where he served as president for eight years. He sold his ownership interest back to the firm in 2015 after a disagreement with other executives over its direction.
“When I left my firm, I had too much time on my hands and I started thinking about all the different things that we do; and once you start questioning one thing, it leads you to start questioning lots of things,” MacKillop says.
MacKillop built the portfolios with simplicity in mind, using passive ETFs for the core position to replicate the global market, and then selectively adding both passively and actively managed funds around it. There are around seven positions in each portfolio. Currently, First Ascent offers five model portfolios based on return and risk profiles, along with tax-sensitive versions for taxable accounts.
“The trading costs of putting lots of positions in place and rebalancing them frequently and so forth usually more than eats up any benefit you get,” MacKillop says. The firm doesn’t sell any proprietary products and doesn’t accept payments from product providers.
He estimates First Ascent will reach profitability somewhere around $300 million to $400 million in assets; at that point he plans to do away with the AUM-based fee altogether and charge a single flat fee for all the portfolios.
Robo Competition or Marketing Shtick?
If an advisor comes to First Ascent through a platform like Envestnet they pay 25 basis points up to $400,000, where the fee caps out at $1,000. That is in line with the robos, but gets cheaper as the account grows.
MacKillop believes he can compete with the retail robos not just on price, but on the service model, since the end investor still gets to work with a human advisor.
“The client gets a lower fee schedule than they would get working with robos, plus they get a financial advisor in the equation who is going to help them,” he says. “I think it’s a different model but a better model in the sense that it’s driven by investment people who know the industry and understand clients and understand advisors. The robos will eventually figure all that out but they’re coming at it from Silicon Valley and from the technology culture and not really understanding how advisors work and what they need and what clients need. I think we have a good shot at going head to head with them and providing a better service at a lower price.”
MacKillop isn’t reinventing the wheel; a lot of this technology is already out there, he says. The firm uses DocuSign, electronic signature software, so that clients can open an account online without passing paper back and forth. First Ascent also outsources a lot of its back-office operations to firms like Envestnet and Orion to keep its costs low.
“When I look at the legacy asset managers, they all built their own in-house trading and operations functions,” says Gib Watson, vice chairman at Envestnet. “First Ascent Asset Management is outsourcing their whole back office, which is very unique. It thus allows First Ascent to focus on what they do best, which is the investment management function.”
Watson sees First Ascent as an indirect competitor to the robos, although he believes the firm’s pricing model could be very disruptive to the traditional asset management industry.
Neil Bathon, founder and partner at FUSE Research Network, says it’s too late to compete with the big auto-investing platforms from the likes of Schwab and Vanguard, which keep dropping their prices. And the robos are getting more sophisticated than many advisors, he said, with features like automated tax-loss harvesting.
“I think advisors have been holding out the notion that these robo platforms just do such basic, simple stuff that there’s still quite a bit of room for the advisor to add extra value,” Bathon says. “But every time I hear a Wealthfront or Betterment person speak about what they’re doing with their platforms, there’s no question in my mind that some advisors don’t go as far as they do in terms of sophistication.”
Ninety percent of advisory firm revenue, on average, comes from AUM-based fees, and that has stayed consistent over the years, according to FA Insight’s 2016 Study of Advisory Firms. Less than a third of firms regularly review their pricing model every 12 months, according to the study.
“If you’re a wealth manager, a financial planner, a family office and you’re delivering very a broad number of services and you’re bundling those services under a pure asset-based pricing model, it becomes very, very difficult to ensure profitability per client,” said Eliza De Pardo, a consultant for TD Ameritrade Institutional, which owns FA Insight, speaking at the Financial Planning Association’s annual conference in September. “If you’re not carefully managing your pricing structure, you do leave yourself vulnerable when it comes to market slowdowns.”
First Ascent, arguably, can make the transition to alternative pricing models easier for advisors.
That was the case for Deborah Fox, an advisor with Essential Planning Services and CEO of Fox Financial Planning Network, who recently switched to a flat-fee retainer model and signed up with First Ascent because it was one of the only strategists that met her threshold of charging below 50 basis points.
“I honestly do not understand how advisors can compete in today’s marketplace by outsourcing to providers that are charging 100 to 200 basis points,” she says. “You’re behind the eight ball right away.”
The vast majority of advisors that Fox works with in her consulting business add their own fee on top of the outsourced investment fee. At her firm, Fox reduces her fee by the investment cost, since, she said, she’s not the one doing the investment management work.
“Fees matter even more [during downmarket cycles], so it’s really important for advisory firms to question what they are doing right now and preparing for those times for their own revenues as well as their clients’ net returns,” Fox says. “I think (First Ascent) is coming to the market at the perfect time.”
Sandra Gontero, head of Epoch Wealth Management, started her own RIA after working in accounting, so she was used to that industry’s hourly and retainer fee models. She signed on for First Ascent because the pricing model fits with hers.
“The industry is moving much more toward this transparency in fees, and being much more accountable for the fees that are being charged on investments,” she says. “I don’t think it’s a free lunch like it’s been in the past.”
She said it was particularly helpful for her ultra-affluent clients, who can be the most fee-sensitive. “If I don’t have that added layer of additional investment advisory fees, that makes clients very pleased,” she says.
Gontero says that she’ll cap her client’s fee when the account hits the maximum, along with First Ascent. She then will charge a retainer, either a flat fee or hourly fee for financial planning and any other services she provides.
Some advisors may find this problematic, says FUSE’s Bathon, as it may have some clients questioning why they were paying more.
“Advisors are funny creatures. Do they say, ‘Well I’ve been charging this person a lot more than that for a long time. Does this reinforce that my fees are too high?’” Some advisors might be forced to ask themselves how they justify what they charge. Many might find the answer increasingly elusive.