Professional Advisers - Their Role, the Best Type of Remuneration Arrangement

The Role

For many people, undertaking portfolio investment entails climbing the unavoidable 'learning curve'. Some will slog away at this themselves but the journey can be made easier by resort to the experience of professionals. Some material can be gleaned for free but exposure to the practices of professional advisors is one way of refining a practical strategy appropriate to you.

Further, as far as the maintenance of an investment strategy is concerned, exposure to the expertise of a professional can make a difference in keeping the portfolio in optimal shape.

Remuneration

There is then the question of how to remunerate professional advisors. Probably the most appealing way from the client's perspective is to pay for their time - much as one would a lawyer or accountant. But the cheapest is not necessarily the best -monkeys work for peanuts.

There are however fee benchmarks which are acceptable. 1% of assets should be the maximum you pay. Cheapest (or dearest) is not necessarily best. I know one advisor who continually boasts about his low fees (0.3% of assets) but then I look at what he does - he piles clients into UK investment trusts, many of which do little more than imperfectly track global indexes but with significantly higher volatility than the index. Why would he not just invest in index trackers? The reason is he gets brokerage from buying listed stocks. See - conflicts everywhere.

The following table illustrates the impact on your rate of wealth accumulation from various annual fee imposts. You can see that unless the advisor is going to lift your return above the market average their fees can substantially stuff your objectives.

The impact of fees
Fees per annum	Return net of fees,tax,inflation	Return reduction	Extra years to meet goal*	Retirement income achievable**

0%	4.0%			21,000
1%	3.4%	-17%	0.8	19,973
2%	2.7%	-33%	1.7	19,003
3%	2.0%	-50%	2.6	18,130
4%	1.4%	-67%	3.5	17,345

* for an average 40 year old with no capital, saving 13% of current income and wanting a retirement income equal to 70% of current pre-tax income of $40,000

But it would be naïve to suggest that only advisors that are "free" add value. The sum is not hard. You have to price the value of your time to acquire the requisite knowledge just to be adequate at the portfolio investment game. (This is quite different from the time you have to invest in order to be an intelligent client - see "What are the portfolio skills we all must have?")

Administration Services

Some of the advisor's service will be administration. Don't underestimate this - a good reporting system is worth its weight in gold, in terms of freeing you to concentrate on the investment issues rather than the tedium. Advisors should be able to divide their fees between 'admin' and advice.

Strictly speaking admin costs are non-deductible, whereas advisory fees incur GST and are deductible. It is reasonable to expect your admin fees should be linked to portfolio size, given the additional work larger portfolios require (this fee should be fixed). Admin fees should cover:

A. Reports, (at least quarterly) of statement of position and portfolio performance (effective) return on the portfolio, measured against an agreed benchmark. Annual tax report summarising income, withholding tax, imputation credits, and foreign tax credits.
The administration of the portfolio - arranging and settling transactions locally and offshore, reinvestment or banking of dividend and interest cheques, arranging rights issues, maturities, correspondence from companies to you their shareholder, annual reporting of taxation position.

The advisory component
Client education is an important part of the advisory role. Ignorant clients are not stable clients and an advisor worth their salt should be helping you get comfortable with the decisions being made on portfolio management.

Income Portfolios
For investors seeking income, advisors can add value by assisting in the construction of a portfolio that delivers sufficient income net of costs to meet your needs, without excessive credit risk. For this they should be paid, but obviously, there is a lower overall return available from income assets than from a growth portfolio. The threshold (portfolio size) for a full portfolio service therefore tends to be higher for income portfolios than for growth portfolios.

Mixed Portfolios
Generally speaking, portfolios are a combination of growth and income assets. Put quite simply, an advisor is only worth what he/she adds by way of performance relative to the prevailing market conditions. You are, let's face it, paying for performance, hopefully delivered with a high level of service.

In terms of the amount of fees that are acceptable, an investor has to be aware that typically a portfolio returns after tax and inflation, 4% per annum. So if the effective fees for managers and advisors amount to 2% per annum (very common) then it's most unlikely the investor will make market average returns. This means then you have to build that in to the assumptions and objective-setting you carry out with the calculator.

Up front fees
Some advisory businesses are built on high (5%) up-front fees and ongoing trail commissions from fund managers. This business model has some inherent problems:

There is the unavoidable temptation for clients to be steered towards the highest commission funds.
Trail commissions from fund managers incentivise your advisor to keep your money there, whether or not it is the best thing for you.
When the bulk of the fee is paid on day one, it is unlikely that you will receive the same ongoing level of service as you get during the sales process.
5% taken out on Day One can set you back.

Summary

So the fees issue is very important and deserving of much attention by the investor. This is why many investors have to invest their own time to defray the cost. The ideal remuneration arrangement is very hard to find but some are a lot closer to ideal than the pack.

It is in fact the fees issue that at the end of the day determines how much of the yakka of running a portfolio you have to do yourself. Unless your expected in-the-hand returns are in line with what you've assumed in setting your savings and investment goals when using the calculator, you're going to wake up disappointed one day.

You need the knowledge, you need the administration, and you need the ongoing research to manage your portfolio. Some of that will likely be out-sourced. Your preference and the fee structures on offer, will determine which bits.

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