Fee compression is exaggerated, but competitive pressure isn't
Is fee compression real? Most wealth managers we speak with say they’re worried about fee compression, but here’s something interesting: we’re not seeing any evidence of fee reduction.
Jack Nichols is the CEO of Quantifacts, which does fee analysis for banks (pro tip: working with Jack or other fee analysis consultants is probably the easiest way to improve your margins). Quantifacts sees the actual fees charged by a large fraction of the bank industry, and they’re not seeing any signs of a decrease. We can back this up based on the experience of our clients, who are all maintaining their current cost structure.
What’s going on here? Is all this talk about fee compression just hot air? Not quite. The competitive pressure is real, but the response has been in the form of higher quality, not lower fees. We see our clients upgrading their value propositions, de-emphasizing raw performance and doubling down on what makes their services different — custom solutions, planning, personal relationships and advice.
I think we can shed light on what’s going on with an analogy. If you ran a restaurant and McDonald’s came to town, how would you respond to the low cost competition? You could try to reduce your prices and cut costs by installing walk-up service counters, letting customers order from at-table iPads, or some such. But that’s probably the wrong approach. You’re unlikely to beat McDonald’s at its own game. You’re better off going the opposite direction — improve the food, the service, and the décor. Go upmarket, and maintain or raise fees. You should, of course, still be as efficient as you can by automating what you can. You gain nothing by washing dishes by hand; dishwashers are faster and better, and no one is going to pay you more just because you’re inefficient.
This same logic applies to wealth management. The right response to robos is not to reduce service and cut fees. It’s to increase service and maintain — or even raise — fees. Clients won’t pay for what they can get just as easily from a robo, and that includes alpha-generating strategies of all kinds. What they will pay for is what only advisors can do — act as coach, guide, coordinator and counselor.
This doesn’t mean the pressure’s off — it’s just that the pressure is not on fees, it’s on service.
For more on this topic, check out The Three Types of Wealth Management Firms.