Fee based advice: Winning formula or passing fad?

Fee based advice: Winning formula or passing fad?

Margins in private banking are fading. Increased regulatory costs and a low interest rate environment are not help-ing. But more prominently, the lack of client activity combined with fading trust cuts right into the heart of the private banking business model. Prominent players try to regain lost revenues by re-inventing their advisory services. I have scrutinized fee based advice solutions in the context of business model innovation and identified seven areas critical for success. It is my viewpoint that success requires taking a value based rather than an effort based ap-proach to advising clients.

Numerous private banks are strugling with pressure on revenues and fading margins. Increased costs, due to regulatory requirements combined with a low interest rate environment, are one of the reasons. Decreasing client transaction activity is is another one. In addition, trust in high margin discretionary mandates solutions is dwindling.

Different private banks try to counteract this trends by introducing fee based advisory services. But what does fee based advice (“FBA”) means? FBA solutions provide clients with advice supporting their investment decision process through aggregating, filtering, and summarizing market intelligence. In addition, FBA solutions monitor the clients’ portfolios, alert them pro-actively of unindended risks, and provide ideas to adress them.

Is FBA a winning formula for the future or only a passing fad? To gain insights into answering that questions, I reviewed the advisory services offered by eight of the largest banks in Switzerland based on publicly available information. I identified seven key criteria which I believe are critical for success.

1 FBA as a product on its own

Observations. The advisory services offered by private banks can be classified into two categories:

  • Advisory services are defined and marketed as distinct products. A dedicated fee is charged for the services provided. Innovative characteristics of the service offering are used as differentiating factor.
  • Advisory services are seen as a free door-opener and trust builder to sell related products.

Innovative offerings were found in the first category. Traditional, and usually also smaller, private banks tend to position their advisory services along the lines of the second category.

My viewpoint. I believe that times are over where providing “free” advice, cross-financed through the sales of other products, is a sound business model. Increased pressure on cost transparency, an ongoing search in value for money, and the avoidance of conflicts of interests, will drive private banks towards having clients pay for the services they obtain, and ideally for the value they receive.

2 Client segmentation

Observations. All providers of FBA define their solutions based on the labor incurred in delivering advice and related services to the clients. The most common efforts identified and used in defining client segments are

  • contact frequency with the trusted advisor,
  • access to dedicated investment specialists,
  • frequency with which investment ideas are provided, risks monitored, and portfolio reports delivered, and
  • inclusion of additional services, like tax reporting or online access to research.

My viewpoint. I believe that taking a labor based view to client segmentation is sub-optimal. Defining different FBA solutions based on actual client needs will lead to a better segmentation and increased benefits. Broadly speaking, there exist two categories of clients interested in FBA solutions:

  • The first category of clients don’t want to spend too much time managing their investments but don’t trust their private bankers enough to fully delegate. They want to have the final say on any investment made but expect FBA to come up with investment proposals and monitor associated risks. They are interested in transparency and want to avoid unnecessary hassles.
  • The second category of clients are those clients that believe they are better in managing their investments than the private banks are. They are looking for research, investment ideas, and a partner with whom to discuss financial markets whenever and wherever they feel for it. They also want to delegate operations of portfolio management and stay hassle-free.

The key for success is focusing on satisfying needs that clients see value in and are willing to pay for. Client value is best achieved through proposing FBA solutions based on identified needs rather than internal efforts or costs.

3 Fee transparency

Observations. Whether driven by regulators or appreciated by clients, there exists a trend towards fee transparency. Two opposing approaches to providing fee transparency can be observed:

  • The line-item approach – Each component of the service is charged separately. No hidden fees exist and clients can relate the services received to the efforts of the private bank to deliver them.
  • The all-in approach – Clients pay a fixed fee, known upfront, which covers all services provided. The focus is put on the value delivered rather than the effort of the private bank to deliver the services.

My viewpoint. I believe that private banks should rely on all-in fee models related to the value created for their clients. The focus should be on charging a fee directly related to the added value clients obtain from satisfied needs. These models, if successfully implemented, provide high margins and are not perceived negatively by clients. They represent a win-win situation.

4 Regular and automated portfolio reviews

Observations. A key value proposition of all FBA solutions reviewed is that they ensure regular and automated monitoring and reporting of the client’s portfolio risks. Different solutions differentiate themselves with respect to what is monitored, how often the monitoring process is executed, and the activities performed when an issue is identified.

My viewpoint. Monitoring portfolio risks is critical to success. But, it is also important that clients don’t get the impression that monitoring risks means risks will never materialize. I believe that regular and automated portfolio reviews, as well as any reporting modules of a FBA solution, should support the advisory process rather than define it.

5 A multi-channel approach

Observations. Most FBA providers implement a dual channel strategy: i) they offer a single point of contact for all interactions and ii) use for one-way delivery of information existing channels, like their e-banking platform. Private banks do not offer dedicated FBA FinTech platforms allowing clients to optimize their investment processes.

My viewpoint. FinTech should be used as a key enabler. One way information delivery should be technology driven. Human interaction should focus on two-way communication where and when emotional and/or judgmental factors play a key role. The FBA solutions provided should promote agility and just in time delivery. For example, when a risk starts to materialize, technology should be used to alert the client in a timely manner and suggest possible courses of action, which he/she could directly execute without additional human interaction. Only if and when the client needs additional information, should the interaction with a trusted advisor occur. Depending on the client’s needs either a single point of contact or a specialist channel approach should be implemented.

6 Investment process

Observations. The investment process underlying the advice provided to the clients has not changed significantly. It is still based on defining a strategic asset allocation representing the client’s strategic financial goal, his risk tolerance, and risk preference. A top-down, usually region based, asset-only view is common. No clear concepts for integrating liabilities in the investment process are presented.

In addition, none of the FBA solutions reviewed exhibits any performance track record. The focus is not on performance. This may be due to the fact that the goal of private banks introducing FBA, is inwards oriented and targeted towards generating revenues rather than generating value.

My viewpoint. I believe that overhauling the investment process underlying FBA is mandatory to deliver investment performance in an environment where private banks advise and clients decide. It should be liability driven rather than an asset only, whereby the liabilities formalize the client’s needs. I am convinced that a differentiated investment process, combined with a proven track record, will be critical for success.

7 Unique value proposition

Observations. FBA solutions distinguish themselves from traditional free advices through increased pro-active interaction with the clients. Private banks still have a hard time characterizing why their FBA solutions is different from and superior to the one of their competitors or to their “free” offerings. The biggest differentiators are found in the frequency of client contacts, portfolio reviews, and reports made available, in addition to the charged fees.

My viewpoint. I believe that lasting success requires private banks focusing on stating why their specific FBA solution adds more value for the client than the one of their competitors or “free” offerings.

Key takeaways

FBA solutions address a well-defined need of private banking clients. To be successful, FBA solution providers should focus on

  • what’s in for the clients
  • rather than what’s in for the private bank.

Private banks should increasingly exhibit the added value for the client in excess of costs of their FBA solutions. Being able to answer the question why will a client have more money with rather than without using FBA will be key to increased revenues and margins from FBA solutions.

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