As investors grow more sophisticated, will the fee-based model for services better serve financial retailers? Ma-Do, a magazine for Japanese financial retailers, surveyed financial operators about the fee-based model. Responses came from banks, over-the-counter brokerages, and independent financial advisors (IFAs). N=122.
Translated from an article originally published in Ma-Do, vol. 62, May, 2021
The fee-based model has long been touted as the preferred format for asset management compensation. In a bid to promote more consumer-friendly practices, Japan’s Financial Services Agency (FSA) released a revised edition of its “Principles of Customer-Oriented Business Operation” in January, and published related documents in April to encourage practical approaches such as reporting forms, analysis points and Q&A. “Customer-oriented” is now a buzzword among asset managers and Japanese financial retailers. Has the industry changed its view of the fee-based model? Ma-Do surveyed industry insiders over two weeks from late April to early May to find out.
Under the fee-based model, financial advisors collect a fee based on a client’s asset balance, rather than through a commission on sales. We first asked about the feasibility of the fee-based model becoming the industry standard.
More than a third of respondents predicted the fee-based model “will become the norm”. “Customers' financial literacy is increasing and their attitude toward sales commissions is becoming more critical. As a result, the value of advice is increasing”, according to a regional banker in Kanto region. Another Kanto regional banker at headquarters noted, “With the rapid development of remote transactions, it is inevitable that sales commissions will become unacceptable. As a result, we will be forced to adopt a revenue model based on consulting fees.”
The majority of responders (61%) believed the fee-based model “should become standard, but such a move is practically difficult” to achieve. Doing so would require overcoming significant hurdles. The most essential changes envisioned were a “revamped sales structure” (68.8%), “a changed advisor mindset and upgrade in skills” (59.8%), and a “revised rubric for performance evaluation” (45.9%). In terms of sales structure and evaluation, it seems little has changed. “I feel at our headquarters that products with high commission rates are selling well. I can't deny that we are being forced to meet our profit targets,” said one regional banker in Shikoku.
Respondents were keenly aware that when financial advice is made the basis of compensation, consumers need to feel that advice is valuable. A regional banker at HQ in Hokkaido-Tohoku region explained, “When the asset management business shifts from commissions to fees in exchange for advice, you need to ensure that the quality of the advice given by sales staff is sufficient. Although financial institutions are making efforts to assign sales specialists and educate and train sales staff, I can’t deny that it is still insufficient.”
Another regional banker in Tokai region added, “You need to have solid expertise to justify charging your customers a percentage of their portfolio performance. Since the differences among retailers and sales personnel will become apparent, a systematic training curriculum is needed.”
From a product perspective, the shift to a fee-based model can be seen mostly in the widespread adoption of (mutual) fund wraps. Major securities companies and major banks have steadily adopted these products, but recently, regional banks have begun increasing their offerings. Among respondents, 31.1% have introduced fund wraps, 1.6% are planning to introduce them, and 4.1% say they are considering introducing them. One regional banker in Kanto reported from HQ, “Our bank group waives toshin (Japanese mutual funds) sales commissions for clients above a certain level, and the only real compensation is trust fees (management fees). We are using fund wraps for proposal-based sales as well, so we’re in the process of realizing a fee-based business model.”
Nevertheless, most respondents (47.5%) declared themselves "undecided" about fund wraps, indicating that the fee-based model has yet to gain wide acceptance in practice, if not in theory. Some criticize the promotion of fund wraps as insufficient and misleading, when retailers have yet to consider what constitutes a “customer-oriented product”. “If retailers are saying this is the only product they can confidently charge advisory fees for, then they are really dropping the ball,” said one brokerage employee in Tokai region. The fee-based model envisions clients holding a core product for a long time, providing advice on an ongoing basis, and collecting a fee in return. The product is merely a tool and the focus should be on how you increase the added value of the service.
Some in asset management are concerned that if the fee-based model becomes the norm, most clients will be wealthy, and smaller investors interested in asset building and such will be shut out. “Serving clients with small assets under management will not be viable under a fee-based compensation system. If the fee-based compensation system is forced on the industry, there will be no advisors to advise younger clients,” one IFA in Kinki region worried. An employee at a major brokerage reported the trend is already underway, “It has become more like a private bank, with a sales style that focuses only on wealthy customers who can afford the fees.”
According to one Hokkaido-Tohoku regional banker at HQ, “The shift to a fee-based model is the way things should be, but getting there means a lot has to change, such as changing the mindset of advisors, improving their sales and explanation skills, changing the mindset of clients, and getting management to understand the temporary decline in profitability that will accompany the shift to a fee-based model.” Whether the shift in business model proceeds or stalls comes down to how well management understands its mission and its client base. Every retail financial institution will need to decide for itself which business model best suits its strengths.