To qualify to sell securities or funds to a retail audience, an adviser at a minimum has to be a “registered representative” and for many years this was the preferred model in the industry. A registered representative looks to sell specific financial products (securities or funds) to their clients and they must determine their client’s suitability to purchase that product and ensure that their client has all required disclosures before allowing them to engage in a transaction. The registered representatives were typically paid a commission when such a transaction occurred.
A new breed of adviser began to emerge in the early to mid-1990s that looked to differentiate themselves from the traditional representative by actually registering as an RIA with the SEC and taking on fiduciary responsibility for their clients’ portfolios. For compensation, these advisors chose to take a fee only on the assets they managed and to not charge commissions. They marketed themselves as having greater independence as a result of not having to push product, and as promoting better long-term “ What’s driving the emergence of these products is the demand for
downside protection, outsized returns and alpha. The RIA and wire house community in gatekeeper positions are really clamoring for alternative products.”
— Law Firm
“ High net worth investors like these regulated alternative products because they’re so sick of waiting around for K-1s. They like getting the 1099s so that they can get their taxes done on time.”
— Asset Manager
“ There is some interest from the mass affluent for the liquid alternatives. Most importantly, the structure allows them to get a 1099 versus a K-1 form. I’ve had direct conversations with the distributors of these liquid alternative products and its puzzling to me that the 1099 issue is such a big deal, but they tell me that no financial advisor wants to be the one to introduce a K-1 into their client’s portfolio.”
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“ Targeted investor demographics will be a deciding factor since many retail platforms will not distribute products to their clients that issue K-1s. These platforms’ investor base is not familiar with K-1s so the advisers need products for their clients that issue 1099s. The more retail platforms may not even have procedures or systems able to process K1s for their clients. Conversely, most accredited investors (and their wealth advisors) are familiar with K-1s so everything else being equal they would be agnostic to whether a fund is structured to issue 1099s or K-1s.”
— Law Firm
“ Advisers were also pushing for alternative mutual funds and ETFs because there had been a shift in adviser’s pay from commission to fee-based. They liked these products because they reduced volatility in their pay stream.”
— Morningstar Alternatives Research Team
returns by encouraging clients to buy and hold rather than move in and out of investments.
The traditional brokerage firms resisted this trend toward fees rather than commissions until just after the technology bubble (1999 to 2001). Revenues for many of the brokers at these firms were exceptionally high in those years due to the excessive day-trading
that was taking place from retail investors. When the market crashed, so too did the compensation for many registered representatives. To keep their most successful advisers, the traditional broker-dealers moved to a combined fee and commission model. Chart 27 shows that by 2008, 30% of financial advisers were compensated solely by fees, and 43% were compensated by a combination of fees and commissions. The sharp drop in assets that occurred in the GFC hit the wealth adviser community especially hard because they saw not only their clients’ assets, but their own compensation, drop precipitously.
Since 2008, the trend in the wealth adviser market has trended towards a combined fee and commission structure. By 2012, 60% of advisers were being paid in this manner, and the share of advisers being paid solely on a fee basis was down to 17%.
Alternative mutual funds and ETFs are seen as especially attractive to financial advisers that are paid on both fees and commissions. As already discussed, the ability of these strategies to offer some volatility dampening effect, keeping their clients’ portfolios more resilient to market corrections, can help to stabilize adviser asset-based fees.
These are also the “new” products on the block, and many are being offered by investment managers that were previously unavailable to the retail audience.
Chart 27: Shifting Pay Structure for U.S. Wealth Advisors
2008 2011
Chart 27-A
Source: College of Financial Planners 11%
30% 16%
Commissions Only Fees & Commissions
Salary Based Fees Only
43%
Shifting Pay Structure for U.S. Wealth Advisors 2008
Chart 27-B
Source: College of Financial Planners 7%
17% 15%
Commissions Only
Fees & Commissions Salary Based
Fees Only
60%
Shifting Pay Structure for U.S. Wealth Advisors 2011
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As a result, these funds are able to command higher commissions than the traditional long-only mutual funds and ETFs, where fees have been under compression for many years.