The concept of private wealth management is gaining popularity in India, recently. More and more financial institution, banks and brokerage houses have started offering wealth management services for a nominal fee - normally ranging between two to three percent of the assets under management. On the face of it, the fee structure looks reasonable as the wealth managers do have a reasonable expectation to provide returns exceeding the market return. However, is the fees structure really a fair pricing strategy?
Lets take an example of two friends - Ravi and Sumit. Over his life, Ravi worked hard and built an investment portfolio of Rs. 10 lakhs. His friend Sumit managed to build his pensions and savings portfolio of Rs. 10 crores. They have the same wealth manager - who charges a standard fees of 1% of their portfolio value each year. So this means that Ravi pays Rs. 10,000 each year and Sumit pays Rs. 1,00,000 each year. Simple arithmetic says, Sumit pays 10 times more than Ravi. But the point to note is - Ravi and Sumit receive exactly the same service, the same performance reports, the same portfolio returns and the same advisor. The fee they pay is simply based on how much money they invest with the wealth manager and what it is currently worth. This creates a huge issue, because the extra fees made on Sumit's portfolio is probably paying for the costs of managing Ravi's portfolio. This cross subsidy is one of the four C's that concerns forward thinking wealth managers and industry commentators. If you have a large investment being managed by a wealth manager, it should concern you too.
Recently, Sumit asked his advisor withdraw some money to help his son buy a house. He was surprised that his wealth manager suggested it could be better buying the house by taking a loan or consider renting. This is the second of the four C - conflict of interest. As the wealth manager is paid based on the amount of the money invested and its current value, he would suffer an immediate pay cut, if money is withdrawn. Sumit began to wonder if he was always getting a most impartial advice.
Soon afterwards, Ravi received a inheritance and was considering whether to pay off his credit card loan, clear his daughter's student loan or buy a home that he had been looking at. Ravi met with his wealth manager, and was told that one of his best bet was to invest all of the inherited money to his portfolio, as it was the perfect time to invest. This is the third of the four C - contingent charging. Simply put, the only way the wealth managers earns a fee is when the client invests money and keeps it invested. Repaying debt or investing outside the portfolio, means the manager misses out on additional fees. At this stage, Ravi began to wonder if his advisor always had his best interest at heart.
So Ravi and Sumit did a little research and number crunching together. They were both shocked by the results. With his savings of Rs. 10 lakhs, Ravi discovered that over his retirement years, his portfolio could loose a substantial amount compared to a fairer alternative - one that was not based on a % charge of the investment but a simple annual fees. The gap for Sumit was much larger over the same period. This is the fourth C - costs. Simply put, annual charges of about 1%, sound and look like a small amount. However, over the years they turn to some really huge numbers. Investors like Ravi and Sumit need to be really clear about the impact of fees on their family's financial future.
The next day over coffee, Ravi and Sumit discussed their individual experiences and came to the same conclusion. It was time to change! The current system just did not make any sense for them and they both needed to find a fairer way to pay for wealth management. Fortunately they were able to find a wealth manager who charges a simple flat fees and provide a sensible independent advice. No percentages, no confusion and no conflicts.