A New Way To Charge Custodial Fees – ValueWalk Premium

A New Way To Charge Custodial Fees

If you’re looking for something new to worry about, imagine how it would impact your firm if the independent custodians were to decide that instead of charging your clients a variety of fees for their services, they would charge you an asset-based fee that would cover everything. The custodial costs would suddenly come out of your pocket.

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Custodial Fees

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What would drive such a change? The custodians worry that their favorite customers – the most fiduciary, cost-conscious among us – are also their least profitable customers, and the trend is not encouraging. Most advisors are trading less, and using the least expensive fund classes wherever appropriate, and keeping as little as possible in the 0% interest custodial sweep accounts. They are doing everything they can to squeeze custodial profit margins – which is normal fiduciary behavior.

Meanwhile, the costs of maintaining the custodial trading platforms are going up.

Even some advisors consider the current arrangement to be somewhat un-fiduciary. The custodian is providing the conveniences of a trading and back office platform to the advisor in return for the fees that it is collecting from the advisor’s clients. This is not unlike a soft dollar arrangement: you give us a certain amount of business, we’ll pay for a variety of services that are vital to your firm.

I recently polled my Inside Information readers, asking what they thought of this arrangement, and (not astonishingly) they wanted to know how much money we’re talking about. Michael Kitces, who actually started this discussion (see here: here proposed that the smallest firms would pay 10 basis points on client assets, with the price scaled down to 7, 5 and 3 basis points as the firms brought in more assets and business. In other words, larger firms would be paying a lower percentage fee than smaller ones, and this was a pretty big sticking point, even with some of the larger firms. They didn’t think it was fair to disadvantage their smaller competitors.

Others noted that the 10 basis point fee, for a firm charging, say, an average of 80 basis points on client assets, is 12.5% of revenue. Assuming the firm’s profit margin is around 20%, this fee could represent more than half of its total profits.

Others noted that, if the custodians are hoping to recoup all of the revenues they are currently collecting from advisor clients, we could be talking about more than 10 basis points. Custodians make their money a variety of ways: on trading costs (whatever you’re paying is almost all profit, considering that the actual dollar cost to a custodian for a trade is reputedly at or below 10 cents); on sub-TA fees paid by mutual funds not named Vanguard or DFA (5-15 basis points); similar fees on ETFs not named BlackRock; on NTF fees (25-40 basis points for mutual funds, somewhat less for ETFs); on the spread between 1.5% normally paid out on money market funds and the roughly 0% that your clients get from custodial sweep accounts; and on payments for order flow (unknown amount but reputed to be significant).

Advisors can monitor those money market accounts and keep the balances as low as possible, trade as little as possible and use mostly non-Sub-TA funds, and it is still possible to imagine that the total fees collected by their custodian would equal or exceed 10 basis points.

The most interesting proposal I heard would have the custodian approach each advisory firm with a target revenue goal. If the various client fees were to reach or exceed that goal, the advisory firm would pay nothing. If they fell below that goal, then the advisory firm would pay the difference out of pocket. The obvious drawback is that this would give the advisory firm an incentive to make a few trades or keep some money in NTF funds to make sure the custodian is paid out of client assets rather than its own pocket.

Read the full article here by Bob Veres, Advisor Perspectives


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