As with any profession, wealth management has its own jargon for clients to get a handle on. Understanding these key terms will help to empower investors, wherever they are on their wealth journey.
The term “ad valorem” comes from the Latin for “of the value” and refers to the management fees you pay to the institution. These are usually charged annually and are calculated as a percentage of the amount of assets you have entrusted to the wealth manager.
Ad valorem fees are usually around the 1.5% mark, although clients will larger portfolios may well be able to negotiate a discount on fees. This is because you could argue that the costs to the wealth manager (for the custody and administration of your assets, and for the expertise of your adviser) do not double for a portfolio twice the size. Economies of scale can apply to wealth management, just as any other industry. Ultra high net clients with tens of millions of pounds to invest are sometimes able to negotiate very significant discounts.
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Clients tend to like ad valorem fees as they are easy to understand and offer a degree of certainty over how much they will be charged. However, if the value of a client’s portfolio rises dramatically in value, so too will the management fees payable – in line with the increase in assets under management. More importantly, critics of ad valorem fees point out that this charging method does not align the interests of the client and the institution since it gets paid regardless of investment performance.
It is also arguable that ad valorem fees could encourage investment managers to take on more risk than is appropriate for the client, so that they can chase a level of performance which will better justify the charges being levied. (The irony here of course, is that clients are usually more worried about losing significant amounts of money than “missing out” on investment returns; the former certainly causes investors more psychological pain, various studies have shown).
There are clearly pros and cons to ad valorem wealth manager fees but this is the charging method both clients and institutions are most used to and so we probably won’t be saying good-bye to them any time soon.
There are firms which use different pricing methods; they may even completely “unbundled” their fees so that the charges for transactions, their investment expertise and advice, and the custody and administration of the assets are broken down. It may surprise you to learn that the cost of doing business is actually quite high for wealth managers. Charging in this way holds out an admirable degree of transparency to clients, but such granularity may be too much detail for some people.
In either the upfront fee or ad valorem model, it might also be the case that your wealth manager charges a performance fee. This will only be levied if the wealth manager hits pre-agreed levels of investment performance and this is likely to be more than compensated for by the level of growth you will have enjoyed. Investors who want to aggressively chase growth might like the idea of incentivising their wealth manager to pull out the stops, but of course others are looking predominantly for capital preservation and modest growth.
The Retail Distribution Review reforms implemented by the regulator at the start of 2013 have greatly improved transparency over wealth manager fees, making it a lot clearer for clients to know how they are being charged and what they are getting in return in terms of investment performance.
If you are unhappy with your wealth manager’s fee schedule, talk to them about it – they may be able to make small changes to how your account is run. You should also flag up anything which isn’t clear straight away. It is incumbent on wealth managers to be upfront about how much you will pay for its services.
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