Could Your Family Benefit from an Independent, Outsourced Chief Investment Officer? Part VI
Richard M. Todd, Principal, CEO
Wendy Dominguez, MBA, Principal, President
Scott Middleton, CFA, CIMA®, Principal
Kristy LeGrande, CFA, MBA, Principal
Fee Disclosure – A quality OCIO can help a family understand the fees that they are paying
Families often do not understand all the fees that they pay to their brokers, advisors or investment managers. While some structured products, insurance products, and fixed income fees are hard to uncover or understand, a quality, independent OCIO can uncover them or provide professional estimates. Fees are a headwind for investors, and full disclosure can be very enlightening. Fees for similar strategies can vary immensely from advisor to advisor, and it is important to determine why and whether extra compensation is being paid to the advisor on certain strategies. The figure below is an example of a fee disclosure summary.
Fee Negotiation and Related Issues
An independent OCIO can help with fee negotiations for clients, thereby paying for OCIO services multiple times over. Advantages that an independent OCIO has over a single-family office are size and clout. Families need to be aware of the pressure that brokers or advisors receive to drive up “client profitability,” which is not what the client is making in returns, but the compensation that the broker or advisor is receiving.
The article “Private Banking Meets Cross-Selling for JPMorgan’s Wealthy Clients” published in Bloomberg(1) is revealing. According to the article, “How banks cross sell – essentially a ‘would you like fries with that’ approach – has come under regulatory scrutiny after revelations last year that Wells Fargo employees opened millions of fake accounts in clients’ names to reach sales targets. Wells Fargo admitted to a lapse and has changed its incentives. Nonetheless, the scandal brings an old question about banking into sharper focus: When do bank’s incentives for employees put the customer second?” The article mentions that JP Morgan’s executives have touted their ability to cross-sell: “’Cross-selling is a big deal. And we do an exceptionally good job at cross-selling. We think we’re among the best out there,’ Chief Executive Officer Jamie Dimon told an investor conference in September 2012, referring to the bank’s retail business. Fifteen months later he told another conference: ‘We do as much cross-selling as a Wells Fargo.’” As the article identifies, “There’s nothing illegal about cross-selling. Every company wants to sell its own stuff, and JP Morgan, the nation’s biggest bank, is no different.” It is common for firms to have programs to increase their brokers’ or advisors’ compensation at the expense of the firm’s clients. The prevalent “buyer beware” Wall Street culture can help build a strong case for an independent, family OCIO.
Investors should be aware of the following fees:
Manager/Product Fees. Many of the same investment managers and strategies can be accessed by different firms, often at different costs. There can be overlap between brokers or advisors for the same family, which is an opportunity for negotiation. Benchmarking managers’ fees versus peer groups is important to disclose. What are underlying managers’ fees and how do they compare to the median comparable product?
Share Class Differences. Reviewing mutual fund share classes on an ongoing basis is a helpful way to reduce fees. Often, when the least costly share class is not being used, it means that the advisor is receiving additional compensation. Figure 8 is an example of a share class review.
Placement Fees. Brokers or advisors, at times, will present a product to a family but then reveal a one-time “placement fee” of one to four percent. Placement fees are unnecessary, highly negotiable, and are used to increase client costs and advisor compensation. A good independent OCIO can be very successful at negotiating them away.
Fees to Hedging Concentrated Equity Positions. Tremendous value can be added by having several firms bid on the hedging strategies for concentrated equity positions. This competition between brokers can significantly reduce the usually undisclosed fees and compensation spread that the broker is making.
Fees on Structured Products. Many advisors recommend “structured products” to clients, which can come with very high fees. One former creator of structured products estimated that compensation spreads for the firms that put these products together were around 10 percent. An independent OCIO can help to provide transparency into product fees and determine less expensive ways to get the same exposure.
Case Study: Disclosing Mark-Ups on Broker/Dealer-Purchased Munis
Situation: A family was working with a broker/dealer that was charging a fee on most of the assets, but stated they would, “work for free” on the municipal bond portfolio. The broker marked up the bonds by 0.50 percent and sold them to the family. On a $5,000,000 total municipal bond purchase, the broker/dealer made $25,000 in commissions that were undisclosed to the family.
Independent OCIO Solution: At the time, broker/dealers were not required to show mark-up on statements and/or confirmations. In addition, the broker/ dealer was buying bonds specifically for the family and most likely overpaid for the bonds because they were buying odd-lot bond positions (under $1 million).
1 “Private Banking Meets Cross-Selling for JPMorgan’s Wealthy Clients.” Neil Weinberg. Bloomberg. February 1, 2017