Data analytics are revolutionizing the way mutual fund and ETF providers are approaching wholesaler compensation.
With the inclusion of data analytics, wholesaler compensation can be adjusted to put more attention on asset retention, says Matthew Fronczke, a director of research at kasina. The implication: With more insight into distributor and advisor profitability, it may not be in the best interest of some firms to have a presence on every broker-dealer platform.
"The cost of distribution may be too prohibitive or simply not worth the effort," says Fronczke, who discusses how data analytics is an important part of evaluating product distribution partners.
Compensation and benefit costs are growing more rapidly than asset-based revenues. What are firms doing about that?
Traditional wholesaler compensation plans are unsustainable with several trends that are counter to how wholesaler compensation plans are currently structured. Fee compression on mutual funds and ETFs is a major force squeezing revenue available to asset managers to pay for the distribution of the sponsored products. Fund distributors across channels are seeing value in seeking lower-cost funds and management fees for active funds are pressured by competition from their passive counterparts. Even alternative strategies and multi-asset products which are commanding higher fees and padding operating margins will eventually face fee compression as more players enter the market so there is no foreseeable catalyst for margin expansion in the longer-term for asset management firms.
The overall cost for distribution has also been increasing. There's more demand from broker dealer platforms for marketing support, revenue sharing and set-up fees. On top of that, wholesaler commissions are increasing so you have both external and internal costs of distribution on the rise, resulting in the increased cost of acquisition for every new dollar coming into the firm.
So what are asset management firms doing about it? Asset managers are becoming more selective and focused on who they are building relationships with. They're seeking relationships that are both sustainable and profitable. They're doing this by integrating advanced data analytics to assist in measuring the quality and profitability of their distributors. Because of all the pressures, asset management firms need to incorporate data into their distribution strategies to ensure operating margins can be marinated at or very close to their current levels.
If net sales and AUM metrics become more prominent in compensation plans, wholesalers may be more motivated to pursue more valuable relationships and assets. From an operations perspective, does this change the operating model for providers?
It changes the way that asset management firms are segmenting their advisor base. It's essentially changing the way asset management firms are looking for the opportunities in the segmentation process. Rather than segmenting based on basic demographics like channel and AUM, they will look for factors, which may hint at how receptive advisors may be to their firm's products. The receptivity towards a certain asset class or a preference for mutual funds over ETFs are examples of that. Knowing what and who influences their portfolio asset allocation and fund selection is also an important factor. Asset managers know they need to be more sophisticated in their segmentation so they are integrating data and predictive analytics to identify advisors who are more likely to be advocates and long-term supporters of their funds.
It's well known and discussed fairly frequently that it's much more expensive to acquire new assets and customers versus retaining existing assets and customers. So asset management firms and their wholesalers are beginning to focus more attention on the retention of assets and not just the attraction of new assets. The school of thought that large gross sales overcomes issues with net sales is being questioned as the best method to prop up net sales. This changes firms operating models to some extent because providers are looking to build out more sophisticated data systems, focusing on predicting wholesaling methods, for example. The technology and processes need to be integrated into their current systems, such as the CRM, which support the distribution effort.
kasina research indicated that a franchise territory model may help wholesalers focus on the most profitable relationships. What types of relationships win and which lose?
It's not to say wholesalers haven't developed strong relationships where they're paid on gross sales metrics or that some relationships win or other lose. We're saying a more balanced compensation plan can lead to deeper and better advisor relationships. So the relationships that will last are those where advisors see the fund sponsors as true investment partners, not just a product supplier. Advisors are more and more often requesting portfolio analytics and asset allocation guidance, for example, so those asset managers which have incentivized their client-facing staff with balanced compensation encourage wholesalers to be more consultative in their relationships.
kasina has shown that the discretionary bonus for wholesalers is not a large enough component of total compensation to impact behavior and that a larger bonus tied to clear behavioral metrics can align wholesaler compensation with the broader firm goals. Why?
In the traditional compensation model the discretionary bonus in most wholesaler compensation packages is roughly around 10% of total compensation, the base salary is roughly another 20% and the rest is variable and usually only tied to gross sales. A larger wholesaler base salary would be more consistent with the compensation experience of the whole organization, plus potentially making it variable will limit concerns about wholesaler complacency due to large salary. This would properly incentive them to maximize territory activity and not sit on a strong franchise business they built over several years. Additionally, in the current structure, the discretionary bonus it is too small and does not have a large enough monetary impact to influence behavior. Annual goals and metrics tied to the bonus are too abstract for a role where most of focus is on monthly performance. Finally, the variable comp component has a very heavy weight and is vastly different from the rest of organization. Net sales is a better indicator of wholesaler performance. Comp plans should make more use of base salary and bonus with metrics that involve the long-term growth of assets, namely net sales and AUM.
How are product providers' relationships with advisors evolving?
There is generally a longer sales cycle and more people involved in the process besides the wholesaler. There are different times in the process where product specialists or divisional sales managers are involved in discussions with the advisors. The availability of data and this increasingly institutionalized sales process enables wholesalers to have more influence on asset retention than in the decades before so the conversations they're having with advisors are very different from even just a few years ago.
Compensation models are numerous. Can you describe a few?
The most common is the traditional model where base salaries and bonuses are typically a smaller component relative to the variable component, which consists mostly of gross sales metrics. A few firms have already included net sales as a piece of the overall variable component. Although base and bonus and still relatively small. The bridge model, as we call it as kasina, consists of a smaller variable component based on gross sales with a larger base and a bonus tied to net sales and asset retention metrics.
The aligned model has a similar sized variable component based completely on net sales, a base salary based on territory AUM and a meaningfully sized bonus tied to hard metrics. The model we believe is most aligned with firm goals also happens to be a model which usually received the most skepticism. This is very much the franchise model of territory management. This model is obviously not practical for many firms at the moment, however, it could be implementable in the longer-term should firms take small but important steps to bridge compensation plans which focus on top line figures to those performance indicators based on asset retention and the development of deep and profitable advisor relationships.
Why are most fund providers using the traditional model?
The traditional model is the most common because it's fairly simple and can be easily implemented by asset management firms. In fact, all comp models no matter how traditional or progressive need to be simple and easily understood by the team of wholesalers. The main point we are trying to make is the variable component can still be large and significant enough to incentive and motivate inherently competitive people who are in wholesaler positions. That being said, the metrics built into the variable component need to be aligned with firms' goals and the growth and stability of the overall business.
You have suggested that all aspects of compensation should be made more variable and tied to successfully building advisor relationships deliver stable wholesaler income.
Wholesaler income today is as stable as they're willing to work for it. However, the emphasis on gross sales doesn't necessarily translate to a more consultative process built on the premise of longer-term retention of assets. There is no doubt comp plans with a heavy gross sales metric can bring assets through the door. However, including AUM and net sales metrics focuses advisors attention on advisors, which will maintain allocations to their firm's products for long periods of time. These relationships will be more profitable for the firm. A comp plan with a large variable component tied to assets and net sales in a territory with a stable base of assets would also provide wholesaler with stable income.