Across most sectors of the retail financial services industry, advisors report that they are generating more and more revenue from fees and less from transactions. This arrangement is meant to work better for clients — and Investment Executive’s 2007 Report Cards indicate the shift is pleasing advisors, too.

The trend away from commissions and other forms of transaction-based compensation has been going on for some time. The shift reflects a number of factors. For one, firms of all stripes (but particularly those controlled by banks and other publicly traded entities) favour fees over transactions because fees represent a more stable, predictable revenue stream, enabling the firms to ratchet down their exposure to market risk.

At the same time, many advi-sors and their firms have been taking their businesses upmarket, focusing their efforts on clients with investible assets of more than $500,000. This process lends itself to holistic, comprehensive wealth-management services that can be packaged up in a fee structure rather than the volume- and product-driven services that advisors traditionally had been providing their clients.

Third, fee-based products are a way of tying both clients and advi-sors to the firm. It is tricky enough for an advisor to move a straightforward stock portfolio to one firm from another; it becomes that much harder when the client is in a proprietary managed-account program.

Finally, fee-based arrangements also work well for clients because they better align clients’ interests with those of the advisor and the firm. In a fee-based arrangement, firms and advisors see their revenue increase when clients’ assets increase. The traditional commission structure encourages more frequent trading — which is not necessarily in clients’ best interests. Fees reduce the risk of clients being harmed by the advisors’ conflicts of interest.

So, whether it’s being pushed upon them or they see the merits of it themselves, “fee-based stuff is what clients are really going for these days,” an advisor with BMO Nesbitt Burns Inc. in Ontario told IE in a Report Card interview this year.

With clients biting and firms seeing the numerous benefits for themselves, financial services firms are keen to create effective fee-based products — and they’re using the compensation system to prod advisors in that direction.

A TD Waterhouse Private In-vest-ment Advice advisor in British Columbia says that, while there is plenty of independence for advi-sors at that firm: “Compensation is skewed toward fee-based [because] that is what the bank wants.”

“They do try to steer us with incentives for the fee-based products,” confirms another TD Water-house advisor from the West. “No-body says anything or forces anything; it’s just steering us toward that.”

Firms can subtly shove advisors in the direction of fee-based products simply by granting those products favourable treatment under their compensation grids, which, advisors say, are otherwise under pressure.

Whatever the reason for the shift toward fees, what’s clear is that the trend is active and ongoing. In IE’s four 2007 Report Cards, advisors in most sectors of the industry display a meaningful swing toward fee-based revenue sources over the past year.

Investment dealers have made the most progress toward fees, with more than 40% of the average broker’s revenue now coming from fees, up from about 31% a year ago. Both transaction-based and deal-based forms of compensation saw their market share among brokers fall year-over-year as a result.

While the entire industry is making increasing use of fees, it’s the top producers that are driving the trend. This year, fees became the single biggest source of revenue for the country’s most productive brokers — the top 20%, as measured by assets under management per client. These brokers saw their reliance on fees jump to almost 50% this year from less than 36% last year.

The rest of the brokerage industry experienced a similar jump, with fees going to 38% of revenue this year from 29% in 2006 — suggesting that while the magnitude of the reliance on fees differs with productivity, the overall size and direction of the shift is the same throughout the brokerage business.

A substantial and growing reliance on fees is evident in a couple of the industry’s other major channels, too. While investment advisors are making the most use of fees overall, the shift toward fees among planners is even more dramatic. Advisors in this space saw their dependence on fees more than double to 30% of revenue this year from about 12.5% last year. As with the brokers, this move came largely at the expense of transactions, which saw their share of planners’ revenues fall to 65% in 2007 from almost 85% in 2006.

@page_break@Similarly, the banks’ and credit unions’ account managers report a large jump in their use of fees, albeit from a much lower base than either brokers or planners. The average account manager more than tripled his or her use of fees — to 7.9% this year from 2.3% of revenue in 2006. For a group that still gets more than two-thirds of its compensation from salaries, this represents a significant shift.

For account managers, the shift away from transactional sources of revenue has been even more decisive than their move into fees. They report that transaction-based revenue dropped to less than 1% this year from about 10% last year. At the same time, salary revenue dipped year-over-year and “other” sources of revenue grew to more than 20%.

The one segment of the industry that hasn’t seen a significant shift to fees is the insurance business. It is obviously much different from the other channels of the retail industry, with the vast majority of advisors’ businesses dedicated to insurance sales and with relatively minor reliance on investment products. For these advisors, fees remain a very small part of their overall revenue, and transactions still dominate.

This year, IE did drill deeper into the composition of insurance reps’ transaction revenue — revealing that the single biggest revenue source for agents that operate within dedicated sales forces is renewals, edging out first-year commissions. Advisors that work through managing general agents, however, generate almost 60% of their revenue from first-year commissions, more than double their reliance on renewals.

Amid this overall evolution in advisor compensation toward fee-based sources — and largely away from transactions — it appears that advisors remain reasonably happy with their remuneration. Although, as an advisor from Investors Group Inc. in Ontario says: “Even if I’m overpaid, I’ll always complain about my compensation.”

That said, advisors report being happier overall with their compensation this year than they were last year. Apart from the account managers, all other advisor channels claim increased satisfaction with their total compensation year-over-year.

The biggest increase in satisfaction is for brokers, who score their compensation an 8.3 (out of 10) this year, up from 7.9 last year. “We’re ridiculously overpaid,” admits a Nesbitt broker from Ontario.

Both types of insurance advisor (dedicated sales force and MGA) also report greater satisfaction (8.1 ) with their compensation, up 0.3 points from 2006. The planners inched up to 8.0 from 7.9 over the previous year. And the account managers remain least satisfied with their remuneration, unchanged at 7.3.

Of course, this ongoing shift toward fee-based revenue isn’t the only thing affecting advisors’ appraisals of their compensation. Some of the increase in the scores may simply reflect that, during the period of the survey, markets rose and AUM increased significantly, which should increase advisors’ revenue substantially, too.

Moreover, the composition of compensation is evolving. Firms are constantly tinkering with pay packages in an effort not only to drive advisors’ asset-allocation behaviour but also motivate them. For example, equity stakes in the firms are increasingly important features of some compensation packages — which may also contribute to advisors’ overall satisfaction.

In the current bull market environment, the fact that the use of fees is up may have nothing to do with advisors’ increased satisfaction with their compensation. Indeed, advi-sors may not be truly grateful for the impact this shift is having on their bottom lines until the next bear market hits, when they are likely to find themselves thankful for steady fees. IE