Wealth management conflicts of interest are failing investors. Here’s what’s needed

The original version of this article first appeared in World Economic Forum.

The first time I invested in a financial product as a teenager, I asked the bank teller for a solution that could offer “higher returns”. I was quickly presented with a compelling story and a fund that had surging performance of over 20% in the previous three months.

Trusting as I was, I ploughed the little, hard-earned savings I had into the opportunity, ignoring the subscription fee, management fee, level of diversification, longevity of the strategy and other obvious things investors should consider.

It was about 10 years after that first investment, which performed very poorly, that I understood fully what happened that day. In addition to the many factors I missed was a critical question I had not even realized I needed to ask: the motivation and incentive for the bank teller to recommend me that financial product in the first place. Such incentive systems are what led to disappointment for me, as well as the poor outcomes of many investors that should rightfully be avoided.

Conflicts of interest

Distributors of financial products come in many shapes and sizes: retail bankers, insurance agents, independent financial advisers, remisiers, brokers, wealth managers, private bankers, relationship managers, online brokers and platforms, external asset managers, multi-family offices and more.

The challenge lies with the need for consumers to distinguish the services worth paying for. Subscription and transaction-based fees incentivize distributors to favourize churn (i.e. high-frequency trading or buying and selling of financial products). Naturally, investments that expire or are volatile create churning opportunities; in traditional financial advice models, high churn can result in higher commission for financial advisers, creating a space for misleading incentives.

Trailer commissions (also known as trailer fees, loads, sales commissions and retrocessions) are payments made by financial product manufacturers, such as fund managers, product structurers, insurance companies, to distributors. These payments, which can be one-time or recurring, incentivize distributors to sell products that benefit them financially. The higher-commission services tend to be innately more expensive and in need of “pushing” to investors, as opposed to their innate merit or suitability for individual investors. In this case, advisers can have a negative selection bias toward products that financially benefit them.

Double-dipping is another issue, where a firm has their own client advisers, as well as their own products. Unsurprisingly, this can lead to a potentially higher margin on their own products, and consequently an inherent conflict of interest.

In a world of hundreds of thousands of investment options on a daily basis – stocks, bonds, commodities, currencies, derivatives structured products, ETFs and funds across public markets and private markets, hedge funds, and much more – the wealth management industry’s entrenched churn and commission-based incentive systems undermine investors' best interests and their probability of success.

Learn more: Mutual fund investing: On surge pricing, institutional clean share classes, and sales incentives

The fee-based system

Strictly “fee-only” wealth firms are only paid a flat fee based on the assets they advise or manage for their client. Advisers (or wealth managers) cannot be paid on transactions or commissions. This system encourages wealth managers to fulfill their fiduciary responsibility where they are legally bound to help their clients find suitable investment solutions at the best price, in a constantly aligned and conflict-free pursuit to serve the best interests of their clients.

The only way fee-only firms can increase their revenue, year-on-year, is if their client’s assets grow. This business model creates no incentive to churn or push expensive products, and removes negative selection bias.

Aligned incentives lead to better motives, choices, business models, advice, outcomes and lives. To illustrate these values of independence and alignment, Endowus innovated 100% cashback on trailer commissions, where all of such commissions received by our firm are fully returned to clients. This not only lowers client costs, but importantly also ensures that our assessment and selection of investment strategies is based wholly on merit.

Learn more: A guide to mutual fund fees in Hong Kong

Race against time

The fee-only business model has been around for decades, popularized in developed markets like the UK, Switzerland, Netherlands, Australia, Canada and the USA. Here, market size and regulation contributed to the success of the independent fiduciary model in curbing misaligned incentives.

The regulatory framework in each country plays a pivotal role in advancing meaningful change.

For example:

• The US’s Investment Advisers Act of 1940 mandates that all registered investment advisers (RIAs) act in the interests of their clients. RIAs are the fastest growing segment of the US wealth management market, with over 50 million in activity in 2023, up from under 30 million in 2017. Assets have doubled in the same period to almost $20 trillion.
• The UK-initiated Retail Distribution Review (RDR) in 2013 resulted in the ban of commissions for retail investment advice.
• Independent wealth managers manage almost a quarter of all wealth assets in Switzerland. New pieces of supranational legislation, such as MiFID II, mandate that investment firms are now required to take “all sufficient steps” to obtain the best possible results for their clients and to act in their best interest. That includes being upfront about commissions and fees.
• The Australian government has banned fund managers from paying sales commissions to advisers and brokers in 2020, forcing them to shift to the fee-only independent model.
• Following high-profile mis-selling cases, the Netherlands introduced a ban on trailer fees on all retail investment products in 2014.
• Canadian Securities Administrators (CSA) introduced a ban on trailer fees in 2020 for execution-only service.

The world needs to speed up curbing conflicts of interest and encouraging the fiduciary responsibility of people working in wealth management. This is critically important in nations facing increasing pressure on retirement adequacy, as birth rates remain low and life expectancy rises. The fee-only model leads to better investor outcomes, which in turn builds a financially secure and independent ageing population. This reduces the strain on national welfare systems, breaking the chains of the “sandwich generation” caring for both their children and their parents, and improving societal outcomes.

Technology makes transformation possible

The wealth management industry has undergone significant transformation, with digital platforms and wealth technology significantly lowering the entry barriers for investors.
Research shows that approximately 80% of people in Asia would consider receiving financial advisory services through digital channels. Our latest survey of high net-worth investors in Hong Kong and Singapore revealed a burgeoning preference for digital-first solutions.

But while the technological side of the industry has evolved, business models have not evolved in tandem. Many players, including new fintech operators, continue to operate on commission and churn-based models, to generate greater transaction revenue from their clients, rather than focusing on creating better outcomes.

Wealthtech's key value-creation opportunity is using technology to democratize investing – enabling a lower-cost scalability of excellent advice and product access, and lowering the minimum assets needed to open an account. This can also mean that a wider affluent demographic, which is important to society, can now access private markets, hedge funds, and alternative asset classes that were previously available only to institutions and the ultra-wealthy.

With Asia’s intergenerational wealth transfers approaching $30 trillion, we cannot afford to accept the broken commission model eroding investor wealth built up over decades. We must embrace fee-only fiduciary standards as the new norm for a more financially resilient future. Asian investors deserve advice focused on their interests – not tainted by hidden incentives. We owe it to future generations to build a more equitable, prosperous financial future.

Read more:

• Choosing Endowus when investing in Hong Kong
• Why investing in Hong Kong shouldn't be expensive
• Unit trust investing in Hong Kong: The pains of trailer fees

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