When you create a new model, one the important factors you need to take in consideration is the pricing you're going to charge. To begin, you simply cannot copy the competition. All too often, I heard stores from advisers were they base what is it they are going to charge for management simply by looking at competition. One of the problems with this is if your competition is charging 1% to manage their investments, there really is no way you can effectively stay in business and also provide value to your clients.
When an adviser charges 1% percent for management, they are typically just taking a Buy and Hold strategy. They may rebalance the account on a quarterly or annual basis, but there is not much more done than that.
VPM Partners offers a Participate, Protect and Grow strategy. As a result there's going to be additional costs within an account. Therefore, whenever you build a model, you need to determine the price that is appropriate for your business. To do this, you first need to take in consideration the target account size of a portfolio. Now, there may be some accounts within your practice that are too small to deploy certain strategies. So, you need to determine what the minimum account size that is appropriate for your strategy. Once you have constructed your model, you need to determine the average number of trades that occur within a year. With this information, you can then determine the internal costs of portfolio and in turn, the profitability for your business.
To do this, we have created the Portfolio Cost Calculator tool. This tool takes some basic information and provides you with the breakdown of the internal costs.
The information that you need to enter are the target account size, the average trades per week, the average trades per week with one standard deviation, and the current annual management fee. If this portfolio’s positions incur ticket charges, enter the average ticket charge in the field provided. Lastly, if there is a broker dealer haircut, there is a place for that information as well.
With this information, we can very quickly and accurately determine the internal costs.
To begin, you can acquire this information either VPM 2.0 or PortfolioExpert. I’ll begin by pulling up the portfolio’s settings by clicking on the book icon to the left of its name. This will open up a window with the settings used to create the portfolio. You’ll see that I've already assumed a 2% annual management fee and a beginning equity of $250,000. Once you have entered this information into the Cost Calculator, you can close this window.
From here, open the portfolio by clicking on its name. Next, select the Trade Profile link. The Trade profile screen will list both the average trades per week and the average trade per week with one standard deviation. I can then take this information and then copy and paste it into the Cost Calculator.
In the event that the underlying positions have ticker charges, or if there is a broker dealer haircut, you can record the information in the fields provided.
With a Target Size of $250,000, and a management fee of 2%, I have $5,000 of income that is generated. If I have a broker dealer haircut, that amount will be listed beneath the total fees.
Using a portfolio’s average weekly trades, I can see what the expected costs will be for the execution of trades. By also entering the standard deviation of the average trades, we will know what the costs could be in a year with a higher amount of trades. This number is shown to the right of the average number of trades.
At VPM Partners, we recommend that advisor utilize wrap accounts for their clients instead of non-wrap accounts. We have heard from some advisors who have tried to pass the ticket charges onto their clients that the clients will focus too much on the cost of the trades, instead of the value being provided. It will likely be a topic of conversation during a review that would not be productive.
Instead, we recommend that advisor use a wrap account with a slightly higher management fee than would be used in a non-wrap environment. By doing this, the client has a fairly good prediction of the fee that they will pay on a monthly or quarterly basis and there will be less questioning of the number of trades made to provide the returns they see.
In either case, we have provided a breakdown of the fees if the advisor absorbs the ticket charges or if the client pays for them in addition to their management fee. The Wrap environment is shown on the left, while the Non-Wrap environment is shown on the right. Furthermore, we have also broken down the amounts to reflect the fees prior to and following a broker dealer haircut.
With all this information, we can adjust the management fee to see what the net fee would be to your practice with a higher or lower amount.
We could also adjust the target account size to determine if it is cost effective to manage smaller accounts than what you have structured your model’s pricing around.
By using specific factors to determine the pricing of a portfolio, you can provide your clients with the best management fee while making the prop er consideration to the costs of implementation.