This figure shows IAM income sources in Switzerland. Retrocessions still make up approximately 35% of the average Independent Asset Managers total annual income in Switzerland.

Envisage does not accept Retrocessions in any form. Provisions and other discounts negotiated with partner banks in the normal course of business are always rebated to our client, to the benefit of our client.

  • The acceptance of payments sourced from client money (brokerage and commissions), not disclosed to the client is ethically highly questionable.
  • Violation of the principle "Client brokerage is the property of the Client" 
  • The conflict of interest for an Asset Manager taking Retrocessions makes it very difficult to act consistently in the best interests of the client.

 

To take the example of brokerage commissions. For every SFr. 1 brokerage paid to the bank by the client for the purchase or sale of securities, the Independent Asset Manager receives up to SFr. 0.50 back from the bank, not disclosed to the client.

The conflict of interest is not subtle, the Independent Asset Manager has an incentive to trade the account. He is receiving 50 cents on the dollar back for every trade he puts through. Hence, you would expect high turnover on such managed accounts. Which is what we often see in practice. One “Non-retro” Asset Manager observed in an interview in 2008 that, “There are asset managers about who do turn over striking volumes of stock”.  Another result is selection of depot bank/broker not on the basis of best execution, cost and quality of service, but the question “who pays the highest Retros?”.

The situation is changing, but very slowly. Some Asset Managers have switched to "Non-Retrocession" models, or are rebating Retrocessions and other kickbacks on to the client. Unfortunately, too many Asset Managers have simply added "All Retrocessions and Provisions received in the normal course of business belong to us" clauses in the asset management contracts.

So What?  Or what does it mean for a Portfolio?

Consider Retros as a hidden tax, in effect a "wealth tax", but levied by the Asset Manager. Assume “blanket” constant Retro rates, ignore management fees, bank costs and charges (we are trying to look only at the effect of undisclosed payments).

The Table below shows the effect on a:

  • SFr. 1,000,000 portfolio
  • with an 6% annual return
  • over 20 years
  • Retro Rate ranging from 0-1%.

The total impact on return we will call the Retro drag. Let the assumed rate of return be r, the retro rate be t and N number of years. The assumed Future Value Interest Factor (FVIF) for our wealth tax analogy is FVIF = [(1+r)(1-t)]ᴺ

The "Retro Drag" column is the percentage of total return Asset Manager takes from his client over 20 years.  For a 1% Retro Rate; 26.4% or SFr. 583,997 over 20 years on a SFr. 1 Mio. portfolio. Note: 

  • The Retro Drag is far greater than the Retro Rate itself
  • Retros consume greater share of investment growth as Retro Rate or investment horizon increases
  • If rates of return are low or negative, capital is reduced!

A more intuitive way of looking at the effect is the graph below.

“Retro Drag” again, is the percentage reduction in total return.

 

Account example for an individual investor

The table below illustrates the ease with which a 1% annual Retro rate can be achieved. The asset classes have been chosen intentionally to illustrate the effect and potential income to an IAM. Figures do not include the IAM management fee (generally around 1% annually).  

  • SFr. 20,300 is charged to the client, of which;
  • SFr. 10,050 is paid back to the IAM
  • SFr. 10,250 is the actual cost of services provided to the client

Obviously, the high Retrocessions on funds and structured products make it rather challenging to act in the clients best interests. We see this in practice with many IAMs buying large volumes of fund and structured products for their clients, even when the client is wealthy enough to achieve diversification through other means. 

 

 

Explanatory Notes.

1. There are extra fees and charges, for example administration, postage charges, or costs for a numbered account. Retrocessions can also be agreed on these additional charges.

2. These amounts are the effective fees and charges paid by the client, when the IAM retains all Retro payments.

3. Most common types of Retrocessions have been intentionally shown in this example.  IAMs may pass on Retros as discounts. In particular discounts from the depot bank.

4. This would be the cost to the client, if the IAM would rebate all Retrocessions to the client.

5. Assumption of 16 transactions with an average volume of SFr. 25,000. Implying a 40% annual turnover, the account is being turned over every two and a half years. Retros on Forex trades varies greatly depending mostly on the size of the IAM and his AUM. 

6. The level of Funds in the portfolio is intentional at 40%. Bear in mind there are still IAMs who invest the total (100%) of assets under management in actively managed funds. This sum of up front loads results when per year SFr. 102,000 SFr. active funds with a 2% up front load (NAV 100,000 plus 2,000 up front load) are purchased. With structured products the emission costs are contained in the gross fee. These vary from product to product by several percent. In general, no Retros are paid on indexproducts and ETFs.