Value in financial services now warrants a capital V. The regulator demands we articulate it, advisers assure us that only their clients determine it, while investment managers use complex algorithms to calculate it. Indeed, Warren Buffet’s hackneyed quote, “Price is what you pay; value is what you get,” is perfect PowerPoint fodder.
There is a certain irony where value is being discussed in the context of investment management. On one hand, managers must now detail the excess utility they believe they deliver in exchange for the higher fund fees they generally charge. Higher fees are almost universal (while alpha isn’t), but managers will seek to include more nebulous benefits to demonstrate ‘added’ value. Meanwhile, their need to calculate ‘value with a small V’ is well defined and fundamental to the art of successful stock selection. This latter context is, of course, the source of Buffet’s quote.
The phrase appeared in Buffet’s 2009 report to investors in his investment conglomerate, Berkshire Hathaway. In the shadow of the 2008 financial crisis, Buffet reflected on the fall of $11.5bn (£8.9bn) in net worth of his businesses – almost 10 per cent. Despite price falls, he was utterly confident of the utility of BH’s portfolio of businesses – its ability to deliver varied streams of earnings and hence dividends, and the river of investable funds generated by the underwriting profits on BH’s hugely successful insurance businesses.
The full quote reads: “Long ago, Ben Graham taught me that ‘Price is what you pay; value is what you get.’ Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.”
Utility per unit of price
Herein, the prerequisite of value is the quality of the utility provided per unit of price. It’s worth mentioning BH’s share price has grown four-fold in the 10 years since he made that statement.
With securities, ‘price’ is the net present value of future cashflows. Given those cashflows and discount rates are estimated, ‘what you get’ is not finally known until it’s got, but the cashflows may be significantly less variable than the price. Share prices can vary minute by minute and through a market cycle to quite spectacular degrees, despite the respective businesses’ cashflows being entirely constant. So, utility may be more predictable while market prices remain volatile.
Price falls may not raise the value. As Buffet said in the 2009 report: “We like buying underpriced securities, but we like buying fairly priced operating businesses even more… it’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
So, lower prices are opportunities to increase value where one can be confident of future cashflows. In other industries, a new product whose utility promises to match that of my current brand and yet has a visibly lower cost must be attractive. Supermarkets understand this where ‘own brand’ products compete with more expensive brands.
Consequently, discounted prices and limited-period special offers lead consumers to focus on comparative value.
On the other hand, higher prices can be applied to imply higher quality, creating the impression comparative value is being maintained and possibly uplifted. This is easily tested and exposed in the first purchase. If you subsequently find little value in the premium price of a lager, the lesson cost you less than a fiver.
However, the varying quality of financial services costs customers an indefinite price measured in thousands of pounds. Prices are generally obfuscated and hidden, if not inaccessible until the service provision is agreed. Quality is often declared by reference to independence versus restriction, qualifications implying competence, and the veneer of an attractive website and lifestyle coaching. Data on the comparative success of financial planning strategies between advisers is not compiled, let alone verifiable.
Where price is concerned, clients understand that there are charges, but not the impact of those charges on expected outcomes. For example, a £100,000 portfolio growing by 5 per cent a year net of the fund’s OCF will be worth just over £265,000 20 years later. However, should a 30bp-a-year platform fee be applied, the return falls by over £15,000. Where a 1 per cent initial and 1 per cent annual fee are included, the return falls by a further £45,000. In other words, advice and platform fees have eroded almost a quarter of the investor’s return.
Ad valorem fee structure
The measure of the value of advice under an ad valorem fee structure is whether the involvement of the adviser and platform were worth sacrificing £45,000. Put another way, the combination of an adviser’s fund selection skills, alongside the custody of an adviser platform, would have to produce a 30 per cent greater return than the naive investor could manage unaided, yet probably using the same information sources.
Of course, advisers will protest that professional financial planning produces countless benefits that clients would otherwise be unlikely to garner. That being so, financial planning should be priced as a project, not linked to investment. It should reflect the quality of the advice, but also the benefits.
The value of financial planning cannot be assessed unless one can point to benefits achieved – beyond fees expended – that would not have been enjoyed without adviser intervention. When not apparent, the justification for value may be harder to establish. Or, to use another Buffet aphorism: “It’s difficult for an empty sack to stand upright.”
Graham Bentley is managing director of gbi2