Every year, Registered Investment Advisory firms must calculate their Assets Under Management as a part of their annual ADV Update. For firms that focus on Financial Planning, this can pose an interesting dilemma. Where is the line between providing advice on investments, and actually managing the assets? While that line may not always seem clearly defined, the SEC has provided guidance to help firms understand the distinction clearly.
Why is it important to disclose Assets Under Management?
From a regulatory perspective, many RIAs charge fees that are based on a fixed percentage of Assets Under Management. Therefore, it is important for both regulators, and investors to be able to understand how those assets are calculated. Also, from a performance perspective, AUM disclosure allows investors to adequately evaluate the asset manager’s true performance over time.
What Constitutes Assets Under Management?
When completing the Form ADV Part 1, the SEC provides guidance through their instructions document on how to interpret certain key terms that are important to understand as it pertains to AUM.
Securities Portfolio – An account is a securities portfolio if at least 50% of the total value of the account consists of securities. For purposes of this 50% test, you may treat cash and cash equivalents as securities. You must include securities portfolios that are:
- your family or proprietary accounts;
- accounts for which you receive no compensation for your services;
- accounts of clients who are not United States persons.
When thinking in terms of the traditional billing practices on Assets Under Management, this concept makes perfect sense. For instance, most commonly, the fee is assessed by applying the percentage fee, to the market value of the account based on the last day of the previous quarter. Included in that market value, is both securities and cash which is presumably set aside for future investments.
Value of Portfolio – Include the entire value of each securities portfolio for which you provide continuous and regular supervisory or management services. If you provide continuous and regular supervisory or management services for only a portion of a securities portfolio, include as regulatory assets under management only that portion of the securities portfolio for which you provide such services.
Again, this ties back to the previous item. The value of the portfolio is derived by taking the total value of cash and securities that the firm manages, provided those assets are held in a category as described in the definition of securities portfolios.
Continuous and Regular Supervisory or Management Services – You provide continuous and regular supervisory or management services with respect to an account if:
- You have discretionary authority over and provide ongoing supervisory or management services with respect to the account; or
- You do not have discretionary authority over the account, but you have ongoing responsibility to select or make recommendations, based upon the needs of the client, as to specific securities or other investments the account may purchase or sell and, if such recommendations are accepted by the client, you are responsible for arranging or effecting the purchase or sale.
There is a rather important distinction to point out on Continuous and Regulatory Supervisory Management Services. Many firms that provide financial planning services, will provide investment advice as one aspect of the financial planning engagement. Perhaps the adviser reviews the client’s 401k Statement, and makes asset allocation recommendations. Or, maybe the adviser reviews the client’s brokerage account statement, and provides commentary on performance of individual securities or the performance of third-party asset managers. But according the SEC’s regulatory guidelines, to constitute Continuous and Regulatory Supervisory Management Services, the adviser must have the ability to select or make recommendations, AND if the recommendations are accepted by the client, the adviser must be responsible for arranging the purchase or sale.
In other words, simply making a recommendation does not constitute assets under management, unless the adviser is also responsible for implementing that recommendation. A logical interpretation therefore, is that only advising a client of an asset allocation change in a 401k Account, or only advising on securities purchases or sales in an investment account, does not constitute AUM, because it is the client’s responsibility to arrange the purchase or sale.
How are you compensated?
Another item that to be considered when calculating AUM, is how the firm is compensated on the relationship. On the advisory contract, it should stipulate if the adviser provides ongoing portfolio management services. However, this can be tricky based on how the services are framed in the ADV Part 2 and the Advisory Agreement. Theses documents may list services as “Investment Advisory”, “Investment Management Services”, or “Portfolio Management Services”. Regardless of which label is applied, it’s important to go back to the definition of continuous and regulatory supervisory management services, when evaluating the activities performed as outlined in the advisory contract.
Under more traditional financial planning arrangements, if the firm is compensated based on a monthly retainer, quarterly or hourly fee, or an upfront fee with an ongoing monthly, this usually doesn’t constitute Assets Under Management. However, in some cases, continuous and regulatory supervisory management services may be included in a single fee that also encompasses financial planning services. In this instance, assets in securities portfolios should included in AUM.
About the Author: Scott Gill is the Director of Keeping Us Compliant here at XY Planning Network. Outside of the office, Scott enjoys watching sports, exercising, and operating the charitable organization he created upon his father’s passing. You can connect with him on LinkedIn.