Relaxing the grip
The investment consultancy industry seems due for a change. The Financial Services Authority (FSA) recently stated the UK investment consultant market is concentrated and prone to conflicts of interest, and many institutional clients are disillusioned with their advisory model and are taking more responsibility for digging themselves out of pension deficits.
So, is this is a new era – a time of change?
Investment consultants have traditionally had a dominant hold the UK institutional investment market, far more than seen in any other country. For example, research by our company shows that investment consultants are highly influential in more than 90% of UK manager selections, with just the top four UK consultants are responsible for more than 70% of total UK manager selection services. Additionally, the major consultants have the lion’s share of both the actuarial and investment markets.
However, with recent regulatory governance, as enshrined in the Pensions Act, this concentration will change.
The Myners Report criticised the trustee/investment consultant relationship. But why the criticism? Consultants have worked hard to get close to their clients, it is a people business. Myners suggested that these carefully fostered relationships have led to an over-reliance on investment consultant’s advice, sometimes to the detriment of pension fund performance. And with the words ‘pension deficit’ and ‘insolvency’ having entered the national vocabulary, pension fund trustees are asking where and why their advisory models went wrong.
Consequently, they are taking more responsibility to restore balance to their portfolios by hiring in new expertise and looking elsewhere for advice, for example from investment managers and investment banks providing derivative products. These new names coming to the investment consultant market and they are finding a niche. This can only be good for the institutional investment industry, providing more opportunity for trustees and investment managers alike.
What stimulated these changes to the advisory model? They have come in response to a number of external and internal pressures, primarily the closer scrutiny to which investment consultants’ asset allocation decisions have been subjected. Look at some of the quotes our research uncovered:
q ‘Why does the money reside with the top four managers? Because they are good and because it is very unlikely that all four will underperform at the same time…’ consultant 1994;
q ‘There is little place for property in a pension portfolio…’ consultant 1998;
q ‘Equities remain the most appropriate long-term investment, so we do not advise reducing allocations here…’ consultant 1998;
q ‘Equities should be sold…and market timing should not cloud the issue…’ consultant 2005.
Asset allocation is one of the most important decisions for trustees and consultants have little ability in this area. Their models supported holding onto heavy equity allocations when they were in downturn and then the move into bonds came after they had risen.
So, was there a better way to build a strategic asset allocation? If a pension fund wants to match increasingly mature liability profiles, it could be argued that bonds are usually the most appropriate investment to buy. And if consultants’ advice was so influential, why were increasingly mature pension funds so heavily weighted towards equities in the late 1990s? Consultant advice around this period was often wrong, ignored or both.
But should the entire onus be put on the consultants? Under UK trustee law, ultimately responsibility remains with the trustees. However, the roles of the influencers and persuaders need to be scrutinised properly now that we have greater transparency. Many trustees are also questioning why investment consultants influence asset allocation decisions so significantly. Who is or should be responsible for the advice that informs trustees’ decisions on asset allocation? Should it be the consultants, who many claim have little day-to-day experience of markets, or asset managers, whose very lifeblood must be to compare and contrast relative valuation levels or a different combination of forces.
The quest for both higher returning assets and tailored propositions, such as liability driven investment and currency management, has created a more fluid environment within the UK pensions market and consultants have responded by deepening their research into a greater range of products. This is a positive reaction.
However, trustee boards’ greater investment sophistication could give investment consultants a surprise. Our research shows that trustees are keen to see providers with genuinely differentiated investment solutions. Some consultants are right to worry that the greatest threat to them comes from the investment banking community. It is here where many of the most innovative investment management products, particularly related to liability driven investment and derivative usage, are developed.
Some major consultants are making (mostly unpopular) changes to their structure – particularly in ownership issues. This has caused some high profile defections at a time when asset managers, investment banks and trustee boards are in hiring mode. And don’t forget start-up consultancies. Remember, it’s a people business and relationships travel. We are still waiting for the big breakaway from a major consultancy – with major clients following.
Consultants are also showing, or have already showed, an urge to move into higher-margin business –asset management. Russell Investment Group has led the way and many others are, including Mercer Global Investment, looking for a share of the spoils. We are also seeing the rise of implemented consulting and the growth of new consulting models for example whereby asset managers themselves pay for information (not advice) flowing through to pension fund decision makers.
The consultant world is turning but let’s not delude ourselves. Despite growing client disillusionment with their consultants, the situation not going to change overnight. Currently, the new competition is having an impact among the smaller pension funds; the majority of large schemes are still dominated by the cartel. Consultants such as HSBC, Gissings, Psolve and Entegria are mainly visible in the £25-50m (e36-72m) pensions funds, although this is likely to grow.
What does this mean for investment managers? This is an interesting time for investment managers. Poor performance by consultants and greater expertise embedded in trustee boards means trustees are much more amenable to direct approaches by managers.
While this is an opportunity, many investment managers have work to do before they can market direct to pension fund trustees. Investment consultants have been researching managers’ portfolios for years. Whatever their marketing material says, most consultants will have discovered the details of managers’ processes. But trustees do not yet have this knowledge. It is very important for managers to clearly communicate their processes, to say what they do and do what they say.
So, what does the future hold for the leading consultants in the UK? It is less clear than it has been for some time. Internal as well as external pressures have meant that many consultants are changing their models to meet current demands. But the UK pensions marketplace has become a lot more complex with more products, higher levels of client sophistication and greater competition not only from rising consultants but also from other financial service providers.
And many trustees would appreciate a direct approach from investment managers. While the larger consultants’ influence might be eroded, there’s more choice for trustees and greater opportunities for those managing their portfolios.
Philip Robinson is principal of the client management practice at
Investit in London