The role of consultants in helping pension funds pick a multi-manager is crucial, despite manager concerns about potential conflicts of interest.
Consultants are most important in the UK, where they dominate the investment management selection process by UK pension funds, which in 2003 put about £1bn (e1.4bn) into multi-managers, according to the Association for Institutional Multi-Manager Investing.
Stephen Delo, chairman of the trade body and managing director of one of its members, Escher, says a major driver leading to UK-based consultants recommending multi-managers was the Paul Myners review of institutional fund management and the Pension Act, which “both ratcheted up the level of responsibility on trustees to use best practice in selecting fund managers and asset allocation”. As a result of this pressure, it was easier for trustees to outsource the selection of fund managers as a way of devolving this risk, he adds.
The L’Oreal UK Retirements Benefits Plan, for example, last year gave a £24m equities multi-management mandate to Russell Investment Group after taking advice from Mercers. At the time, L’Oreal ascribed the decision to “the dynamics of the equities market today and the rigorous time, effort and expertise needed to select and review fund managers”.
“In the UK the importance of consultants cannot be overstated; they are vital,” says Jeremy Beswick, head of business development at RMB MultiManagers. “It is relatively rare for pension funds to choose a multi-manager without taking the advice of consultants as the trustees are often not fully informed of the concept. The consultants, therefore, do the pre-selection of two or three multi-managers that are presented to the trustees.”
As a result, a small coterie of consultants act as powerful gatekeepers, and potentially put a brake on competition. Beswick complains that new multi-managers faced up to three years in purdah as large consultants require to see a multi-management group in operation for that long before rating it. But seeing a group steadily increase assets under management was another criteria often used by consultants to give a high rating, which again was unlikely unless they had first rated them, he says.
However, in continental Europe consultants play a less important role in advising pension schemes more generally and as a result, Beswick notes, “schemes will only choose a multi-manager if they are au fait with the concept, which requires the multi-managers to market themselves directly to pension funds”.
But once they understand the concept there is no difference between UK and continental schemes and their likelihood to use multi-managers if they are unhappy with their current arrangements, he adds.
In Switzerland, for example, about half of the pension schemes by value do not employ a consultant full-time. The €400m British American Tobacco Switzerland fund hired Mercers as its consultant only to help decide whether multi-management was a good option and, if so, to help select the best provider.
In July 2001 BAT chose Northern Trust, which manages about £500m on the continent, £1.5bn in the UK and £13bn elsewhere round the world. Paul Froidevaux, chairman of the board of trustees at BAT Switzerland, says: “After the merger of two different pension funds into BAT Switzerland, multi-management was seen as the best way to manage the assets.”
The scheme has since decided to employ local consultant PPCmetrics to help review Northern Trust’s manager selection decisions. Northern Trust was also meant to provide advice on allocation between the different asset classes, BAT Switzerland says.
Tony Earnshaw, managing director at Northern Trust, accepted there had been a misunderstanding about the terms of the original brief because of the different ways consultants are used in the UK and Switzerland. He adds that the role of consultants on the continent was becoming more important but their relative absence did partially explain the slower take-up of the multi-management concept than in the UK. “In Europe, consultants have had less influence but this may be changing, especially in Scandinavia,” he adds. “But in the UK consultants have been enthusiastic whereas five or six years ago they were unsure of the concept.”
“Consultants are all expert at multi-management and how we construct a portfolio,” says Beswick. “They know the right questions to ask on our investment style, research methods, the number of managers we have in a portfolio and how this affects the aggregate performance.”
Some multi-managers try to have between two and four underlying fund managers in their portfolio to provide the best trade off between risk, or diversification, and reward, or likelihood of outperformance, rather than just tracking a benchmark. Other managers can have up to nine underlying fund managers to reduce their chances of significant underperformance.
However, there are differences between consultants in their enthusiasm for multi-management as a concept, industry insiders note. Some large consultants are seen as rarely suggesting multi-management as a solution to clients while others, particularly smaller firms with relatively more actuarial than investment consulting experience, tend to refer just one group as a ‘safe’ option.
Some smaller consultancies have made the relationship with multi-manager providers clear by formally making a ‘distribution’ agreement. Heath Lambert Consulting in the UK last year started to offer the manager-of-manager service from SEI. At the time John Crisford, chairman of Heath Lambert Consulting, says SEI’s independence from other fund management or consultancy operations was a key criteria.
For other consultants there is a more apparent risk of a conflict of interest by offering an in-house multi-management operation through a subsidiary at one step removed by a Chinese wall. Aon, which declined to comment, is one firm, and Mercers, which claims to be the biggest global employee benefits consultancy, is understood to be preparing to bring its US multi-management operation over to Europe.
Marc Littlewood, senior investment consultant at Mellon Human Resources & Investment Solutions said it was expected to look at setting up a multi-manager operation under its new owner, US business process resource outsourcing company ACS, when its sale is completed in the summer.
He added: “We do all this research into managers as we are in the best place to do so and there are no real issues in having a firm do both. I am definitely for it.”
Mellon, which also owns a large fund management arm, had, however, blocked its consultancy arm from setting up a multi-manager. Paul Black, a senior investment consultant who is now off to rivals Lane, Clark & Peacock, last year had described firms with both operations as potentially suspect. “Multi-manager arms have inherent conflicts of interest; we do not do this at the moment as we have thought about it and are against it at this stage.”
Bart Heenk, managing director at SEI, said in the early 1990s the firm had sold off its consultancy arm to concentrate on multi-management as an independent operator. “It is incompatible to have both,” he said. “You cannot give independent advice and offer an in-house solution.”
SEI has set up distribution agreements with consultants, such as Heath Lambert Consulting, but Heenk said there were no potential conflicts for pension funds as it was purely a commercial relationship where the multi-manager could be fired by the consultants, “unlike an in-house manager”.
But potential conflicts of interest are just part of the issues facing consultants. Other criticisms have focused on their ownership by financial services groups, such as insurers or banks; their advising of both scheme sponsors and trustees; the maintaining of actuarial and accountancy arms in one firm after the US Sarbanes-Oxley Act; the providing actuarial and consultancy services to a pension fund after the UK’s Myners report; forming or advising a manager-of-managers arm; having a fund management arm within the company given the evident failure of Chinese walls in investment banking; and advising fund managers on how to market their wares to pension consultants.
However, multi-managers were cautious about whether these potential conflicts of interest could be detrimental to pension funds. “Consultants running their own multi-management service is not a bad thing, per se,” notes one. “If they have the best research process internally and are cost effective then it can be good. But it does lead to questions about whether the clients know they are getting the best of breed multi-manager or whether a manager is being changed in the in-house portfolio because of performance or business reasons. It can also cause collateral damage to other business streams, such as their actuarial services.”
But despite manager concerns, pension funds themselves appeared sanguine about potential conflicts, with the firms interviewed either unaware of the concerns or content with the service provided.