The environment in which institutional and other large investors operate is becoming increasingly turbulent. Stricter regulations, demands for more corporate governance, lower expected investment returns, demographic factors and a growing number of asset categories that are also more complex pose greater challenges to institutions. Asset managers and consultants serving these institutions must also face up to this challenge.
This is especially true in the investment world, where developments can occur at a dazzling pace. For example, even regulated UCITS can apply hedge fund-like techniques, hedge funds have moved into private equity markets, private equity funds have moved into real estate, and so on.
Additionally, banks are offering a growing number of products, with the average complexity level of these products increasing as well. Investors do not want to be left on their own after the initial asset allocation or manager selection services.
Implementation of portfolios, including best partner selection for administration and custody, is also required. Permanent searches for better managers and ongoing consulting about more complex products (overlays, portable alpha, liability-driven investment, structured products, etc) are high on the agenda.
Institutional market segmentation fades away
Companies, either asset managers or consultants, react differently or don't react at all to the changes in their working environment. A couple of scenarios can be distinguished. The first is that some asset managers move into consultancy and vice versa. During the fifth Institutional Fund Management Conference in Geneva in February, a number of speakers (among them Ruud Hendriks, who is responsible for sales in Europe for Goldman Sachs) indicated their belief that there is a growing need among asset managers to advise pension funds on the many different aspects of the link between asset management in its narrowest form and pension management in general. Hendriks said: "We respect consultants, but there are situations in which it is easier for us to give advice directly to asset managers taking on a fiduciary role."
However, we do see that not all
asset managers switch to fiduciary structures. Others, as they themselves proclaim, concentrate on "adding alpha". Roberto Falzine, president of Dukere Asset Management, said on IPE.com: "asset managers have to create value, consultants have to provide solutions".
On the other hand, we see many consultants shift activities in such a way that they can be considered "second-tier'' asset managers. They offer multi-manager solutions, for example, taking performance-based fees for the service. This is especially true among Dutch pension plans, where we see a growing trend for assets to be taken away from one single asset manager that manages all asset class mandates and transferred to a more diversified portfolio of different asset managers in a multi-manager solution, with the consultant playing a pivotal role in the construction of the portfolio and the monitoring of the different asset managers.
Conflicts of interest might arise here. For example, when an asset manager offers an ALM product it should be crystal clear that the outcomes are not pointing (deliberately) in the direction of the asset classes in which the asset manager is specialised. When an asset manager is also offering a multi-manager product, this product should not contain only (or mainly) strategies from the asset manager itself. Conflicts of interest need not be that much of a problem, however, provided that they are addressed and discussed with the potential investor upfront. Performance-based fees can also guarantee that conflicts of interest are not really an issue. In this case, the interests of both the client and the asset manager are more easily aligned.
Often, traditional institutional consultants do not serve many of the areas of expertise discussed above, which is especially true for local firms with actuarial background but also human resources or insurance-focused international firms such as Hewitt or Aon. Such companies as Watson Wyatt and Mercer seem to be reacting to the new demands, but are doing so rather slowly, as with multi-manager offerings, for example. The market has basically been left to (investment) banks and independent fund of funds promoters, for example from the hedge fund or private equity space, which mostly try to sell ready-made products. Some local consultants also have started to select funds of funds for their institutional clients. But it is not so obvious why institutional investors should pay fees - at least for alternative investments - to inexperienced consultants to invest in standard fund of funds products.
In general three business models seem to have emerged:
q local consultants focusing mainly on actuarial or human resources (HR) work that offers investment consulting as a byproduct, and banks offering such services as an add-on, not necessarily for-profit activity;
q international, centrally organised specialists such as Mercer and Watson Wyatt with their own fully controlled offices in the major markets; and
q an (international) network of local and alternative specialists cooperating closely, sharing each other's knowledge.
An example of this last business model is the recently announced cooperation between German-based consultant Feri and Dutch firm Compendeon.
When Feri started to offer independent institutional financial consulting in 1997, this service was almost non-existent in Germany. Feri's concept was to build on the economic research, asset allocation and manager research capabilities in traditional and alternative asset classes that had been developed mainly for its office activities. Today, the German consultant is seen as the clear market leader in its home country and has a strong presence in Austria.
Compendeon started its business in 2004 as an independent firm offering pension funds a complete hybrid range of services such as strategic consultancy, pension management, pension execution, asset management advice and communication. The primary business lines of Compendeon are strategic management (boardroom consultancy), pension management and asset management advice. The primary focus of the asset management branch of Compendeon is on ALM quick scans, tactical asset allocation and multi-manager-solutions.
It is Compendeon's belief that, in the end, asset management, pension management (the liability side) and general management issues are related to the institutional investment world and they should therefore have a solid and integrated basis in the business strategy of any pension plan or other type of institutional market participant. That is why Compendeon offers a complete range of services related to pension and investment management according to its integral fiduciary management concept. This distinguishes Compendeon from other consultants such as Hewitt and Mercer and/or asset managers such as Goldman Sachs - as far as the definition of fiduciary management is concerned.
By the end of 2005, Feri had started to look for business opportunities outside Germany. The analysis showed that the traditional institutional investment consulting market is not attractive in size or profitability, and is not easily accessible to foreign players. Even for the UK, the largest European consulting market, the Myners report supports this view. Feri concluded that it could compete with most of the local experts in terms of the services that it offered but lacked local knowledge and client access. Also, since Feri is not offering standardised products, hiring traditional sales people for the markets abroad is probably not a successful approach. "Buying" or hiring local consulting experts in different countries looked like a costly and risky approach, given the apparently mixed experience of international consultants that have taken this route before. Therefore, Feri decided to look for cooperation possibilities with leading local investment consultants. An important requirement for a successful partnership was the independence of any financial product provider.
Compendeon was, for all of these reasons, a natural partner in the Netherlands. Compendeon is an independent solution provider with a strong network and client base in the Netherlands and activities in the UK, Switzerland and Luxembourg, with some renowned qualities in the areas of strategic consultancy, tactical asset allocation and multi-manager solutions. In other areas, Compendeon works with other - mostly local - partners and companies with regard to communications and ALM, albeit that its own ALM Quick Scan is receiving a warm welcome in the market.
Apart from the three possible business models mentioned earlier - local players focusing on areas like ALM and HR; the big international players; and the network model, such as the Feri/Compendeon combination - other specialised local investment consultants may survive but are not expected to grow significantly. These have difficulties covering all aspects of liabilities and assets and may try to focus on quantitative analysis, which requires fewer resources, like Alpha Portfolio Advisors in Germany, structured manager searches like B-finance, portfolio controlling like Complementa from Switzerland, or risk management, like Risklab from Germany.
Many of these niche players - as well as large banks and insurance companies - will offer ALM studies and manager searches at low bulk prices, but investors will probably "get what they pay for" or "pay for it without knowing" and receive standardised, non-custom-made solutions that apply to the average pension plan and not necessarily cater to the needs of the specific client. This is risky in a period characterised by huge changes such as IFRS, demographic changes, new asset classes, and a changing world with emerging markets now playing a different role, etc. Only the companies in the second and third of the business model groups are able to independently offer all of the above. In this scenario, even leading traditional local investment consultants like Hymans in the UK or Fixage in France may have hard times ahead of them. There are also doubts about what companies like Aon or Hewitt will do, since they don't seem to be particularly active in alternative assets or implemented investment consulting.
In the second business model group, it seems clear that firms will more often offer asset and/or performance fees based on multi-manager services, potentially including highly profitable standardised investment products. It is possible that more consultants will take the Russell route, at least to some extent. Given the few true alternatives when it comes to broad and independent implemented consulting, European institutional investors should welcome additional competition for Watson Wyatt and Mercer.
But even this competition will be limited, since there are not many potential suppliers in a position to offer full-scale and independent multi-asset implemented consulting services.
The Compendeon/Feri cooperation is designed to be open to other partners, including experienced teams of consultants willing to spin off from other organisations to start their own boutiques. For the additional partners, a platform is offered that provides immediate access to a wide range of multi-asset and multi-manager services that can be offered to their clients while still maintaining their independence. For the time being, though, only one partner per country is expected to be allowed into the new network.
Dirk Soehnholz is managing partner at Feri Institutional Advisors in Bad Hamburg and Erik van Dijk at Compendeon in Bunnick, the Netherlands
The future of European pensions consultants
This article is the first in a series of articles IPE intends running over the coming months from the pensions consultancy community as to how they see their industry shaping within European markets. This contribution, written after the move by Compendeon in the Netherlands and Feri in Germany to work more closely together as a response to what they see their clients demanding, but also in reaction to the forces they see at work in the marketplace. If your consultancy firm wants to contribute to this debate, email IPE's editor Fennell Betson with a brief outline of what you would like to say - firstname.lastname@example.org