Consultant monogamy is still widespread in Germany, but faithfulness does not mean fiduciary management, finds Barbara Ottawa

Institutional investment consulting is a relatively new game in the German market, and one that is increasingly dominated by a few large players. While surveys show use of consultants gradually edging upwards, most relationships are on a project only basis.
But the dynamics of the sector are changing. While there has been no rush either to fiduciary management or the implemented consulting variant, there is increasing interest in specific topics like fixed income or real estate portfolio diversification.

"Because of their work with consultants and because of stricter supervisory regulations, many clients have become more sophisticated," explains Marcus Burkert, managing director at Heubeck-Feri Pension Asset Consulting. "They have more in-depth questions on certain subjects and are demanding more in-depth answers from consultants - simple manager selection is becoming rarer."

Nevertheless, manager selection comes very high on the list of most of the consultants when we asked which services clients require, together with advice on strategic asset allocation (SAA) and risk management, which has gained even more importance since the crisis.

"Clients prefer the full service, ranging from consultancy on the strategy, its implementation within asset classes and the selection of external managers," says Joachim Meyer, managing director of Meyer & Cie Allokationsberatung, a management buy-out of Swiss consultancy Complementa's German operations last October. The subsidiary in Germany is now focusing on investment controlling and performance reporting while the existing consulting mandates were sold to Meyer, the former chairman of the board at Complementa Investment Controlling and a shareholder in the company.

For Meyer, a problematic development in light of governance issues is that sometimes the same consultancies that helped set up the strategy and choose managers are then used for performance reporting and monitoring.

But Oliver Dräger, senior investment consultant at Faros Consulting (founded in 2003 by former Feri-consultant Uwe Rieken), notes that it is mainly smaller pension funds that go for ‘all-in' mandates. "Smaller pension institutions, like those with just two managers and two employees, are using consultants for the whole value chain - asset liability study, SAA, manager selection, KAG/custodian construction, continuing qualitative controlling," he observes. "One major reason for this is the lean structure within the pension fund - quite often there is not enough capacity for doing everything in-house. Pension institutions with a very pronounced governance, ie, the necessary structures in the asset management, the staff and the right qualifications, are more prone to using consultants for special projects such as special manager selection processes which are not part of their daily business." Dräger gives as an example, a manager search in the field of renewable energies where a pension fund wants to make a direct investment.

Benedikt Kutschera, senior consultant at Towers Watson in Frankfurt, concurs that there is "a bit of a trend" where the size of pension funds is directly proportional to how much the institution is delegating to a consultant.

Fiduciary management
"What exactly do you mean by ‘fiduciary management'?" is a counter-question posed by many German consultants when asked about this structure for outsourcing the full service, including asset management decisions.

"Sometimes tenders say ‘fiduciary management' but clients in Germany normally do not really want to outsource investment decisions," stresses Kutschera. He adds that even pension funds that have only one consultant for the full range of services want to make the ultimate decisions on manager selection and asset allocation themselves. "There is a fear of delegating too much decision-making power," he expains, refering to the legal framework stating that, in the end, the pension fund itself remains responsible for any decision made.

RMC founder and co-owner Patrik Bremerich also sees little demand for fiduciary management in Germany, where most clients have only just emerged from a stage in which the people responsible have made all decisions themselves, but he also speaks from a critical perspecive: "The outsourcing of the management decision is contrary to the basic philosophy of consulting," he says.

At Mercer, the firm's head of investment consultancy for central Europe, Herwig Kinzler, is convinced that fiduciary management in the most narrow sense of the phrase "does not play much of a role", even as "more and more decisions are being outsourced to consultants". In turn, Meyer notes that clients are demanding higher quality services than before the crisis and "expecting individual, on-time support in dynamic portfolio construction".

Feri's Burkert also sees a legal obstacle to an increase in outsourcing decisions, especially since the implementation of the so-called MaRisk directive last year, a new regulatory risk management framework for insurance companies and Pensionskassen. "Pension funds are more professionalised; they want to know and understand things and they know they cannot buy a black box." He adds that many clients are adamant about separating, for example, advice on the strategic asset allocation from manager selection consultancy to prevent a conflict of interest.

The lack of fiduciary mandates in Germany is not only because of the pension funds' attitude towards outsourcing and external advisers. In order to be able to proxy asset management decisions for clients, the providers of this service have to have a special licence under the German Banking Act (KWG). But not many consultants have filed for one.

"At the moment it is mostly the asset managers offering this all-in service," Dräger from Faros points out. "However, we think it would be more credible if consultants, rather than asset managers, were to offer these services - only, of course, if they are not offering products themselves." He certainly sees that "more and more clients are asking consultants to take an active role in managing assets".

A consultant for life
So German institutional investors are cautious to "remain in the driver's seat", as Meyer puts it. But how much are they willing to delegate? For a long time, German investors were known for hardly using consultants at all. And while consultants are adamant that there is "a continuing trend to use external, independent expertise", as Towers Watson points out, fuelled by the crisis, various surveys paint a different picture.

In its latest pension risk management study on Frankfurt-listed companies, Towers Watson itself noted that only 46% of surveyed companies are using external advisers for their German pension plans, while 91% do so for their international plans. Nevertheless, the number of companies using consultants for SAA advice has increased from 53% prior to the crisis to 63% after the crisis.

Research by Greenwich Associates supports these findings, showing that 28% of institutional investors surveyed in 2010 use consultants, compared with 25% in 2009. But, according to Greenwich, this share remained "far lower" than the rate of consultant use in most other European countries. A similar percentage was calculated by analysis company kommalpha and rating agency Telos.

The latter also found the most impressive increase in consultant use in its survey on German master KAGs, a provider of administration services for asset management including reporting, monitoring, manager review and implementation of overlay strategies - and thus themselves partly competing with consultants. While in 2009 only 10% of surveyed institutionals used a consultant to tender for a master KAG, the number surged to 42% in 2010.

According to SEB Asset management, approximately 13% of Pensionskassen and 12.5% of insurers currently use consultants and 25% of all surveyed Versorgungswerke, the first-pillar professional pension schemes.

A case in point is the Versorgungswerk for doctors in the German province of Northrhine-Westphalia (NAEV). The scheme recently completely overhauled its bond portfolio to increase diversification. For this restructuring, the fund used a mix of three consultants - Mercer, Feri and alpha portfolio advisers. Bu t while many larger funds are frequently using consultants on a project basis, it seems that many are still monogamous when it comes to their advisers.

"Primarily, there is a focus on having one adviser over a longer period," says Meyer. And Bremerich concurs that the "one-consultant model prevails" as it is not easy to find specialists for different subjects. Further, it is RMC's belief that advice should come from one source rather than having eight different sources and losing sight of the bigger picture.

Dräger, however, does not see a clear trend either way: "We saw pension funds booking the ‘all-in carefree package' but there are also those who would never consider the same consultant for two projects in a row."

If pension funds are turning to their advisers they are currently doing so mainly because they need help to find sources of return in a low-interest rate environment, all consultants concur. Because of this, RMC has seen an increase in its specialist topic ‘real estate consulting' which, according to Bremerich, "had only been a marginal theme five years ago".