Brendan Maton asks whether fiduciary management is really a new advisory structure, or just a new charging structure
In his essay of 1644, The Areopagitica, the English poet and philosopher John Milton made clear that Man's burden after the Fall was to know both good and evil. "Good and evil we know in the field of this world grow up together almost inseparably". He mused that Adam's loss of innocence, or ‘doom', was actually to know good by evil.
The charge levelled at modern-day investment consultants is that they still exist in a kind of state in which they provide sound advice to clients but can't deal with the ‘evil reality' of asset management.
This does not matter for the likes of Hymans Robertson, Lane Clark & Peacock, PPC Metrics or Mangusta Risk. These consultancies in Europe have no pretensions to run assets (years ago LCP consultants keenly distanced themselves from fund of funds manager Investment Solutions, an associate company via parent Alexander Forbes). It is an accusation levelled, however, against AonHewitt, Mercer and Towers Watson, the three largest fiduciary consultancies.
Fiduciary (or delegated or implemented) management means taking contractual duty for how clients' assets are managed. To follow a metaphor first introduced by Don Ezra and Keith Ambachtsheer in their 1998 book ‘Pension Fund Excellence', the fiduciary is akin to a company's management, running the day-to-day business. The trustees can be identified in a more natural role as the supervisory board, responsible for oversight of the management four to six times a year.
The claim against fiduciary managers housed in consultancies, however, is that they have few employees with day-to-day knowledge of running an asset management business. Thus, an adviser might currently oversee a transition management - but there is a world of difference between devising a shortlist of managers and actually conducting post-trade execution analysis in-house. Consultants are not renowned for liaising with brokers directly (one ex-employee of a Big Three firm famously remarked that he didn't even have a Bloomberg screen during his employment at that firm).
Likewise, consultants have no history of establishing and running private equity vehicles. How could they compete in fiduciary management with a business like Russell, which has decades of experience here due to the interests of George Russell himself, plus key acquisitions like Pantheon Ventures to draw upon?
It is widely accepted that asset allocation explains the majority of returns. That would demote the importance of individual portfolio managers running a specialist mandate, but whence comes the reputation of these consultancies for rotating between asset classes, whether on a monthly, yearly or three-yearly basis? Asset-liability models were never sought after by investment houses keen to strip out the underlying assumptions as superior replacements for their own research.
All of this suggests that consultants have little experience of generating the kind of superior information or interpretation of information necessary to provide clients with market-beating returns. So what more do they bring in 2011 as fiduciaries than they did in 2006 as consultants?
The general gripe is that the adviser's psyche of offering an opinion rather than giving orders is poor training for managing assets. This argument continues with the stack of staffing provision by asset manager fiduciaries. One roster supplied to IPE has an asset management team, including derivatives overlay, cash and collateral management, SRI and proxy voting of 74 full-time equivalents (FTEs). The operations and reporting team, covering custody management, tax reclamation and fund accounting is 62 FTEs. Client servicing has 29 FTEs, as does the division responsible for risk, legal affairs and compliance. In total 194 professionals - and this is not the largest of its kind.
But here comes the riposte: asset management should not be confused with fiduciary management. Ezra and Ambachtsheer's model was for the efficient running of a retirement fund, not an asset management house. Many pension fund personnel are wary of asset managers and investment banks - not consultants - because the former lack a holistic sense of how retirement plans work. Yes, Mercer has a kind of fund of funds based in Dublin but it is not essential to the fiduciary offering. Likewise, Aon Hewitt has established offshore vehicles for clients' benefit but there is no direct asset management.
"We are doing what we have always been doing," says Zuhair Mohammed, head of delegated consulting at AonHewitt. "Scouring the world and bringing back the best parts necessary for servicing occupational pensions." The only difference he sees is that delegated clients agree to a service where his team make the decisions for them.
Mohammed readily admits that expertise for issues such as post-trade execution analysis is conducted elsewhere. That is not what clients sign up for and he has no pretensions that such specialisms are being grown in-house. The purpose of the fiduciary is to oversee the best service in each discipline. In this light, attacks on consultancies' fiduciary services seem blunted. If one accepts that the firms were doing a fair job as consultants - with excellent access to all corners of the market because of their enviable list of pension fund clients - then it should not be a great step to leaving them more in charge than the trustees.
Criticisms remain. Paul Kemmer, head of asset solutions at PSolve, believes that employing individuals with experience of day-to-day managing of money is a big advantage for all sides of the business. PSolve has 35 people in operations covering issues such as trading, settlement and collateral management. "We have pure consultants sitting in the same area. I believe they become better consultants for working alongside people who are dealing with practical issues such as settlement delays."
Kemmer was previously a corporate financier at Lazards. Alongside him are the likes of Jack Berry, Glyn Jones and Andy Drake who also has investment banking experience. PSolve, like Russell, is of a rare breed where investment consulting and asset management co-exist successfully.
Gary Yeaman, director of fiduciary management at Russell Investments, says that between consulting and asset management lies implementation, for which a host of skills are needed that consultants don't fully possess. "They are learning with clients' money to establish competencies we have had for decades," he says.
Chris Ford, head of investment, EMEA, at Towers Watson, however points to the disappointments in the Netherlands with fiduciary management, which have involved pure asset managers rather than consultancy fiduciaries. Ford believes that there are dangers in becoming merely an asset gatherer, because clients' interests are at risk of being suppressed. Instead, he emphasises the number of mandates where Towers Watson offers directed consulting - where the trustee board makes the final decision.
"They want to know what we are doing. We have added resources but so have they in order to understand," he says. Likewise, of the 40 or so mandates run by Ford's team, several are for a portion of total client assets. A common example here is hedge funds.
So although Towers Watson operates longstanding full fiduciary mandates for a few US clients, the only equivalent in Europe is for the UK's Merchant Navy Officers Pension Fund, which it retained in 2009 under competitive tender (although this represents the same volume of assets as all of Aon Hewitt's implemented mandates put together).
All told, the message from Towers Watson in 2011 is more traditional than 12 months ago, when the former head of Advanced Investment Solutions (AIS), Paul Trickett emphasised that 25% of all investment consulting revenue came from these mandates and that he didn't want to oversee a business predicated on hourly fees. (Trickett has since left to join Goldman Sachs Asset Management's fiduciary offering, as did his predecessor Andre du Plessis four years earlier.)
None of Towers Watson's delegated or fiduciary business is on an hourly rate but Ford is less zealous to separate his department from the larger consulting business. He recognises his clients' sophistication and seems happy to serve them in the best way possible, whatever the label given. This makes most sense for Towers Watson given its clients' preponderance at the large end of the UK market. Bigger schemes are more likely to improve their own governance in response to increasing complexity of investments and regulation, and several made clear to IPE that they wanted Towers Watson to remain their consultant, not their fiduciary.
But if Ford is content to underline his company's ongoing partnership with clients, he won't accept the allegation that consultancies are under-resourced in comparison with asset managers, or innocent of the knowledge of good and bad investment practice. "If you look at our research base - alpha-generating strategies, capital markets, economic research - it looks like an asset management house," he claims. "More than 40% of total staff in Europe are focused on investments."
Nick Horsfall, occasionally the bête noire of investment banks for his interrogation of their swap pricing, has a team of 20 alone in liability hedging. This team is separate from traditional actuarial work. Towers Watson has more than 100 full-time equivalents in manager research. The investment committee steered by Robert Brown meets three days a month.
These facts alone might quell criticisms that consultancies are underresourced for fiduciary activities. Ford goes further and questions what percentage of the staff at pure asset managers are the sales force and marketing department, rather than investment professionals. "I am not about to go out to recruit 100 people; we are not a small funds business. We don't deal in standard products but at the same time have more content than any investment house."
Ford produces the trump card of access well. But not everyone is happy with the state of play. Russell's Yeaman reckons he saw about a dozen tenders for fiduciary management of any sort in 2010 which, by anyone's reckoning, is far fewer than the number of new clients acquired by the consultancies. He would like to see more pension schemes test the open market, just as they would for other service mandates. Until that day - and it might come later rather than sooner - consultancies can prosper without employing many marketers.
Dan Melley, head of Mercer's Dynamic Derisking Solutions in London, accepts the obvious - boards of trustees are altering their contracts with their existing consultancy rather than exploring other options. "They view it as a different delivery mechanism for the same things they come to Mercer for in the first place," he says.
This argument over openness is pertinent especially to AonHewitt and Mercer, which deal with smaller schemes on average than Towers Watson. Like PSolve, a true pioneer in fiduciary, Aon Hewitt and Mercer are building this new business by means of conversion. While PSolve could go higher than its current €2.4bn, the sky is the limit for AonHewitt and Mercer. Together they advise €400bn of pension assets in the UK alone. Of this potential, Mohammed's team has tapped just €3.5bn under management while Mercer has €7bn. No wonder the likes of Yeaman are concerned. He does not have a long list of clients that are easily convertible. Schemes which employ Russell as consultant are of the same calibre as Towers Watson's. The difference is that the former have had 10 years to go over to fiduciary if they wished.
It should be remembered that while everyone talks of the endgame in defined benefit provision, even in the Netherlands now, some trustee boards and their sponsors enjoy the challenges of running pension schemes. When asked why they had rejected the offer of fiduciary management from a trusted adviser, one UK scheme told IPE that its investment committee met 17 times the first year the adviser was appointed. Evidently, not every organisation wants to outsource retirement responsibilities just yet.
While larger schemes show less interest in ceding more control to their consultants, some specialist asset managers are feeling less comfortable about ceding precious information. One source pointed out that, as pure researchers, these companies have the right to come in and unearth proprietorial secrets of asset managers for the sake of clients. Unease grows if those same secrets are informing the fiduciary division "free of charge". So, Ford's boast of great content is not greeted with enthusiasm by all.
For others, such as Hugh Cutler, head of distribution at Legal & General Investment Management, relationships with fiduciary consultancies are fine. He senses no animosity or incursion on L&G's territory.
In conclusion, consultancies offering fiduciary would claim that they are not innocents, but neither are they out to compete entirely in the big, bad world of asset management. The rather familiar complaints that have emerged from fiduciary management in the Netherlands - lack of dynamic allocation, truly objective manager selection - have left consultancies keen to differentiate themselves. By working on their own client base, and in alliance with all those asset managers who still see them as the biggest route to winning business, the consultancies are improving their margins.
Mercer appears best placed here. Of the big three, it has the greatest volume of small clients - its current average client size is €55m - and there are many more out there to convert. The Achilles heel would be performance, not conflict of interest. Russell is a good example of a house that advises and manages assets in harmony. What has hurt Russell's reputation in years gone by has been poor performance. Mercer declined to divulge figures for their Dublin-based funds, but results for their Australian funds, which are available publicly, have been mixed.
The key question is how much pressure is placed on the heads of these divisions to earn revenue. AonHewitt, Mercer and Towers Watson are now all part of companies listed on the New York Stock Exchange.
When deciding the level of pressure, the likes of Phil de Cristo at Mercer might do well to look back over recent history. In its submission 12 years ago to the Myners Report, the then Watson Wyatt complained that consultancies did not earn revenue commensurate with their contribution to pension fund management. Watsons supplied a figure of 1.5 basis points as a guide to its earnings. Today, as a rule of thumb, on a medium-sized scheme worth €500m, the consulting fee would be 3 basis points. The implemented consulting fee, however, jumps to 10 basis points. These consultancies have belatedly found a way to boost their revenue to a more appropriate level. This is still far lower than specialist asset management but comparable with fiduciary fees for large Dutch schemes. It is also a great improvement on the traditional advisory model.
So the question of temptation for these companies must be: how many old-fashioned advisory relationships do we want to keep? The decision will not be entirely their own. Even small clients ultimately retain the right to move. Kevin Frisby, a partner at Lane Clark & Peacock, points out that many of the problems allegedly solved by fiduciary can be addressed by diversified growth funds (DGF).
"Lots of cutting-edge activities such as moving from swaps into physicals or following a flight path to buyout can be achieved with a DGF," he claims. "These guys are at the coalface and see what's happening in the markets. Issues such as responsiveness of governing boards or failure to spot short-lived opportunities do not require a fiduciary managers to be overcome."
In some segments at least, asset managers have less to fear from investment consultancies than they imagine.