Consultants are powerful players in the institutional fund management market. Investment managers need to be on the big consultants’ radar and make it on to their lists of acceptable providers. Evolving legislation and regulation, changing investment options, such as the emergence of technology stocks and consolidation among investment managers, all mean that pension fund managers and trustees increasingly welcome external input. Events like the downfall of the UK’s Equitable Life highlight the way things can go wrong, the difficulties that can arise and the value of sound investment judgment and advice.
John Gee-Grant, head of consultant relations at Merrill Lynch, says:“The independence of the investment consultant is of immense value to pension schemes. The tripartite relationship between scheme manager, investment house and consultant offers a very valuable safeguard to scheme members. If something isn’t working it will quickly be picked up.”
As in other markets, there is a trend towards separating the value chain into its component parts, leveraging the competences of various specialist organisations. There is pressure on pension funds to review their activities and performance, identify their strengths and areas of skill, and to outsource functions and services where appropriate.
Thus pension scheme managers tend to be pretty sanguine about the use of consultants. “It’s an inescapable fact that pensions asset management is a global business these days,” says one. “You need the help of investment consulting firms to give you global reach.” As well as shedding light on the bigger international picture, consulting firms are very useful sounding boards for new strategies and in scheme management generally.
But such views are not universal. One manager of a large Belgian pension fund buys in risk management and actuarial consultancy but is otherwise fiercely independent. “We outsource all our asset management,” he says, “but we want to be firmly in control of asset allocation and which managers we use. Manager selection is not that important compared to strategic asset allocation. We set ourselves high standards and demanding objectives. If you know your business and understand your liabilities you can undertake your own asset allocation.”
He is dismissive of consultants’ “standardised approach”, which he believes they apply across a range of clients. “I don’t see enough innovation and good ideas coming from them. In fact, there is a risk that they will use your ideas for the benefit of their other clients. And I’m not convinced they perform consistently well over the longer term.”
Bríd Horan at the Electricity Supply Board pension scheme in Ireland is comfortable with relying on strong consultant input, but agrees that innovation is important. “Clients are looking for information on market developments and trends and for new ideas. Consultants need to be very proactive in this.”
Certain markets like the UK and Ireland are more consultant-driven than some in continental Europe where, historically, funded occupational pension schemes have been less common. The constitution of UK and Irish schemes, involving trusteeship and its attendant responsibilities of prudence, security and sound governance generally, also encourages the use of external expertise. As European pensions evolve, with legislative reforms and stimulation of private sector provision, they will undoubtedly generate new business for consulting firms.
Scheme managers and consultants are agreed that the relationship between the consultant and the client is key. “The consulting firm has to know you really well to be able to deliver the best results for you,” said one scheme manager. “And equally you have to know them well to be able to select the right one in the first place and to ensure that you can extract maximum value from the relationship.” Consultants need to work consistently and hard at relationship management if they are to avoid being merely reactive to clients’ demands. This is where the smaller consulting firms can score: operating in niche markets with smaller teams means they should be able to develop closer client relationships and give more personal, tailored service. Indeed, individuals are as key to successful client relationships as the overall size and quality of consulting firms’ teams and the strength and depth of the expertise available.
Although there is plenty of overlap between actuarial and investment consulting – many schemes use one firm for both – investment consulting has grown into a key specialist skill dominated by a handful of large international firms. Can small consulting outfits survive in the modern market place? Crispin Lace at Watson Wyatt in Reigate points to the globalisation trend. “The investment market is now a global one. That means that pension funds have to look outside their own countries. The choice of investments is huge, and so is the choice of managers. Investment consulting firms with global operations and reach are able to give that wide perspective.”
Andrew Kirton, head of UK investment consulting at William M Mercer in London, says that the investment needed for analytical tools and modelling programmes will be a deciding factor. “We spend millions developing risk and asset/liability modelling software. You need a critical mass of clients in order to repay investment on that scale.” He believes the market will become even more polarised between giants and small niche firms. If he is right, it could be that those in the middle will soon have to jump or be pushed, and it looks doubtful that new investment consulting firms will emerge.
But the business environment is rarely static for long, and the relationships between pension funds and the various consultancies that serve them will change with the prevailing conditions. Other markets are being transformed by the march of information technology and the emergence of the internet as a medium for trading, exchanging information and service provision. Already investment consultants have global databases of information that can be made more accessible to their clients. Some newer operators, like Investorforce.com, IPE-Quest and Pensionsnet.com, are founded on a value proposition of electronic exchange of data and market information.
Merrill Lynch’s Gee-Grant reckons there is scope for new consultants in the market with a fresh value proposition tailored to discrete market segments. But there is a vital distinction between information and knowledge. Data needs interpretation to make sense of it, and that means that the personal touch and individually tailored service will always be valued by certain types of client.
Whichever way you look at it, investment consulting seems to have a very assured future, although the rules of the game will undoubtedly change in response to market developments. Pensions evolution in Europe will create new opportunities and extend the consultants’ influence. In the UK the Myners review of institutional investment could result in a shift towards a fiduciary model of pension scheme management along US lines, growing the demand for external expertise. But everywhere the tighter scrutiny of how pension funds are run and the demand for strong investment performance and value for money, increasing the pressure on fund administrators and trustees, strengthens the case for involving consultants.
But the consulting business is, and will remain, very competitive. Innovation in products, service and strategies is essential. And consultants have to demonstrate good performance and in particular that long-term investment objectives are met. They need to be accountable and to deliver real, transparent value. Their ever more demanding clients should see to that.