The investment consulting business in the US is very concentrated, with the leading firms controlling 70% of the market. But this situation is slowly changing, because of the increasing competition coming from new entrants and because of the recent mutual fund scandal’s ripple effects.
“The top 20 leading consulting firms have lost 10% share of the market during the last two years: two years ago they controlled 77.6 % of the market, now only 69.3%,” explains Kathleen O’Connor, senior analyst at Cerulli Associates, a Boston based research and consulting firm. Cerulli recently released a paper about investment consultants in the US that shows how the market is becoming more and more competitive.
“We have seen two trends,”says O’Connor, who is the author of the report. “The first one, is pension plan sponsors hiring more than one consultant firm: they tend to give different pieces of the business to different consultants, which may be smaller players, specialised for example on alternative investments or real estate or asset liability models”.
This finding is confirmed by another source, Nelson/Thomson Financial: nearly 9% of all American pension plans with over $100m (E79m) in assets hire more than one consultants; and mega plans with over $10bn in assets have demonstrated the greatest desire to use the services of more than one consulting firm, with over half of the plans in this category participating in this trend.
Beside niche players, “additional competitive pressures have come from new entrants to the market,” reads the Cerulli paper. “Actuaries, management consultants, asset managers, custodian banks, internet portals and individual trustees all in some way are encroaching on functions that traditionally were the role of the institutional consultants.”
For example, “custodian banks pick-up a lot of performance reporting,” explains O’Connor: “They have the technology to do that, thanks to all the transaction records they keep. While management consultants leverage their relationship with clients on the investment side”.
Not everybody agrees that this is a very recent trend. Monica Butler, managing director of Russell’s US consulting group, based in Tacoma, thinks it is a long wave: “Over the last 10 years, the institutional investment industry has seen many changes. Many providers – asset managers, custodians, and so on – have tried to expand their capabilities to include consultative activities, both as a retention tool and a cross selling strategy. Providers want to be more relevant and valuable to their clients. We feel good in this environment, because competition forces us to stay current and strive to be ahead of our competitors. With the increasing number or vendors providing advice, we have to be certain we can add value’.
Russell, which is among the top consultants to American pension plans, claims it has ‘a unique position’ in the market: “Our extremely deep manager research group clearly allows us to excel,” goes on Butler, “and the other providers are not encroaching on us in that area. The fact that we do implementation as well as consulting gives us an advantage in both our multi-manager business and our consulting business. We can provide consulting type services to our investment management clients. And our consulting clients reap the benefits of us knowing the practical issues our clients face on the implementation side, such as the actual hiring, firing, structuring, execution, and so on.”
But this double know-how may also become a problem in the post-mutual fund scandal market: it may be put under scrutiny as a source of a potential conflict of interest. In fact US regulators have recently asked for information from many investment advisory firms, including Russell, Wilshire and Mercer. The latter is owned by Marsh & McLennan like Putnam, the first mutual fund company charged with wrong doing by New York Attorney General Eliot Spitzer.
The problem regards the definition of fiduciary duties and what that means both for pension plan sponsors and for consultants. “The second new characteristic of the consulting business is indeed the increasing pressure on fiduciary duties,” says O’Connor. “Nowadays plan sponsors may hire one consultant to do the asset allocation and another one for the ongoing due diligence, to be sure they have an unbiased opinion. This translates into more opportunities for new entrants.”
One of these new players is Edward Siedle, a former Securities and Exchange Commission attorney who now manages his own financial services firm, The Benchmark Companies of Lighthouse Point, Florida, and investigates consultants for pension plan sponsors. According to the Dow Jones Newswires, he is preparing to launch a “major initiative to investigate pension consultants”, because he believes “much harm is done by consultants who siphon off money that could go to pensioners”.
The idea is made clearer by Donald B Trone, president and founder of the Foundation for Fiduciary Studies, a Sewickley, Pennsylvania, organisation that develops fiduciary standards for trustees, investment committees and advisors. “You have consultants out there involved in pay-to-play schemes,” Trone says, “where they have been taking hundreds of thousands of dollars each year from Putnam, Janus, Strong and Pilgrim Baxter to have those managers appear in more pension fund searches at the state level.” Some of the advisers, according to Trone, have relationships with firms they recommend, some receive substantial fees for various services from money managers now being investigated in the mutual-fund probe. For example firms take in money from asset managers for services ranging from conferences to software programs. “The fees are often exorbitant and in some cases much larger than disclosed,” says Trone. “When fees are so egregious you can’t help but view them as nothing more than extortion fees.” Required for a comment by the Dow Jones Newswires, Mercer, Wilshire and Russell said they don’t engage in the so-called “pay-to-play” arrangements detailed by Trone.

But the same Cerulli report confirms that concerns are motivated: “Some consulting firms have expanded their core business, losing their independence and building relationships that have the potential for creating a conflict of interest as the firm may not be able to provide unbiased objective advice.” Consultants are under tremendous fee pressure, according to O’Connor, because plan sponsors are committed to cost cutting. “We have not seen any increase in fees in two years”. That is why some consulting firms “have explored additional means of generating revenues and now derive a significant portion of their revenues from their clients’ portfolio transactions or through consulting to money managers”. Cerulli thinks that reputable firms that are transparent about their fees should not have any problem and should not be affected on their bottom line.
Anyway, these kind of concerns about conflict of interests are growing and some pension funds are taking steps to prevent it. A first sign comes from the Illinois State Board of Investment, which manages $10bn in public retirement funds: it has just hired a new consultant, after seeking out companies whose sole source of revenue was consulting. “They weren’t selling databases to money managers or research services”, explains Bill Atwood, executive director of the board, adding “When somebody says they have a Chinese wall, that means there is no Chinese wall”.
On the other hand the increasing pressure on fiduciary duties means also more pension plans outsourcing trustee-related responsibilities, according to Cerulli, that is more business for consultants.