Europe’s Pension Consultants: Shifting plates
Chris Ford has advice for asset managers – deploy your resources with care and be mindful of the structural shift that is taking place in institutional investment management.
Echoing the claim by John Kay in his government-sponsored review of the UK equity markets, Towers Watson’s global head of investment sees the need for a shift away from asset management business models built around short-term relative returns and in favour of long-term capital allocation.
Ford points to the huge capital market resources concentrated on relative returns in equities – the aggregate cost of which he reckons at about 100 basis points per annum for investors. “You’ve got a huge amount of cost that’s not doing very much price discovery or capital allocation,” as he puts it.
But he also sees a sector that is undergoing a reinvention process: “You have an industry that is oversupplied with skills that won’t be as widely needed in the future. Other participants are stepping in and saying either change what you are doing or we will step in and do what you are doing better and cheaper.
“This might mean a smaller industry, or it might mean redeploying people to do things in asset management that have greater aggregate social value than pure relative return mandates. You always need those and we have some fantastic, smart and innovative people doing things in that space. But you don’t need everybody doing that.”
Like other consultancy firms – among them Russell, Mercer or Aon Hewitt – Towers Watson has adapted its business model away from manager selection and in favour of delegated consulting or fiduciary management.
Ford sees this as part of a wider shift. “It feels like a tipping point where the really big investors are re-thinking their approach to traditional equities and bonds, and looking for improvements to the traditional fund of funds model for alternative assets. The leading fiduciary managers are doing the same thing so you can see two separate sets of investors moving in that direction. And they are both disintermediating the traditional asset managers. There’s no doubt about that. We are doing that not in the sense of doing stock selection but in the sense of saying less of the time and effort on portfolios needs to be spent on those things and more on capital allocation.”
No-one should be in any doubt about the complexity of this process. The sophisticated investment operations of large Danish, Dutch or Canadian pension funds have taken years to build up (Teachers’ Private Capital was started in the 1980s by way of example). This re-thinking of investment processes of course has implications for investors’ internal organisations and some of the work the likes of Towers Watson now blurs the boundaries with management consulting as large investors seek to re-engineer their internal structures and organisation.
“In recent years we have had a number of very large funds with a large internal staff who want us to help redesign their processes,” Ford says. “These are large pension funds, sovereign funds, insurance companies and they think of themselves as asset allocators. They may use external managers to implement certain things but they need a holistic investment process that covers all the asset classes.
“We can contribute through innovation and finding new asset opportunities, through picking better managers than the market, or by helping clients make better investment decisions themselves,” adds Ford. This is, of course, not in any consultant’s immediate commercial interest.
What proof does Ford have of Towers Watson’s success in finding and promoting new asset opportunities? Ford claims for his firm the first UK delegated investment mandate (1999), a very early inflation hedge (2003) and adoption of what it then called beta prime (2002), now more widely known as smart beta. He also points to the firm’s advocacy of a risk premium approach “for people who are willing to move away from the norm”.
The key point is first-mover advantage, according to Ford. Assuming Towers Watson comes up with good ideas and clients adopt them in a timely and efficient manner, the clients will profit from asset price rises as the wider market follows the early movers. But persuading clients used to the famously slow decision-making processes of the UK defined benefit world can be arduous. Can Towers Watson shorten the time from idea to implementation? “We always have that ambition but I’m a realist. You have to put the effort into the research for a long time before you get the full value out of it.”
Ford is also realistic about the fact that definitions of intellectual property can be nebulous and hard to retain in the somewhat fluid world of investment decision making – there is no copyright or intellectual property value in something that is just an idea, after all. The firm’s internal research suggests that it takes 18 months for pack-leading clients to adopt Towers Watson’s investment ideas and five years for such ideas to penetrate the wider industry.
“We started talking about beta prime 10 years ago and it took an awfully long time to gain traction,” Ford recalls. “People probably don’t remember it was us talking about it because it’s become part of the lexicon now.
“People get quite wound up about intellectual capital leaking but if you come up with an idea, you get value out of it for about 18 months or two years and it is then socialised. The sustainable advantage for us is the amount we spend on research over time.”
Investment consultants have many detractors – and prominent among them have been hedge fund of fund managers. Ford acknowledges that firms like his both create portfolios of single manager hedge funds and research funds of hedge funds – and recommend funds of funds where appropriate.
“We are doing a similiar thing to them – we’re competing against them,” he admits. “They have a massive structural problem and they are complaining because we are disintermediating them. We are disintermediating them because they are overcharging and not providing a relevant service. If they charge what we charge and provided the service we provide, I think they could talk to clients much more directly and not feel they were being excluded, but they have become less relevant.”
As they channel very large volumes of assets to new strategies, Ford believes consultants assist the asset managers, and by extension clients, by lowering the costs needed to develop and run those new strategies.
“We can take managers to profitability on day one and as a result, instead of having to charge 70 basis points, they can charge us 30 because they don’t need to charge a risk fee or recover costs. If we get it right, fiduciary managers like us can facilitate the flow of capital to high-quality managers and can stabilise their business, which in turn allows them to deliver services more cheaply.”
Some will agree with Ford’s view that boundaries can and must blur between the traditional roles of investor, adviser and manager, given this shift in the tectonic plates of the institutional investment industry. Others, of course, see a consultancy industry using its power and relationships to encroach on the traditional territory of asset managers and raise its own fees.
“People could fairly criticise us that we are taking on things the asset management industry has done and are doing them more cheaply but actually worse. That’s a very fair point to raise. We try to be transparent and be very clear we are not replicating existing activities. Why would we do that when we are trying to change investment for the better? Providing a different mix of services and solutions that doesn’t already exist in the market surely makes more sense for clients, who are looking to the future and seeing ways to compete for returns and risk-reduction.”