The consulting kaleidoscope
Investment consultants, asset managers and investment banks are increasingly operating on each other’s territory. Rachel Fixsen charts the overlapping boundaries in the advice market and canvasses views on how potential conflicts of interest can be managed
Nothing is ever quite the same after a storm, so perhaps it is not surprising that changes in the pensions industry has left the role of investment consultants less clear cut than it was. These days, a trustee or pension fund board member is just as likely to have a consultant offering investments as to hear advice on funding issues from an asset manager. But does this kaleidoscope of new business models create conflicts of interest?
The new breed of combined consultancy and investment product service goes by many names - implemented consulting, multi-manager and fiduciary management are but a few, says Daniel Melley (pictured right), principal at Mercer. “The lines are kind of blurry - everyone has a slightly different definition,” he says.
Mercer itself launched its multi manager offering, then branded Mercer Global Investments, in the autumn of 2006, and Melley asserts that what it now offers is really just a packaged version of its advice. “It’s just delivering it more efficiently, the way we look at it,” he says.
He believes the question of whether conflict of interests arise hangs on whether the firm makes more money from the implementation model or the traditional consultancy model.
“But investment managers have the same conflict of interests, in that they make higher fees on the pooled funds,” he says. “For us, the margin on the funds is about the same as the consulting margin. The way we handle it is full disclosure to the clients - who are intelligent people.”
Watson Wyatt’s version of implemented consulting is called Advanced Investment Solutions, explains Paul Trickett (pictured left), European head of investment consulting at Watson Wyatt. The firm is not offering investments directly, he says, but rather “designing and managing bespoke portfolios across a spectrum, ranging from single manager selection exercises to the full investment strategy, dependant on clients’ governance strength and needs.”
The issue of impartiality is certainly raised, he agrees, and the consultancy manages these concerns in two ways. “Firstly, we try to align our interests with those of our clients - we only do well if they do well,” he says. “And the second part is that we talk to clients about the need for better pensions governance.”
There seems to be a widespread acceptance of the need for better governance, and this ‘governance expansion’ service that Watson Wyatt offers helps trustees achieve this by improving decision making, he maintains.
Russell moved into multi-management several years ago, but remains a pensions consultancy for a few clients. “The whole industry is becoming a bit more greyish in terms of the players interaction,” says Johan Cras, managing director EMEA of institutional investment Services at Russell Investments. “We believe that the need out there from our clients is for the integration of advice and implementation.”
The issue is not whether there is a conflict of interests, but how the potential for one is managed, he says. “Our way of dealing with this is to have clients ask themselves three questions: Is there a conflict? If there was, how much would it hurt us? Should I trust this advice or should I hire another company?” But Cras goes on to stress that Russell is always an agent on behalf of its client, and is never the counterparty.
John Conroy, principal at Psolve - a division of the actuarial consultancy Punter Southall, says the classic conflict comes when consultants set up funds. “In our case, there’s less of a conflict,” he argues, “because we don’t have PSolve funds. We have a small range of funds of funds. As with all conflicts of interests, the way to handle it is with transparency.”
So are the consultancies that have gone beyond the traditional model in the same game as investment managers, or not?
For Conroy, there is no hiding behind the new terminology. “Implemented consulting? It’s fund management,” he says. “We as a business are regulated as a fund manager. What I do know is you can’t be a little bit pregnant.”
He freely acknowledges that there are conflicts when a consultancy offers investment products, but says marrying advice and implementation makes sense for clients. “We’re in an industry that says for help with the question, you use a consultant, and for implementation of the answer, you use an asset manager - well, we don’t think so.”
To illustrate the problem with the traditional business model from the client’s point of view, Conroy says the process is like being taken to the edge of the cliff, and then jumping off while the consultant stays in the car park.
Erik van Dijk, CIO and partner at Compendeon in the Netherlands, agrees that implemented consulting is a tricky thing. “Especially as a consultant it has to be totally clear if advice is fully independent and objective,” he says. Compendeon itself is about to enter the manager selection market, moving into fiduciary management with a large partner, he points out.
“But [we] insisted on a best-of-breed model, in which our quantitative tools play an important role in derivation of short lists,” he emphasises. “Products and strategies not on short lists cannot be chosen. This ensures that clients know that we only select what we really believe in.”
And there should be total transparency over fees, Van Dijk insists. “A good fiduciary consultant should be willing to show his belief in suggested solutions by constructing a fee structure that is sufficiently variable to ensure goal congruence. If the client is happy - outperformance - the consultant should earn more. Underperformance should translate into lower fees.”
But while consultants have been wandering into the traditional territory of asset managers and multi managers, both asset managers and investment banks have been busy dealing out advice to pension clients on both corporate and trustee sides.
Investment banks have become more involved in giving pensions advice because of the “process of de-risking” that has been going on within pension funds in Europe, says Kevin Carter, managing director and head of JPMorgan’s Pensions Advisory Group.
That move has shifted the emphasis in pensions investment from equities to bonds, which are seen as providing a better match for liabilities - a change in exposure which often involves the use of swaps. “This is why investment banks have become active in the pensions space, because they are the counterparties when these swap transactions occur,” says Carter.
JPMorgan’s Pensions Advisory Group has been in this business for two years now, and Carter says his team is largely composed of people who previously worked for consultancies. “In many ways we are analysing cash flow data for liabilities, using similar options which the trustees have in front of them,” says Carter.
“We are able to engage with a pension fund no less well and, I would argue, in many ways better than a consultancy - we have all the skills.”
But even if a conflict of interests were to arise, the new Markets in Financial Instruments Directive (MiFID), which was came into effect last November, means clients are protected against being overcharged for investment transactions, he argues.
“Under the new MiFID regulations, we have a regulatory obligation to deliver the best execution to our clients.”
The way Schroders’ Strategic Solutions pensions team prevents conflicts of interests is by not replacing the consultant’s role, says Neil Walton, Head of Strategic Solutions.
“We don’t have advisory appointments, so we don’t formally offer advice,” he says. “We’ve been asked a couple of times to tender for that, we’ve turned it down.”
That said, the team shares views with pension funds and provides input on funding and investment issues such as liability hedging, perhaps demonstrating how a particular strategy would work, he says, while stressing: “For a fund to go forward with our ideas, they should share them with an investment consultant.”
However on one or two occasions consultants have been reluctant even to consider the ideas Strategic Solutions puts forward, he says, and puts this down to ‘turf protection’.
From a business point of view, traditional pensions consultancies have often tended to lose out on potential higher fees from clients because the delay between advice and investment outcome makes it difficult to quantify the value-added from the advice.
“This delay makes it difficult to measure the result and justify the value that’s been added,” says Walton. “As consultancies move more into a product world, margins can increase, because you’ve delivered something measurable. It’s higher-margin stuff and that’s why consulting firms would try to move towards it.”
While he emphasises that pensions consultants generally do a good job of staying independent, Carter makes the point that those ultimately profiting from acting as a counterparty cannot be entirely so.
“Implemented consulting, if organised properly, doesn’t have to have conflicts and to be organised properly means having the client involved in the decision-making process,” he adds.
Van Dijk says that it has always been easier for asset managers to encroach on consultants’ territory than vice versa. “In general: a consultant cannot easily enter asset management and but an asset manager can easily add consultancy to his activity portfolio.”
Melley welcomes the fact that investment banks are now more active in offering advice to pension funds. “They’re making the marketplace interesting if you look at it from the point of view of the customer; it’s got to be a good thing because it drives efficiency in the market.”
And Conroy says he, too, is more than happy that asset managers are moving into the pensions advice marketplace. “We’ve been aching for it to happen,” he says. “We think the old model of each part occupying its own space in an agreed turf carve-up is flawed.”
An increasing number of players from all sides will be offering combinations of products and advice to pension funds in the next year, Conroy predicts.
Van Dijk sees an interesting playing field developing for all pensions players. Not only will there be more providers, but also difficult market times and a changing world will bring growing levels of demand from clients, and a quest for better performance, he says.