Finding the right advice
An old English proverb suggests “it’s an ill wind that blows nobody any good”, and the crisis in the pension fund industry has certainly benefited the investment consultant community. Its members are busier than ever as pension funds seek new ways to cover future liabilities with assets that sometimes refuse to grow in proportion.
Our questions included the following:
n Few would argue against the added-value an investment consultant could bring to a small fund but do large funds need them?
n What can a consultant add to a large in-house actuarial and investment team?
n Are investors satisfied with the current choice of consultants? Is the pool big enough to stimulate an efficient, competitive service?
n Can an asset management company ever be considered objective enough to be an investment
n When it comes to the specific needs of the real estate asset class are the consultants sufficiently experienced to offer best advice?
n Are investors satisfied with the advice they’ve received? Do you they feel they are getting the individual consultant’s view or ‘the company line’?
n In countries where consultants act as ‘gate keepers’ to manager selection and mandate awards are they assisting the development of the real estate asset class or holding it back?
n And when it comes to the consultant’s fees, are they sufficiently transparent?
n What is the most effective payment structure: a retainer, an hourly rate or a performance-related scale?
We do use consultants but only on an ad-hoc basis. For example, for our last beauty contest to find
the right pan-European real estate asset manager we used the consultant FERI.
The fund has been in place for a year now and I think FERI did a very good job because we found the right manager and the fund has already made substantial investments.
I don’t think that it makes sense to engage in a permanent process with a consultant because it begs the question “why don’t you do it yourself?” But for special analysis and projects it’s a different story. For example we’re working on our strategic asset allocation analysis with Mercer. Real estate forms one part of that analysis, obviously.
Five years ago we implemented an active real estate portfolio management system and that was done with the help of Sebauer (Sebauer was bought by Mercer).
I reiterate that if there is a permanent need you should do it yourself.
For our (German) Spezialfonds we have external asset managers, and some people may call them consultants but I call them asset managers. That’s as close as we get to a permanent arrangement.
For the German market, I would like to see more consultants
specialising in real estate and
real estate asset managers. FERI
is one, but more are needed.
There are plenty of consultants who can conduct beauty parades for asset managers of equities or fixed income, but not of real estate. I don’t know why this is. I’ve spoken to other people in the investment field and they have the same feeling.
Manager selection process on the real estate side is more expensive (in consultants’ fees) than it is for equities or fixed income.
I don’t know if that is fair, because at the end of the day it’s more or less the same process and you ask more or less the same questions: Who are the most important asset managers? What’s in their curriculum vitae? What are their risk management processes? And so on.
I suppose the fact that there are less consultants on the real estate side it’s more expensive. Therefore you could say that maybe the pricing system is more transparent on the equities and fixed income side.
But I would say that we have still achieved good value for the money we’ve had to pay consultants. We had three beauty contests for the real estate class, two we did ourselves, one with a consultant. Out of the consultant process we learned a lot and we used that knowledge for the two other parades. So in the end it was a good price.
LONDON PENSION FUND AUTHORITY
I would not say we are a major user of consultants because we’re a local government/public sector fund and we don’t have to follow the same structures as private sector funds. But we do appoint advisers and actuaries with statutory duties under the framework we operate within.
As advisers we’ve appointed Peter Moon who is chief investment officer at the USS (Universities Superannuation Scheme) scheme and David Rough who was chief investment officer at Legal & General. We also use Hymans Robertson as our actuary and it could equally well have been one of the other big players.
We chose our advisers through a selection process of people we knew in the market.
We didn’t go out looking for a firm to do it, we wanted individuals with the right skills and experience. Our view is that given the fact that we only have a small in-house team, it would be difficult to bring in all the expertise that we would need in a single person. And changing that level of expertise if circumstances changed would also be difficult, not to mention retaining it.
If you want expertise on derivatives, for example, it’s so much easier to seek advice from an external expert than to try to provide it in-house.
Our real estate allocation is held indirectly through property unit trusts, we only have about £100m (e145.5m) in there which - in our view - is not big enough for direct management.
We haven’t experienced difficulty in finding a property adviser. We used David Rough, who has specific
experience in property. He helped us to select five funds to put some money into and achieve some degree of
I think advisers do offer value for money, at least in the way we use them.
It’s difficult to judge other funds’ situations. I think a consultant’s value depends on the scale of what you’re attempting to do. Most pension funds probably cannot have the expertise in-house to understand every issue sufficiently. But the concern is that the consultants take over and you get the firm’s view rather than an individual view. That’s the difficulty.
We have been making use of consultants to assist with our real estate investments for more than 20 years, both domestically and around Europe.
We do feel there is adequate choice, but in our case we have maintained relationships with the same advisers for many years, both in the direct and indirect markets. We have advisers in Denmark, the United Kingdom, Belgium, France and other countries.
I would say that they do have the necessary expertise but their value to us has improved over the years as they come to understand our needs and goals more clearly. For an effective relationship, an adviser needs to know the background and understand exactly why you are entering a market and what you need to achieve from it.
Ours have been very effective, and we put an emphasis on receiving independent advice; we want to know what they would do if they were investing the money personally. We don’t want to receive advice from people who are trying to sell on behalf of funds – that’s too much of a conflict of interest.
Because we have been in the market for so many years and we are rather big, we have been able to achieve fixed fees from our advisers. In some cases we also enter into a performance fee arrangement. So on the whole I would say we are satisfied with the value for money we have obtained. We have seen, however, that advisers’ fees outside Denmark are significantly more expensive than here. We have been very aware of that and we try to negotiate better fees.
The value of long-term relationships means a lot to us, and it means that we can act very quickly when we come outside of Denmark to invest. We need to be aware of the competition in whichever market we’re dealing and we need to receive effective advice quickly.
This year we have made our first indirect investment in Asia. We also moved into central Europe to Czech Republic, Hungary and Poland. Last year our investments were one-third outside Denmark, two-thirds domestic. Now it’s close to fifty-fifty.
This pattern of investment puts more emphasis on our adviser network.
We only use consultants on an ad-hoc basis to help out with certain projects. In general the larger the project the more successful and better value these consultations have been. Smaller assignments - like reviews for example - have sometimes proved expensive and we’ve made decisions to take these in-house.
The choice of investment consultants in Austria is really quite small but we are not committed to using these firms alone. Looking at the consultants based in Germany and Switzerland there is a reasonable choice.
In general we don’t use investment consultants, although in special cases we do. Most of our real estate investments have been made already. The majority are indirect investments and we find the expertise we need in the managers we have chosen.
The direct investments we have made have resulted from special situations where it was not necessary to hire additional expertise.
Also, within our group we have an expert from a special company in the real estate market.
Our indirect investments are in special funds and in listed markets and we monitor their performance to make sure we are in a good position in regard to other possible providers. We have the opportunity to change our providers if we no longer feel comfortable with them. So until now it has been organised very well and if we’re not happy we have the flexibility to change.
Geert de Nekker
What can a consultant bring to a large in-house team? That’s a difficult question because the answer depends on specific circumstances. In general, though, external consultants can offer specialist advice in niche areas. If you are a large fund or company then obviously you can attract people, but it is difficult to be a specialist on every topic.
There could be a broader choice of consultants in real estate, which in turn would promote competition and efficiency, we look for ours on a pan-European basis. The question of whether an asset manager could be regarded as a consultant is also a hard one. It’s an ongoing discussion - not only on the property side but also for equities. I know that there are some funds which are saying they want a consultant without an asset management arm. But if it’s well organised, and I know there are ways to do this, it shouldn’t be a problem to have an adviser which is also an asset manager.
You have to be transparent: for example, you have to make an agreement on the sort of funds that the adviser is going
to appraise. Maybe you have to agree that it can’t be any in-house funds and so on. Some investment consultants have sufficient experience in real estate to be able to offer best advice, but not
all. I think some of them can have a role in the development of the real estate sector and they’re actually doing that now.
You need to have a beauty parade for consultants and you have to sort out what type of company and man you are talking to: the independence of the advice depends upon your choice.
On the fee question I believe in a fixed fee rather than a performance-related one and I think we have received value for money from the consultants that we’ve used.
We tend to manage as much as we can in-house. In fact, in the sense that we also advise other pension funds you could say we are advisers ourselves. But we would use external advisers for niche markets such as property-based derivatives, for example, or new geographies that we’re considering investing into.
Merchant Navy Officers’ Pension Fund
We look after £3bn (e4.4bn) worth of assets, and we have a team of 10 of which only four look after investment administration. So it’s a small but select team and because of that, using investment consultants is useful to us, because they are able to bring the empirical view to bear. They also have the ability within their large research teams to be able to do things that we initiate, but could not do ourselves.
There are enough consultant firms out there for those who want to make a choice. The difficulty is that if you want a review, then the in-place person will have an advantage because they are known to the team and the trustees and there is a comfort level.
At the same time there is also some ‘electricity’ because the consultant has to deliver and this is where the market and ourselves are moving in trying to develop a means of measuring the efficiency of the advice over time.
I don’t think asset managers would want to be investment consultants. All our investment managers are aware of the other investment managers within our investment structure: they know that often they are competing head-to-head and they know they can come and talk to me if they want to change their mandate.
Some years back - when the derivative market had become liquid enough - our fixed income guys came to us and said ‘we’d like to be able to use derivatives but we can’t do so under our current investment manager agreements’.
We had a three-way discussion about this with the manager and the consultant, went to the trustees with everybody’s recommendation and the manager received the requested changes.
Recently, another manager asked for changes but these were turned down because we didn’t consider them appropriate. So it is an on-going dialogue.
Regarding most consultants’ level of real estate expertise, I can’t say. Our pension fund began investing in property in 1974 using an in-house team. It was only 15 months ago that this team moved out to become Wilky AM (while continuing to manage the Merchant Navy’s property portfolio). So I’ve never used an external consultant in this asset class.
Our pension fund consultants work on two fee bases at the moment, a retainer for one particular area of the business, and the rest of it is on an hourly rate. We debate whether they need to come to a meeting, if we don’t think they would add value then they don’t come. We’re looking at performance-related as part of the review of how we measure a consultant’s efficiency. If they recommend a manager to us, you have to look at what has happened to the fund alpha by moving from one to the other. But you’ve got to do that over a period of years, so you’re always looking at it retrospectively.
Consultants may play an important role in some areas but so far we have focused on developing our own expertise. The Finnish pension system is quite unique and deep in-house knowledge is needed in many areas.
Besides that, we have used independent research houses as investment consultants principally to challenge our own research and investment decision-making on a macro level, but not really on the selection of any investments. I find it very difficult to outsource responsibility in most of the investment areas in this environment.
When it comes to the question of what a consultant can add to a good in-house team, in the first place I would say a useful second opinion.
As I mentioned, we tend to emphasise in-house competence but in some areas - such as legal and tax issues - the need for a second opinion is clear.
In terms of the range of consultants, so far we have been happy with our in-house team plus the few consultants with which we have established a long- term relationship. We haven’t tested the market sufficiently to know if it’s large enough to “stimulate efficient, competitive service”.
I really doubt that an asset manager can be considered objective enough to be an investment consultant, there are too many conflicts of interest.
Do consultants have enough experience to offer best advice on real estate?
I tend to look at these situations on a case-by-case basis but I prefer to rely mostly on our own team. I truly believe in a long-term, in-house approach in this area as well. If we consider direct real estate investments local players do have a competitive edge and are highly needed. With indirect investments the picture is not the same: here the advisory role in legal and tax issues is more obvious.
The question of whether you are receiving an individual’s opinion or that of his/her firm is a difficult one to answer. But you do tend to see the same trends emerging everywhere, which suggests a certain amount of “herd instinct” or following of the company line.
Consultants are promoting real estate as an asset class but how effectively they’re doing this obviously depends on the service provider in question.