Survival of the fittest
If there was ever a time when pension funds needed good advice, it is now. Rock-bottom funding levels and regulators’ efforts to boost them have spurred trustees to seek expert help. New business is always good, but consultants now find themselves competing even harder for new ways to beat rivals.
“We have noticed somewhat stronger competition in the last two to three years and a growing number of players in the market - in the German market in particular,” says Bernd Haferstock at Buck Heissmann in Wiesbaden.
In the Nordic market too, competition between consultants has intensified, says Jan Bernhard Waage, managing director of Wassum Investment Consulting in Stockholm.
In addition, more multi-managers are now offering both hedge and long-only products, and banks and asset managers are also offering consultancy services as part of their regular product offering - ALM services, for example, he says.
“Clients are asking for more integrated services from providers,” says Waage. “They do not just want one-off advice, they want continuous advice from an independent adviser.” There is now a battle between providers to get into that position, he adds.
In Germany the rise in pressure is partly due to the increase in demand for consultancy services over the last three years, says Haferstock. “This growing demand is driven by more stringent supervisory requirements,” he says.
And even in areas not directly affected by new rules, such as contractual trust arrangements (CTAs), management and controls have become more professional, especially within risk management and investment organisation, he says. The most recent Heissmann Investor Study showed that within the insurance and pensions sector strategic asset allocation was the basis of investment policy for nearly 90% of respondents. And of that 90%, 80% said that they had used ALM in setting the strategic asset allocation.
“This is a fundamental change from the situation five or 10 years before, since it was still being discussed at that time whether ALM even made any sense,” he notes.
The study also showed that at the same time, investors were very consciously and directly seeking the independent advice of a third party - an investment consultant - to get help with these issues, says Haferstock.
“Above all, this means having a comprehensive overview of the systematics of both liabilities and assets,” Haferstock adds.
Being able to offer international services is now key to a consultancy’s success, says Waage. “With multi-national clients, a global offering is increasingly a very important issue.”
So linking up with firms that cover other parts of the globe can help the more locally-oriented firms compete. Wassum is part of international network Hewitt Wassum Investment Partners, an alliance with Hewitt Associates.
Such links can work very well for consultancies, says Waage. But there are some pre-requisites for a good alliance. “You need to have the same basic values,” he says. “It’s a great advantage if you can share databases and IT-systems. But above all, you need to make people want to work together.”
Swiss consultancy Pendia Associates was bought by Mercer Human Resource Consulting last July. “Pendia was one of the few remaining Swiss-only operators in this market,” says Mike McShee, who is in charge of market development at Mercer in Switzerland.
The needs of Pendia’s client base were the main force driving the firm towards the Mercer merger, he says. Many of Pendia’s clients are multinational corporations and they increasingly wanted a firm that reflected their strategy, he adds.
Identifying what is important for clients and setting about finding answers is essential for consultants if they want to add value. In Switzerland, says McShee, Mercer sees pension fund governance as a very hot issue right now.
“Pension funds are under multiple pressures to have a proper process - a provable, demonstrable process - and to establish good governance,” he says. The Swiss investment industry has been hit by scandals around insider trading and kickbacks from investment vendors.
“That’s an area where we are finding pension funds need our help,” he says.
The way consultants have traditionally charged for their services puts them at a disadvantage, too. “The hourly rate-based business model has a structural disadvantage compared with basis points based structures,” says Erik van Dijk, CIO and partner at Compendeon Pension and Investment Management in the Netherlands. Hourly-rate fee structures do not allow increased costs to be transferred easily to the client, contrary to experiences by asset managers, he says.
Apart from the fee issue, an increasing number of asset managers are including advice as an additional, free, service, and this puts more pressure on the consultant’s business model, says van Dijk. At the same time, clients have adopted a more cost-aware attitude because of the pressure on surpluses, due to low interest rates and the higher valuations put on their liabilities, he says.
“If we add to this that international borders have become less important - with consulting firms acting more internationally, even the ones that were previously mainly local - growing numbers of consultants are fighting for the same clients, while the number of pension plans itself is not growing,” he says.
Advisory firms are fighting back. Compendeon has plans to add more value to its services, starting with a new payment basis. “We intend to provide clients with a ‘put our money where our mouth is’ option on the asset management advisory service,” says van Dijk. “We charge a relatively low fee, based on a calculation of hours worked, and agree an expected level of alpha generated through the advice with the client.” The firm’s consultants then receive a bonus when realised alpha exceeds expected alpha, he adds.
In addition, Compendeon will increasingly offer fiduciary consulting services, where it ‘sells’ breadth of knowledge, says van Dijk. This means a shift away from the detail towards top-level advice that is directly related to the overall result - asset and liability management and governance - of the pension plan, he says.
Paul Trickett, head of Watson Wyatt’s European investment practice, agrees that the delivery of consultancy services is changing. It is partly because of competitive pressure, but also partly in response to demand from clients, he says.
“The nature of the work is changing in that it’s more prescriptive,” he says. He also sees a move away from fixed hourly rates towards different fee models. While most work done is still paid for on an hourly charging basis, in some cases a project carries a single fee and some fees are performance related.
“In order to recruit and retain staff, we have to compete with the asset management industry,” says Trickett. In rising financial market conditions, consultancies cannot compete in pure remuneration terms, he says. “But we do need to see some shift in our business model,” he adds.
Although international consultants do have advantages over smaller, local firms in more traditional asset classes or components of the overall activity, their edge only holds if they are capable of keeping the best people in, says van Dijk. But he questions whether they will ultimately be able to.
“It is especially the larger consultancies that lose bright people to asset management firms,” he says. “This creates opportunities for smaller, specialised, domestically operating boutiques.”
Last year, Compendeon formed a co-operative alliance with Feri Insitutional Advisors in Germany, with the intention of creating an international network of local and alternative specialists who could cooperate and share knowledge. The firms have said their link-up is designed to be open to other partners as well.
Trickett sees alliances between national consultancies as a viable way for them to compete with international firms. But when the number of firms in a network rises to six or seven, the management effort required can be much harder, he says.
But while the squeeze is on for European consultancies, there are new opportunities too. The emergence of new markets, such as those in eastern and central Europe, will serve to compensate firms for lost business, as will the growing need for structured-finance products to cope with longevity risk and other problems on the liability side, says van Dijk.