Global investment consultant Watson Wyatt is on the brink of entering a business it not so long ago decried. It is about to step on the line which many feel Frank Russell has overstepped, and frankly, it is going to make quite a few asset managers feel very uneasy.
The consultant is in the latter stages of research and development into its Structured Alpha approach, a quant model designed to reorganise a pension plan’s portfolio to make it more efficient in terms of risk and return combined with a manager selection and monitoring process.
In essence, the model takes a pension fund’s entire portfolio and div-ides it into three layers; passive, active and satellite, the passive layer being the core part of the portfolio. Within those layers are Wyatt’s suggested managers, selected on the basis of their risk and return characteristics. Once the managers are reviewed and implemented by the pension fund, the consultant will monitor them and take appropriate action should the managers not come up to scratch. It is important to note here that while Watson Wyatt will not be the party who physically fires the manager (that decision is still taken by the trustee), the consultant’s increased responsibility in the manager selection process will be significant.
This enhanced responsibility is re-flected in Watson Wyatt’s renumeration: Structured Alpha will be run on a performance-related fee basis. “Our renumeration will be judged relative to how the satellite layer behaves,” explains Tim Hodgson at Watson Wyatt, who is heading up the programme. “At the moment it is just the satellite layer because the way the clients have gone is to say ‘yes we will have an internal executive responsible for this,’ but it is recognising our greater input. We have a bigger say in ‘you should hire that one’ or ‘you should fire that one’ and it is just linking our fees to that.”
Structured Alpha and Frank Russell’s latest initiative, Russell Integrated Asset Management (RIAM), both share the ultimate aim of greater control over a pension fund’s assets. Sedgwick Noble Lowndes (SNL) is another case in point with its multi manager funds. Since the Mercer merger, however, it is unclear what the strategy will be, whether the SNL approach will be rolled out to Mercer’s impressive list of large pension fund clients. According to Andrew Kirton at Mercer, the company is carefully considering its options. “There is a review under way where we have to reach decisions whether we go with that or not,” he says, adding, “But that is a potentially exciting area in which we might stay.”
Watson Wyatt’s initiative bears more than a passing resemblance to the RIAM approach outlined by Ken Ayers at Russell: “An integrated whole that includes multiple asset classes as well so we are one provider, providing all of these specialist sectors and managers in agreed proportions based on a consulting type of asset allocation strategy.” The only real difference between the two is that Watson Wyatt will not be offering its own investment products to accompany the service, something which it be-lieves keeps them on the right side of that line which has caused a fair deal of controversy. When is a consultant not a consultant? When it is a money manager, it seems. And many in the industry believe that is what Russell has become, not least Watson Wyatt.
“There is an obvious parrallel be-cause there is enhanced responsiblity on our side,” admits Russell Smith at Watson Wyatt. “But the crucial difference is that we still act in an advisory capacity when it comes to selecting managers and, even if our clients want to pay us a performance-related fee, ultimately they sign the legal agreement with the managers. You could argue that there is a fuzzy line between these two approaches but I would probably be a bit firmer and say however fuzzy the line, once crossed you are no longer an independent consultant - you are a money manager.”
The fee issue is evidently a sensitive one, though it would seem to be more for the consultants than those using them. As far as the clients are concerned, as long as they are getting a cost effective deal and improving their spread of managers and asset exposure, it should not really make a great deal of difference how the fee is calculated, as long as it is agreed by both parties on the outset.
Russell recently won its first two RIAM mandates from the UK Compass pension scheme and the Fiat Common Investment Fund, both wins valued at around £100m (E145m) each. Russell believes the savings in benefits both in time and money have worked in RIAM’s favour. And from Compass’ perspective, RIAM won them over largely on the fee aspect, as the fund’s trustees were keen to exit the balanced arena, but lacked the re-sources to employ specialists.
The one concern for the asset managers of course, is that long held relationships with clients will be at risk with these new approaches. Though Watson Wyatt sees it as a fear which is unfounded. When they approached asset managers with the idea, the larger houses understandably percieved it as a threat, despite Hodgson noting that the passive players “loved it”. But the larger balanced managers need not fear, apparently, thanks to the levels of familiarity which is of obvious comfort to trustees. “If all that clients were interested in was re-turn per unit or risk you wouldn’t necessarily look at them, because we are claiming that satellite managers have more return per unit of risk,” argues Hodgson. “But in the real world, people aren’t like that, they do get comfort from brand names.
“With the best will in the world we cannot ask trustees to change their big brand name managers overnight be-cause they have built up a long term relationship with them and therefore it would be unfair to relate our fee to their short-term performance.”
At the end of the day, all that really matters is, does it benefit the pension fund? The main reason behind Watson Wyatt’s initiative was partly based on the fact that the UK market has been traditionally dominated by a very small number of asset managers, which, Hodgson believes, has been detrimental to performance. Fair enough comment, perhaps, if only the consultants who control up to 90% of the pensions market, weren’t the ones who kept on selecting them in the first place. It was for this reason in fact that the Compass pension plan opted out of the traditional beauty parade circuit to go into RIAM, that it was growing tired of the ‘flavour of the month’ being paraded around.
But for one large asset manager, the main factor pension funds should keep in mind in all of this, is that consultants can monitor the managers, but no-one is monitoring the consultants. “How would the consultants be measured in this venture?” he says. “What metrics would be used by the clients to assure themselves that they are getting a good job of their work done? That has always been an issue with consultants selecting managers, that nobody ever seems to measure the quality of their advice.”
But for Russell, the evolution of the consultants has been a natural one, and for Roberts at Compass, they are in the best position to offer this kind of service. “They are much better positioned than any trustee body to be able to identify whether investment managers are coming off or are rising.”
Structured Alpha is expected to be officially launched and marketed to Watson Wyatt’s target markets, the UK, Netherlands and Scandinavia, in the coming months. The pre-launch activity bodes well for the consultant - it is already in the process of implementing the approach with a “couple of large UK clients” as well as two funds on the continent. Rachel Oliver