Looking into the crystal ball

Industry experts say a fundamental shift is under way in the way pension funds make use of their consultants. In 2010, schemes will rely more than ever on their advisers, requesting more services, and more proactive advice. Consultants around the world agreed that pension fund managers want their advisers to come to them with more forward-thinking innovations. 

But questions arise about whether or not consultants have the capability to offer more forward-looking analysis. This could lead to an increased use of third-party providers to work alongside consultants. Furthermore, some industry experts questioned the validity of demanding analysis regarding short-term opportunities from those meant to provide the scheme with long-term stability. 

When asked what the biggest change will be in the relationship between pension funds and their consultants, industry experts believed there is a real need for increased proactivity. 

Mercer head of European investment consulting Tom Geraghty said: “We’re going to have to be much more proactive in the advice that we put forward to plans... There’s a clear need on the part of clients for advice on what some of these short-term opportunities are... We haven’t done enough of that in the past.”

Outside observers noticed the same trend. Schroders head of strategic solutions Neil Walton said: “Consultants’ interaction with pension funds is changing dramatically. There is a strong move to increase proactivity and lead pension clients to be more opportunistic in their asset allocation. The aim is to make clients more responsive to investment opportunities as market conditions change.” 

Working hard

Pension funds only had to look at the spate of research reports on corporate bonds and convertible bonds in 2009 to see that consultants were taking advantage of the dislocation in the markets to get their clients’ assets working harder for them. 

For nearly every consultant to be telling clients to buy corporate bonds “partly reflects the extent of the dislocation in the markets, but also a drive to be more proactive,” Walton added. 

KPMG partner and head of investment advisory Patrick McCoy said: “In difficult times they need more handholding, analysis and proactive, clear advice.”

McCoy recently received a request for proposals from a pension fund looking to replace its investment consultant. He said the wording was typical of the types of request for proposals the firm has been receiving lately: “We found the advice increasingly reactive instead of proactive and are looking for other services.” McCoy declined to name the scheme. 

At least one pension fund manager said this will lead to a long-term shift in the way consultants operate. 

California Public Employees’ Retirement System fixed income portfolio manager Eric Busay said: “The market is forward-looking more than backwards looking. Consultants have typically been study-oriented, which implies backward looking. The skill set of the future will have to include a forward looking component. I think you will see consultants being more forward looking because of this.”

Busay anticipates more pension funds will incorporate the use of third parties to work alongside consultants when making investment decisions. In some cases it could be the asset managers, or other types of analytics providers.

Walton’s team at Schroders works with consultants and pension funds in what he calls a “tripartite approach” that brings together the skills of the three parties to develop a strategic investment plan for the pension fund. 

He said interest in Schroders services has come from both consultants and pension fund clients, and that “inquiries have gone up. It has increased, definitely.” 

Other providers have benefited from the increased need for deeper analysis on asset manager performance. As pension funds take stock of their losses, recent studies have shown that manager replacement activity is on the rise. 

In a survey of 63 plans across Europe and North America, the independent financial consultant bfinance found 62% had either reviewed their managers or put them on a “watchlist” for an average of over one-fifth of their total assets under management.

And while an average of just 7% of assets under management have been switched to date, bfinance managing director, head of research and development Olivier Cassin said he expected this figure to increase in 2010 as reviews were completed.

Under analysis

Consulting firm Inalytics is benefiting from the increased scrutiny on manager performance. The firm works alongside traditional investment consultants and uses quantitative analysis to sift through the asset managers’ holdings and trade data to get a better sense of what drove performance. 

“Over the last 18 months,  pension fund clients have come to realise that the current tools used by their investment consultants to analyse their portfolio diversification, risk profiles and investment manager performance need to be augmented by newer tools that enhance the discovery process. We pick up where investment consultants leave off, creating understanding of skill through forensic evidence,” said Inalytics chief executive of North America Lisa Manuele. 

Company-wide, she said revenues were up 95% in 2008 and 50% in 2009, with the number of clients up by a quarter last year. Firm-wide, 65% of Inalytics’ clients are pension funds, with the rest being investment managers and hedge funds looking for analysis on their investment strategies. 

Despite the chance consultants may have to share the stage with third parties, industry experts agreed their roles would not be decreased or reduced. On the contrary, many have said their roles have been enhanced and pension funds depend on them more than ever.

Towers Watson head of investments for the Europe, Middle East and Africa regions Paul Trickett said the schemes most likely to use third parties will be large, sophisticated pension funds with the capabilities to cope with multiple strands of information. 

“The picture’s quite complicated. There are quite a number of funds growing their own investment teams and as a consequence, growing into themselves,” he said. 

For the rest, however, they’ve come to increasingly rely on consultants to deal with complex issues like longevity risk, mortality hedging, options strategies, and generally looking for new asset classes. 

“More and more our services are being requested,” agreed Wilshire Associates president Julia Bonafede. At least 50% of Wilshire’s new business in 2009 came from pension funds that hadn’t used a consultant in the past. 

She said clients are also increasingly demanding the use of the firm’s analytics capabilities. “It’s been more of a priority for our clients right now. It’s looking at how risk is managed throughout the operation. You can do that on a returns level, but now clients are saying, ‘we really need you to dig into this’.” 

Exploiting asset classes

In response, at least one consultant has reorganised its staff and operations to develop expertise in individual asset classes. In April, Mercer announced it had divided its manager research team into individual boutiques that would specialise in specific asset classes. 

“Internally within Mercer we are becoming increasingly specialised. This reflects the growing need we see across our client base for more in depth expertise in research across various asset classes,” said Geraghty. 

But the focus on additional services and more forward thinking advice has led to a blurring of the lines between consulting and money managers. Some industry players cautioned against placing money-management type-demands on advisers meant to position a scheme for long-term health. 

“It’s very easy to say consultants have been reactive. During the dislocation, nothing was pricing... We were trying to help clients navigate those losses,” said Bonafede. 

“We look at all asset classes over a ten-year period. Nobody knows what the next big investment is going to be. Consultants are not money managers. We’re not out there trying to decide where the next alpha is,” she said. 

Managing clients’ expectations will also become harder, said Busay. “Consultant always need to have an answer, and it has to be an answer that’s defensible... That may be trickier in a forward looking world …The critical issue will become, not only are you right, but are you right within a certain period of time.” 

Geraghty described the new relationship between consultants and pension funds as a balancing act. 

“(Clients) want more of a partnership, they want more innovation in our consulting with them and to hold us more accountable,” said Geraghty. 

“We’re either going to be accused of not being proactive enough, or being proactive and getting it wrong... I’d rather be accused of proactivity rather than not putting the idea to our clients,” he said.