Consulting firms are increasingly chasing higher profit margins by crossing the line between recommending investments and actually managing them.
A growing number of consulting firms are entering the investment management sector in varying degrees, from establishing manager-of-managers programs in what they see as an evolution of their pension consulting capabilities to establishing separate money management firms.
SEI Corp., Wayne, Pa., recently announced it was launching an equity management firm as a joint venture with three economists, Josef Lakonishok, Andrei Shleifer and Robert Vishny. The firm, LSV Asset Management, to be headquartered in Chicago, will be a contrarian value manager using a quantitative stock selection model to screen out-of-favor large capitalization stocks.
SEI also announced recently it is separating its asset management and consulting activities into separate units in the first quarter of 1995. The new SEI Asset Management unit will include the SEI investment management team, its investment research and strategy group; asset management services, its product management group, and a new institutional sales and service team. The consulting services and performance measurement functions will be housed under the SEI Capital Resources unit.
Buck Consultants, New York, and Effron Enterprises, Port Chester, N.Y., also are joining the money management arena with manager-of-manager programs later this year. Neither firm would talk about their products, citing Securities and Exchange Commission regulations, but both are setting up separate divisions to handle the new programs apart from their consulting operations.
Buck's fund-of-funds division, Buck Asset Management Services, is expected to start before the end of the year and will initially offer a large-capitalization domestic equity fund (Pensions & Investments, June 13). Effron applied in July for SEC registration for its program, Effron Common Funds Inc. Albert M. Shagory, formerly managing director of the IBM Corp. Retirement Fund, will be president of the new venture, which will offer a variety of funds. Minimum account size will be $10 million. Fees will normally be below 1% of assets and will not exceed 2% of assets.
Although Buck, Effron and SEI all plan to remain in the consulting business, other firms are phasing out consulting in favor of money management. Collins Associates, Newport Beach, Calif., has withdrawn from consulting to emphasize its 4-year-old fund-of-funds program. The firm has brought in no new exclusive consulting clients since 1990 and now maintains consulting relationships only with some of the clients in its manager-of-managers program (P&I, April 4).
When asked why they are entering money management, most consultants invoke Willie Sutton's famous rationale for robbing banks: because that's where the money is. Christopher A. Nowakowski, president of InterSec Research Group, noted at a recent conference that consultants' after-tax profit margins are 5% to 15%, while managers' margins are four times larger.
While the pension fund management process is becoming more complex and corporations are increasingly outsourcing many functions - creating more work for consultants - other trends are combining to decrease the consultants profit margins, according to Mr. Nowakowski.
Trends driving down profit margins for consultants include a growing perception of traditional consulting products - asset allocation, manager searches, performance evaluations - as commodities. Also, the ease of entry and the rise of star status among individual consultants is leading more senior staff to break away to start their own firms, and the additional competition is causing more pricing pressure.
Revenues from traditional consulting have matured, according to J. Gregg Buckalew, director of Wyatt Investment Consulting, Inc., Atlanta. Speaking at a recent conference of the Association of Investment Management Sales Executives, he said there is declining price strength in consulting and more confusion among clients about how services add value. Mr. Buckalew noted that banks and trust companies now offer consulting services such as databases and performance universes - and while they are not yet performing managers searches, that is a logical next step.
Most consultants agree their profit margins from their project work can't compare to the asset-based fees charged by money managers. More importantly, money management assets generate fees continuously, while projects are spotty fee generators.
"The consultants hate the projects: 'Do this project and maybe we'll talk next year about another one.' They want to have an annuity, a regular income you can depend on," said James Angelone, a principal at Buck Consultants and head of the new manager-of-managers program.
For consultants going into money management, barriers to entry are just as low as they are for everyone else and the profit margins just as high. Mr. Angelone noted the economies of scale: He estimated a money management firm can double assets under management without adding more than 10% to 20% to its client service expenses, while a consultant would have to add more expenses in additional staff and office space to do the same.
If anything, consultants note they have an advantage in that they're already equipped to do funds-of-funds as extensions of the manager search and evaluation work they've been.
"If you can pick managers for a client and the client has faith in you, the evolution is there," said Barry Effron, president of Effron Enterprises.
"What's happened is, the consultants realized that they can pick managers, monitor managers and provide a value-added (service) at an economical price that will allow them compete in the market, like a mutual fund," he said.
Much like mutual funds, which have attracted investors by creating pools of assets, the funds-of-funds can create pools of assets that can be managed more economically than separate accounts and give the consultants a competitive advantage, he said. The outsourcing trend in corporate America has helped the process along, said Mr. Effron, as funds-of-funds provide sponsors with a cost-conscious alternative to running assets in-house.
Sponsors are increasingly squeezing fees for consultants, custody and trust work and weeding out their manager rosters in favor of multiple-assignment managers, said Mr. Angelone. Those developments all open the door for consultants to offer one-stop shopping in a manager or managers approach and bring in higher revenues, he said.
The development of funds-of-funds was a more natural progression for the asset allocation firms than it has been for the actuarial firms, said Mr. Angelone. On the defined contribution side, nearly all major actuarial consulting firms - including Towers Perrin, Kwasha Lipton, Hewitt Associates, William M. Mercer, Buck and others - have created alliances with mutual fund companies and money managers to offer 401(k) services, but the defined benefit side is still a new area for them, he said.
But not all consultants are rushing headlong into the money management business. Many maintain their business is not disappearing, merely changing into a more strategically minded advisory service, offering clients expertise beyond services that have become commodities.
The consulting business as it had been defined before - in terms of information and data - has not been very profitable, said Terrence M. Overholser, managing director-consulting of RogersCasey, Darien, Conn. But rather than seek to boost profit margins from money management, RogersCasey is seeking out new pools of capital, such as hospital investments and nuclear decommissioning funds, and developing new areas of service in education programs, technology and other competencies, he said. The challenge to consultants is to stay ahead of the curve in providing knowledge to the client, said Narayan Ramachandran, managing director-research of RogersCasey.
Mr. Nowakowski noted that in the long term, consultants going into money management will have to compete with large firms, like Fidelity Investments, which are increasingly targeting the same market. The multiproduct firms will present a tough challenge, thanks to their own asset allocation experience, which includes the global capabilities sponsors increasingly crave, as well as deeper pockets than their consulting competitors, said Mr. Nowakowski.
Another challenge will come from the potential for conflicts of interest that arise from a consultant competing with the money managers it evaluates for clients. Managers are reluctant to bring up such complaints because they depend on consultant recommendations when seeking pension business, but many complain privately about the inherent conflict. Concern about conflicts of interest is not overwhelming, said Mr. Effron. Most consultants are honest professionals who know they are staking their reputation when they recommend a product to a client, he said.
In the end, the consulting firm depends on its reputation to retain clients, said Mr. Effron. Since they don't have any index to measure their services against, as money managers do, they can be driven out of business if they're perceived as engaging in questionable practices, he said.
"You know what my benchmark is? My benchmark is: if I screw up, the entire pension community hears about it in one day and I'm out of business," he said.