The trend toward using multiple consultants is expected to grow at large public and corporate pension funds, with increasing competition among consultants to win their business.
That was the consensus of a panel of executives in the pension fund industry at a roundtable discussion in November on the use of multiple consultants sponsored by Paradigm Asset Management, New York.
Participating on the panel were James Francis, chief executive officer of Paradigm; Ronald D. Peyton, president and CEO of Callan Associates, San Francisco; W. Allen Reed, president, General Motors Investment Management Corp., New York; Allan Emkin, managing director, Pension Consulting Alliance, Encino, Calif.; N. Anthony Calhoun, deputy executive director and chief financial officer, Pension Benefit Guaranty Corp., Washington; and Thomas K. Philips, chief investment officer of Paradigm. Michael Clowes, editorial director of Pensions & Investments, moderated the discussion.
While there has been a "flurry of activity among some of the large public funds," Mr. Peyton said, "the industry, by and large, has been and still is confused with the nature of consulting . . . and the notion that there is one right way to do things and one bit of advice that's correct, or there's only one good asset allocation if you can just find the consultant that can provide that, or one good manager, is erroneous. It's a marketplace and there are many, many ways -- hundreds of ways -- to do things right."
Mr. Emkin stated that "in my line, consultants are a lagging indicator, not a leading indicator that plan sponsors have changed . . . There's nothing new about multiple consultants . . . What's new is that plan sponsors in my opinion have said, `We don't necessarily want to buy a bundle of services. We want to go to firm X who has a real strength in a certain area and consultant Y in another area' . . . So the consulting business is responding to the change in needs, in my opinion, of the plan sponsor."
Mr. Philips added, "I suspect that at the largest plans, you will see this trend continue. For the smaller plans, which are sort of trapped, I suspect that the overhead associated with managing multiple relationships can often overwhelm the benefits one could get."
ROLE OF TRUSTEE
The discussion turned to the question of whether or not master trustees had developed the skills to take over many of the tasks previously done by consultants, given the technological breakthroughs and ease of compiling data now. Mr. Clowes asked Mr. Reed for his opinion.
"I think when it comes to performance measurement -- it's basic performance measurement -- there's no question in my mind that they should be doing that job," he said.
But Mr. Peyton said he doubted master trustees would be able to devote all of the necessary resources to do it.
"Boards, trustees, pension investment committees in corporations, mostly are lay people. And if we don't have someone taking that factual data, distilling the information out of it, gaining the confidence of the lay trustees, helping them go through a decision-making process, educating them to the point where they can make decisions on those facts, then you don't have anything," he said.
In particular, Mr. Peyton said he doubted master trustees would want to pay the high levels of compensation consultants that do this type of work command.
Mr. Francis questioned the efficacy of having multiple consultants doing a search to find investment managers for pension funds. "Where you're going to utilize multiple consultants to try to do a manager search, I would be a little bit concerned."
Mr. Calhoun agreed, saying, "having multiple consultants in a specific search is kind of counterproductive, I would think. If you don't trust what they're telling you, then why did you hire them in the first place?"
"Clearly each plan sponsor looks at the use of multiple consultants differently," said Mr. Emkin. He noted he had two clients "where they literally want their consultants to give thoughtful debate on almost every issue. And they use us as a sounding board . . . they're not looking for consensus."
HINDER OR HELP
But there can be problems with having more than one consultant giving advice on the same issue, he pointed out: "The disadvantage is if you don't have the right people, they'll be extremely petty and they'll bring things to a personal, not a professional level. Instead of facilitating decision-making, they'll hinder decision-making."
There was a consensus on the panel that it can be difficult for small pension funds to manage multiple consulting relationships. Mr. Reed said, "in our (GM's) case I don't really see any disadvantages, but once again, we've got the resources to deal with it . . . I think you could wind up with a real mess on your hands if you try to do that without having the internal resources to do it."
The question of "benchmarking" consultants, as there are benchmarks for money managers, and measuring their performance was brought up by Mr. Francis.
According to Mr. Peyton, the way to evaluate consultants, "is the same way you evaluate the professionals that work for you. You set goals and objectives. In the beginning of the year you have a work plan and you measure whether or not that work plan was accomplished."
However, he acknowledged the evaluation is "very, very subjective. There are no hard measures because a consultant does not have a discretionary role in a plan."
Mr. Emkin concurred, saying, "I think Ron has hit the basic issue, and that is the consultant really doesn't dictate investment performance."
At General Motors, the internal pension fund staff specialists who work with consultants do evaluate the consultants they use, according to Mr. Reed.
"We actually would look to them to give us their individual opinions which together would form a collective opinion with respect to one or more external consultants."
A medical metaphor, comparing generalist consultants to general practitioners and specialists consultants to specialist doctors, was introduced by Mr. Clowes.
Mr. Peyton said "one of the disadvantages for the specialists is that they don't have the total fund perspective. They don't know how things fit."
He believes it creates problems evaluating the performance of money managers.
Although pension funds may use specialists for a variety of areas, Mr. Peyton thinks it's important to have one strong general consultant overseeing the fund. "I think the biggest risk for anyone is to have two general-type consultants. If you have a general consultant who is responsible to lead the board through developing policy guidelines, asset allocation, management structure so that it's all coherent, then fine. Let specialists implement those plans. But the whole planning process needs to be handled by one general consultant in conjunction with the staff and board. Otherwise it gets very diffused."
The question of the cost of using multiple consultants drew opposite answers from Mr. Emkin, who said they would go down, and Mr. Peyton, who said they would go up.
"First of all," said Mr. Emkin, "they're going to farm out the commodity products to the low-cost providers, which, generally speaking, are custodians . . . And they'll get that very inexpensively. And then there will be price competition on some of the other services."
Mr. Peyton said costs would have to go up because of the huge additional costs incurred by consultants when they have to bid for projects. "You always lose money on clients the first two or three years of the relationship. And only after you get through that stage do you start to make money. Now, if you're gonna have to constantly resell every time, forget it. We'll find other ways to apply the resources. It just won't work unless the fees go up. And if the plan sponsors truly want second opinions and good advice and good work, they'll pay for it."
"The medical metaphor still carries," according to Mr. Calhoun. "More specialists, higher fees . . . The consultants cannot put their best, most expensive people into this declining fee base where they have to recompete for business."
Mr. Clowes asked if anyone thought those firm might shut down their consulting businesses completely, because the money management business was so much more lucrative.
"I don't think any of them will do that," said Mr. Emkin. "There's no economic reason for them to do it. It's still a revenue stream. They can still offset the cost associated with developing the research."
Mr. Clowes then asked if the trend to hire multiple consultants wasn't in direct contrast to the trend for most plan sponsors to cut the number of money manager relationships they have.
"I don't necessarily see there's linkage between how many managers you have and how many consultants you use," said Mr. Reed. "Once again, you get into
the definition about what is a consultant . . . To the extent you have an asset management firm, and let's say it's one of these broadly diversified firms . . . We see them as advisers, i.e., consultants, just as much as we would the more traditional consulting firms."
The competition from full-service Wall Street brokerage firms, with asset management divisions, came up. Mr. Emkin said, "In terms of just pure brain power, the consulting industry can't touch the Street.
"In the old days they (pension funds) relied primarily upon a pension consultant (for advice). That's no longer the case. The sources of good information come from Wall Street, from money managers, consultants and from the academic community," he added.
The future of the full-service consulting firm then was questioned.
"I think the larger ones will certainly survive," said Mr. Calhoun. "I think there's a need for independent advice. I think, as we were saying, it is difficult to take advice. You have to be careful in these larger plans, particularly, and public plans will run into it even more so. (Taking advice) from people that are also selling you something," he added.
Mr. Peyton said, "I see Callan's business as a very narrow niche in the marketplace. And that's being an independent third party with a strategic perspective. Our value added is that we're the only ones in the investment arena that don't have to have an opinion on what's the best strategy, who's the best manager, what should you do next . . . who is to serve the independent third-party role to try to be objective, to try to eliminate biases about who should do what and where and lead the client through a decision-making process that's rational and well documented and try to keep them on task with their goals and objectives." He punctuated his comments by saying, "Good consultants make their own markets."
As to small firms, Mr. Reed said: "I think the smaller firm that was focused on a niche area is probably the one that will be the most at risk . . . because they're gonna have competition on all fronts . . . on the other hand, a small firm that is providing general consulting, give us the right people in that role and I think they will create their own demand because that's a fairly rare commodity."
Mr. Emkin pointed out "the consulting business has grown with the largest bull market that we've ever known . . . No one's figured out yet what happens to the consulting business if we ever have a '73, '74."
Mr. Peyton, while pointing out the Employee Retirement Income Security Act went into effect in 1974, giving a huge boost to the consulting business, said, "I've always been concerned about the next down market because the first one, we weren't around to be blamed for."
GOOD NEWS BEAR?
Mr. Reed said he thought a bear market might be good for the consulting business because of the complacency now by plan sponsors caused by the long bull market. "Let's put negative returns in place for a couple of years and I think people will get much more focused and start looking for much better advice."
Mr. Clowes asked how the trend toward defined contribution plans and their large growth has affected the consulting business.
"There's a new wave building and that's defined contribution," said Mr. Peyton. "I predict in five years, more than half of Callan's revenue will come from defined contribution because those funds have to be made right in terms of policy, due diligence, documentation."
Mr. Emkin said, "I think that the pendulum's gonna go the other way and there will be a recognition, particularly if there's a bear market, that the defined contribution plan isn't such a wonderful thing from the employee perspective."
"You may see some changes in the world of defined contribution at some point in the future, as more people have come to rely on them as a major vehicle," said Mr. Calhoun.
"I think there's a new school of thought evolving that the plan sponsor has just as much obligation to his defined contribution plan participants as they do to the defined benefit plan participants," said Mr. Reed.
Mr. Emkin pointed out plan sponsors should be "very concerned" about liability from their defined contribution plans if participants don't get the expected returns. "We're a litigious country," he said.