Consulting firms have wrestled with conflicts of interest ever since they started competing with money managers through their manager-of-managers programs. The result has been a sometimes uneasy detente.
In a Feb. 16 round table on the future of the investment consulting industry, panelists delved into the nature of these conflicts — both real and perceived. The upshot: The tensions are still there, and both sides are impinging on each other's turf.
Round-table participants were:
• John J. Haley, chairman and CEO of Towers Watson & Co., New York;
• Jeffery J. Schutes, a worldwide partner with Mercer Investment Consulting Inc., Chicago;
• Richard M. Charlton, chairman and CEO of NEPC LLC, Cambridge, Mass.;
• Myra R. Drucker, former chairwoman of the Commonfund and former chief investment officer, General Motors Trust Bank and Xerox Corp., Bethel, Conn.
Joel Chernoff, Pensions & Investments' executive editor, moderated the discussion, which took place at P&I's New York office.
In the following excerpt, the panel discussed how consultants wrestle with the conflicts of building their businesses and being good fiduciaries.
Joel Chernoff: Manager-of-managers programs have long been a source of tension between managers and consultants. How do you address the conflicts that exist when you find yourself competing against the same managers that you're evaluating?
Jeffrey Schutes: The purpose of the fund of funds was never to go out and sell a product. It's a solution. If you look at every one of the clients that they have in the investment management group or the fund-of-funds group, they're all defined benefit clients of the retirement side mostly or sometimes in implemented consulting.
So we're not out actually competing (with the Fidelities of the world). We're not in there trying to pitch a large-cap growth or a large-cap value fund or a bond fund or anything like that. That's not the market. That's not why we have the business. ...
But to your point, I think you can always derive potential conflicts when you have a business like that. From a consulting perspective, nobody in the consulting side of our business will ever offer up an investment management product or fund-of-funds product. That's first.
Secondly, we are very clear that when we do engage an investment management firm, that it has no influence on research or on anything else that we do. So we try to make sure that we're aware and sensitive to whatever potential perceived conflicts there could be or real conflicts and address them.
But the key thing ... is the strategy (is) part of a broader solution: It's not really trying to sell a product, and to us that differentiates it.
Mr. Chernoff: Do the managers feel the same way?
Mr. Schutes: I think so.
Mr. Chernoff: Or they're not going to tell you.
Mr. Schutes: Maybe not. Frankly, the majority of our consulting staff is not even aware of which managers are in the investment management program. We've worked really hard to try to make sure that we have a Chinese wall there.
Richard Charlton: We prefer to offer investment advice recommendations for a fee and leave it at that, be it on an implemented-services basis or through the traditional model.
We ... have been grappling with how to offer higher-fee levels of service without exposing ourselves and prospectively our clients to potential conflicts of interest. We think we've had some interesting ideas there that have application and will make a difference in the marketplace, but the only way we're going to advance those is if we can go out to all of our clients today and all of our prospective clients and basically demonstrate our objectivity.
Mr. Chernoff: Why have you shied away from that business?
Mr. Charlton: Our business has grown extraordinary well, as our colleagues are aware, and we have a good reputation in the business, and we're extraordinarily interested in maintaining that reputation.
We have 20 of our former competitors working for us right now, which I think is quite a statement. ... When we sit back and take a look at our success, is it because we're really good, or is it because we're unconflicted, or is it because of both? We don't know the answer, and it's kind of an important question.
So we're sorting our way through this. We are kind of enthusiastic with some of the ideas that we've come upon, and I think we're going to have some fun with it.
Myra Drucker: I think that the manager-of-managers business can be a plus or a minus for the consulting firms to have, from a client's point of view.
One of the things that has always been frustrating to me as a prospective client of consulting organizations is to understand how good are their investment recommendations. One of the ways that you can find that out is by being able to actually look at a track record of managers that they have put together.
On the other hand, I will tell you that as a client of consulting firms that had manager-of-managers programs, I often felt that they were stealing some of my best ideas. That instead of being proactive about finding the really interesting new manager in a certain asset class, they would watch where their biggest clients went, and then they would do the research, and then they'd take up capacity in that manager by putting him into one of their funds of funds. ...
As the chair of an organization that had manager-of-managers programs and also sold some of its programs through consulting organizations, there was a tension there. There was a concern on the part of the consulting organizations that this organization was taking their business and vice versa. And that's the story of this business.
There's this kind of creative customer-competitor-consumer spectrum that we all live (with), and I think different firms manage it differently. Most of the investment managers that I know feel (strongly) enough in their own capabilities that they don't worry too much about the consultants working against them or competing against them.
As a client, again, I would want a consultant to be getting all of the good information that they can from each investment manager to color their points of view, and then synthesize that in their own way in bringing that back to benefit me.
Mr. Charlton: So there are two dimensions here, it seems to me. Let me stir the pot a little. There's the competitive aspect: Can the consultants put a product out there that competes effectively against the money managers? And then there's the ... other side of the coin where consultants are a conduit, and ultimately, a vehicle for the placement of the product.
So the question I would pose is: Fine, I'm very willing to compete against a money manager, number one, or I'm very willing to profile a manager's products, number two. I'm not sure I should do (number) one — that is to say, help the manager gain market share, gain revenue, so on and so forth. Why are all the managers trying to put me out of business? Help me out with that.
And we have this debate internally a lot. Believe me. And I'm told the prudent-man rule says you have to put (the) best product out there in front of your clients. And I'm saying well, I understand that up to a point.
Mr. Schutes: But they're working against you on the other side.
Mr. Charlton: If they're trying to put me on the sidelines, why do I have to help them become bigger and bigger?
Ms. Drucker: And I think the question is about whether you think that you've got the best solution for your client and are you giving your client access to the best solutions as you should be in the marketplace? So if you think that this firm with whom you have a potential marketing conflict is trying to put you out of business, but they're the best in their niche in the market ...
Mr. Charlton: And do we ever have that conviction on a product or do we put a search book together with four or five products and say, “Well, these we think are best in class, and by the way, one of them happens to have a competitive product that is part of our consulting offering.”
Ms. Drucker: Right. I understand. You know, these are issues that we're all faced with every day.
Mr. Charlton: For the record, we are committed internally to walking the fine line and offering best-in-class products. But I am struck by the apparent contradictory nature of the relationship.
Ms. Drucker: The other piece is (that) for many consultants having manager-of-managers products ... is a way that they get to implement their best ideas sometimes for smaller clients or for clients who want to do a semi-outsourcing solution.
And in that case, again, you need to be looking at what are the best in class that you can offer to your clients who are doing that.
So I just think that these sorts of tensions have persisted since I've been in this business, which is 30 years or so, and they will continue to persist, and they will only get more (prevalent) as we go toward more of these outsourcing (solutions).
John Haley: We don't do manager of managers as a product. Within (our implemented consulting unit), we do sort of a bespoke manager of managers. We're set up to do that for the large complex organizations, but we don't have manager-of-manager products. ...
I think to Myra's point, though, there are conflicts that have been here and (are) longstanding, and managers do compete against consultants in different aspects of this, so I don't see any reason why they should be afraid of consultants putting together things like this here. That seems fair.
And for potential conflicts, which are just all over the place, I think you need transparency. You need to let the clients know what's going on.
Mr. Schutes: I think all of us are feeling competition ... from investment management firms who want to step into certain areas. Some of them want to be — like from the (investment bank) side, they think they want to do the risk budgeting and the (asset-liability management) studies. There are some firms that want to develop glidepaths for customized DC funds. Frankly, I'm a little bit with Dick. Why do I want to put them in some place where I'm potentially going to lose revenue, you know?
Mr. Charlton: And I'm struck by the question: With the margins of the industry being what we all complain about every day, why the hell do they want in?
Mr. Haley: It's mind-boggling.
Ms. Drucker: But let me step back and say that in some cases, some of the best consulting that I ever got when I was on the plan sponsor side was from investment management firms. And it was consulting that, at the time, my standard-issue investment consultants were not equipped to do.
So if I go back to the '90s, some of the earliest asset-liability stuff with a real understanding of the asset side, I was getting “free” — I put that in quotes — consultative advice from some of my larger asset management firms who had very, very good in-house capabilities that were far more attuned to the issues I was grappling with on the investment side than were those of the large actuarial firms.
Mr. Haley: If you're just thinking about potential competitors out there, too, though, if you do the best job you can for the client every day, in the long run, that's your best work against competitors.
Mr. Schutes: That's exactly right.
Mr. Charlton: But the progress that we've made within the consulting industry — at commanding higher fees, for example, and truly meriting those fees — I think begins to put some distance between us today and where we were then. You couldn't have been more spot on with your comments. If I look at our organization 10 or 15 years ago, there's no way that we could have competed with a money manager for that kind of advice. Today, we have five actuaries on staff. My God.
Ms. Drucker: It's very different.
Mr. Charlton: And our research capability is a quarter of our head count right now. Our firm is so dramatically different now than it was, and our ability to get higher fees and to move into the more attractive and complex space in the business has certainly facilitated that capability.
