State of the industry: flux

An increasingly complex array of client needs and a looming wave of generational change are placing the investment consulting industry in a state of considerable flux that could spur further industry consolidation.

This year's biggest combination involved Hewitt Associates' purchase in July of Ennis Knupp & Associates to form a market leader with combined global assets under advisement of $3.82 trillion.

But the trend appears to be continuing as 2010 draws to a close.

Mercer Investment Consulting Inc., with $3.7 trillion in global assets under advisement, announced last week it was acquiring Hammond Associates in a move designed to give the corporate pension plan advisory giant a foothold in the fast-growing endowment market segment. (See related story on page 2.)

Amid the lessons investment consultants are trying to glean from the global financial crisis and the spate of regulatory changes resulting from it, “the velocity of change has definitely increased,” said Janine Baldridge, global head of consulting and advisory services for Seattle-based investment consultant Russell Investments.

That change is spawning opportunities for consultants, but challenges, too, as firms face pressure to add the resources needed to cover the growing range of generalist and specialist topics on which clients are seeking expertise, Ms. Baldridge noted. She cited growing interest in more dynamic — as opposed to traditional static — asset allocation policies as one of the newer trends consultants are working to master.

Clients are considering an unprecedented range of options in structuring their investment programs, and that has left every investment consultant “expanding and growing their teams,” noted Stephen Cummings, CEO of Lincolnshire, Ill.-based Hewitt EnnisKnupp Inc.

Mr. Cummings said Ennis Knupp's tie-up with Hewitt was his firm's means of immediately fielding a deeper, global lineup to meet those client needs. “Everything changed,” he said, with the combined entity's 58 manager research professionals “easily double” what Ennis Knupp had, while adding global coverage and expertise in non-U.S. alternatives.

Elsewhere, executives at firms big and small report significant additions to their research teams since the crisis began in mid-2007. Among them:

c Mercer has added 20 researchers globally year to date, said Jeffrey J. Schutes, Chicago-based president of Mercer's investment consulting business. The research staff has about doubled during the past three years, to more than 80 now.

c NEPC LLC's lineup of professionals entirely dedicated to research stands at 38 now, up from 22 heading into the recent financial crisis, said Richard Charlton, chairman and CEO of the Cambridge, Mass.-based investment consultant. Roughly half of that expanded staff focus on alternative investments, he said.

c Marco Consulting Group, Chicago, has increased its research group to 25 from 12 during the past five years, said Jack Marco, chairman of the Chicago-based Taft-Hartley investment consulting leader.

c Wurts & Associates Inc., Seattle, has 14 research professionals now, more than double its pre-crisis lineup, and the firm's roll should expand further to roughly 20 by mid-2011, said Eric Petroff, director of research.

c Alan Biller & Associates' research team will be nine or 10 strong within six months, up from six two years ago, said Alan D. Biller, president of the Menlo Park, Calif.-based firm.

Some observers predict investment consultants will continue to struggle to make those investments in resources pay off.

The scope of coverage required of consultants continues to grow, but revenues haven't kept pace, and at some point that gap will become unsustainable, predicted Roz Hewsenian, deputy chief investment officer of the Leona M. and Harry B. Helmsley Charitable Trust, and a former managing director and principal of Santa Monica, Calif.-based investment consultant Wilshire Associates Inc.

That dilemma has left firms struggling to tweak the business model, with consolidation likely in some cases and moves into other lines of business likely in others, she said.

Some veteran consultants, however, insist the industry's evolution is providing opportunities.

With increasingly sophisticated institutional clients looking for solutions targeted to their specific circumstances, there's been an unbundling of various investment consulting services, Ms. Baldridge said. “We are increasingly working with clients in specialist roles,” she said.

That specialization has bolstered the business model, some argue.

The “standard relationship” between consultants and clients — with a retainer fee for a package of services including quarterly performance reports, advice on hiring and firing managers, and an asset-liability study every three years — has given way to a more a la carte pricing model, and clients are willing to pay for the specific services they see as a firm's strengths, Mr. Cummings said.

While there's fee pressure for basic services, such as manager search and asset-liability modeling, clients have been willing to pay for the more sophisticated services offered by, for example, Mercer's financial solutions group, either on a project basis or within a retainer relationship, noted Mr. Schutes.

Even so, Ms. Baldridge agreed the need to provide an increasingly sophisticated array of services for clients will leave consultants looking either to expand their client base in an effort to support those costs; merge with other firms as an alternative way to grow; or provide expanded services that go beyond advice.

Mr. Petroff rejected the argument that the prevailing environment now will prove less friendly to boutiques such as Wurts as they go head-to-head with bigger, better-funded competitors. A smaller, talented team can compete with and outperform larger, more bureaucratic organizations when it comes to producing the creative research clients need, he said.

Wurts is among the growing number of investment consulting firms taking on discretionary oversight of client portfolios — called “fiduciary services” by some and “outsourced CIO services” by others — in exchange for a basis-point fee — the most prominent example of the expanded offerings firms have brought out in recent years.

Mr. Marco said while it's been six years since his firm has begun taking responsibility for day-to-day oversight of some clients' portfolios, the recent financial crisis has buoyed interest. He said Marco Consulting now offers “fiduciary services” to 14 clients, with a combined $5 billion in assets, roughly double the number it served before the crisis. Three or four more clients are considering it seriously, he said.

Executives at other investment consulting firms report variations on the straight retainer fees that many observers have pointed to as a weakness of the investment consulting business model.

NEPC's Mr. Charlton said a few of his firm's clients have agreed to some form of performance-based fees, while roughly one-third have asset-based retainer fee relationships.

Mr. Schutes said roughly 20% of Mercer's clients have asset-based retainer fees, although Mercer officials became less aggressive about pursuing that format after equity markets fell back sharply following the bursting of the technology bubble after March 2000.

As for consolidation, industry insiders say the biggest factor driving that trend now is that the founders of 10 to 15 firms launched in the 1980s or early 1990s, facing eventual retirement, are grappling with the tricky task of transferring control and equity in their firms.

“A lot of people in the business — and I'm certainly one of them — have been in it for a long time, and have to think about succession planning,” noted Mr. Biller, who launched his firm in 1982. “We have something in place, but until something happens it's always a work in progress,” he said.

“It's extraordinarily difficult to effect intergenerational wealth transfer,” Mr. Charlton said. He noted he was one of at least half a dozen consultants who founded their own firms at the start of 1986, when the firm they were working for, Merrill Lynch Investment Consulting, exited the business. Mr. Charlton's compatriots included William Wurts of Wurts & Associates; Russell V. Kuhns, R.V. Kuhns & Associates Inc.; Jeffrey C. Slocum, Jeffrey Slocum & Associates; and Richard Holbein, Holbein Associates Inc.

Mr. Charlton said his team has worked hard over the past decade or two to make a smooth transition possible, selling half of his equity over time as NEPC evolved from a sole proprietorship, to a Chapter C corporation, to a Chapter S corporation, to a limited liability company and finally a partnership.

There are firms that will establish effective succession plans and others that will turn out to be one-generation firms, said John Casey, the investment consulting veteran who left Rogerscasey a decade ago to launch money manager consultant Casey Quirk & Associates, Darien, Conn. For a cash-flow business such as investment consulting, “the only way you cash out is by selling your firm,” he said.

Some observers point to the close ties Mr. Marco has had with his union clients as a factor that will make a generational transition at Marco Consulting difficult. But Mr. Marco said he now leads relationships with only six or seven major clients, and he'll increasingly share those responsibilities with other senior consultants at the firm, during a seven-year transition where the next generation of leadership will buy out his interest.

Mr. Charlton said recent merger and acquisition activity in the industry has been motivated by the desire of senior executives at the firms being acquired to cash out.

That wasn't the case for Ennis Knupp's decision to accept Hewitt's buyout offer, noted Mr. Cummings. Co-founder Richard Ennis sold his equity “at essentially book value” to colleagues long ago. When the deal with Hewitt was done this year, Mr. Ennis had an equity stake equal to that of the 19 other principals at the firm, Mr. Cummings said. Those 20 principals collectively owned about 80% of the firm, while 21 associates held the remainder, he said.

For the Ennis Knupp team, the Hewitt deal was motivated by the principals' and associates' desire to have the resources to compete globally, Mr. Cummings said. (The Hewitt-Ennis Knupp deal was announced just days after Aon Corp. announced it was buying Hewitt in a deal widely seen as bolstering its actuarial and benefits consulting businesses.)

The desire for a global footprint could spur further consolidation, considering the degree to which the most attractive growth opportunities today exist outside of the U.S. market, noted Carl Hess, global head of investment consulting in New York with Towers Watson & Co.