Big firms shift outlook as DB world changes

Investment consultants with practices dominated by big corporate defined benefit plans say the drive by clients to fully fund and immunize their liabilities will make it more important than ever to diversify into areas such as fiduciary outsourcing and defined contribution.

While corporate plan sponsors are pursuing a wide range of approaches, the general push toward “the promised land” of having a “DB program that isn't a tail that wags the proverbial dog” could change the landscape for investment consultants, said Timothy Barron, CEO of Rogerscasey LLC, Darien, Conn.

Anticipation of that new terrain has found consultants increasing their focus on the fast-growing defined contribution space, and adding resources to advise non-pension related asset segments, such as endowments and insurers.

Recent merger and acquisition activity has helped leading players fill gaps:

c Mercer Inc.'s January purchase of Hammond Associates strengthened the corporate consulting giant's profile in both the wealth management and endowment and foundation segments.

c Hewitt Associates Inc.'s September purchase of Ennis Knupp & Associates helped Ennis jump-start a fiduciary outsourcing business.

c The January 2010 merger of Towers Perrin and Watson Wyatt Worldwide gave Watson an entry into the insurance consulting market.

The current business environment will reward the nimble, said Carl Hess, the New York-based global head of investments at Towers Watson & Co. Mr. Hess said his firm has “added more DC business to the mix,” as well as sovereign wealth funds, endowments and foundations, and insurers.

Kevin Turner, managing director, consulting, with Seattle-based Russell Investments, said his firm — which led the industry in fielding a diversified mix of consulting, asset management and implemented consulting services — set up a dedicated DC advisory team in 2009. The move reflected corporate clients' interest in constructing defined contribution plans that have defined-benefit-like characteristics.

Meanwhile, consultants say serving corporate DB clients as they “de-risk” — or move to ensure that pension funding volatility won't disrupt the plan sponsors — will remain a crucial, and even a growing, business segment for them over at least the next five years.

DB clients will be finalizing their de-risking strategies over the coming three to five years, and Mercer is well-positioned to serve them, said Jeffrey Schutes, Chicago-based president of Mercer's investment consulting business. It could be up to 10 years before their assets peak, followed, for many clients, by an “end game” of 20 to 30 years in closing out those plans, he said.

Over the coming decade, helping corporate DB clients de-risk will be a “huge opportunity” for consultants, and longer term there'll be opportunities to grow in segments such as defined contribution, endowments and foundations, and wealth management, agreed Richard Nuzum, president and global business leader of New York-based Mercer Global Investments.

Consulting veterans predict a small, but growing, minority of corporate clients will terminate their DB plans and purchase annuities. Most corporate clients, meanwhile, will likely reach the point where they're largely immunized — with 80% to 90% of their portfolios' assets in fixed income. Others might well remain in the “total return world” with a 60% equity-40% fixed-income asset allocation.

Dylan J. Tyson, vice president and head of the pension risk transfer business team with Hartford, Conn.-based Prudential Retirement, said market players might be underestimating the gathering momentum behind corporate moves to offload their pension risks.

He cited a soon-to-be-published Prudential survey of 171 chief financial officers of companies sponsoring DB plans with at least $250 million in assets, which showed more than 30% “somewhat or very likely to transfer risk management to a third-party insurer over the next two years.”

The current pace of pension “buyouts” — roughly $2 billion to $3 billion a year of a $2 trillion corporate DB marketplace — could rise to roughly $20 billion a year, driven by the growing appreciation among corporate executives of the non-core economic risks they face from their benefit plans, Mr. Tyson said.

For the bulk of corporate DB clients intent on de-risking their plans over the next few years, consultants differ on the implications for their business as those plans better match liabilities by boosting fixed income. While some insist those portfolios will still require plenty of consulting services, one industry veteran, who declined to be named, said the fees for advising a fully immunized portfolio will be, at best, one-fifth of what they are for full consulting services.

The rise and evolution of DC plans, however, could provide a counterweight for consultants' coffers. For the moment, DC-related services may involve less work and lower fees than DB-related services, but as corporate executives put ever-greater emphasis on ensuring their DC plans are structured properly, that could change, said a senior Connecticut-based investment consultant who declined to be named.

And several consultants predict that, once a recovery in funding levels allows a better match of DB liabilities and assets, executives of sponsoring companies will be more willing to outsource management of those portfolios, rather than retaining expensive internal staff to oversee them.

With a five-year track record now for its U.S. manager-of-managers business — including the development of discretionary liability-driven investment offerings — Mercer will be able to serve the growing number of clients likely to seek implemented consulting solutions, Mr. Nuzum said.

One fast-growing investment consultant that has yet to take the plunge into outsourcing is NEPC LLC, Cambridge, Mass. In a recent interview, Richard Charlton, chairman, declined to explicitly rule out the possibility that NEPC would join the fray. “We want to continue to serve the unique needs of each client, while avoiding even the impression of any conflict of interest,” he said, adding “You can be sure we won't offer any proprietary products that would compete with the managers we research.”