For consultants, those higher fees can pose potential conflicts of interest. An example: A consultant recommends a small-cap U.S. equity manager with capacity to accept another $500 million. Would discretionary clients — who often pay a basis-point fee calculated on that client's portfolio assets — get better access than traditional consulting clients paying a straight retainer fee?
In an interview, Richard M. Charlton, NEPC's founder and chairman, said his staff was extremely cautious about preserving the firm's reputation for a “conflict-free revenue model,” pushing ahead amid growing signs that “the industry is going this way.”
NEPC's team “spent a hell of a lot of time preparing,” he said, putting procedures and systems in place to ensure it could offer discretionary consulting services without “even a semblance of a conflict of interest.”
Competitors didn't argue the point that investment consultants can take on greater fiduciary oversight without compromising their ability to serve traditional retainer clients. “We never believed it was a conflicted model, as long as it's constructed properly,” said Timothy R. Barron, president and CEO of Darien, Conn.-based investment consultant Rogerscasey Inc. Rogerscasey began offering outsourced solutions for clients more than three years ago.
Steven F. Charlton, the partner and director of consulting services at NEPC who set up the new business, said the firm announced its decision to begin offering the service at its April client conference and already has three discretionary clients with combined assets of roughly $600 million — one that had previously been an advisory client and two that are new.
He said signs of rapidly growing demand for discretionary consulting from corporate pension funds, endowments and foundations, and Taft-Hartley plans over the past year convinced NEPC executives that it should no longer be considered a market niche, but a trend that potentially could shake the foundations of the industry.
For example, he noted that of the 102 RFPs NEPC has seen from non-public fund clients this year, roughly 40% included discretionary services, up sharply from 5% to 10% a year or two ago.
Steve Charlton, who is Dick Charlton's son, said a survey NEPC conducted last year showed about 20% of its clients had “modest to very strong interest” in further discussions about discretionary consulting.
He said to pursue the opportunity “in a way that stays consistent with who we are,” the first priority was creating systems to ensure equal access for advisory clients and discretionary clients to favored capacity-constrained investment managers. NEPC further decided not to offer its own funds or funds of funds but only to implement the customized investment programs it offers to all clients, he said.
The response from clients overall has been positive, he said.
Clients interviewed by P&I, said they remain fairly confident NEPC can continue providing them with unconflicted advice, even as some concede they'll be keeping an eye on how the growth of the new business affects the firm.
Tim Barrett, director, pension investments worldwide with Rochester, N.Y.-based Eastman Kodak Co., said NEPC consultants and researchers have served Kodak well, and there's no sign of any changes. Still, the impact on NEPC's operations down the road, as the higher-margin business becomes an ever bigger chunk of the firm's revenue, is something that “any client should monitor,” he said. (Kodak's U.S. defined benefit plan assets were valued at $4.8 billion as of Dec. 31.)
An executive with another multibillion-dollar defined benefit plan, who declined to be named, said he's not concerned that NEPC will “let this new service affect the way they offer asset allocation or manager selection advice to clients.” Instead, he noted the competitive necessity of NEPC getting into the business. “I'll be interested to see how the business grows at NEPC (and other firms) — and how they manage any potential conflicts.”
Gerard E. Fleury, executive director of the $158 million Manchester (N.H.) Employees' Contributory Retirement System, said NEPC has been careful to avoid soft dollars and other revenue aside from whatever it earns advising clients. He said the new service the firm is offering doesn't concern him.
Thomas F. Gibson, a trustee with the $60 million Belmont (Mass.) Contributory Retirement Fund, said the issue hasn't been discussed at the board level yet, but Belmont — NEPC's first public fund client — “has a lot of trust in NEPC, a lot of faith in them. ... They've done very well for us.”