Pension executives relying more on investment consultants

Corporate pension executives are putting more demands on investment consulting firms for more specialized and complex advice, giving a boost to the economics of a business that still faces challenges.

Consultants, whose business models were threatened by the decline of the traditional defined benefit system, see new business opportunities by stepping in to assist plan executives with:

• moving to fiduciary management to outsource discretionary pension plan decision-making;


• derisking to mitigate equity market volatility and low interest rates that have combined to swamp pension funding levels;


• integrating pension plan funding into corporate financial strategy and reporting;


• moving away from a long-term static strategic asset allocation in favor of macro and tactical strategies with the latitude to respond to market events;


• diversifying into more types of alternative investments to enhance returns while mitigating risk; and


• making risk management more robust.

In short, the work is expanding even if the traditional client base might not be.

“The world has become increasingly ... complex with the types of strategies out there and demands of clients ... for a broad range of knowledge and capabilities,” said Kevin Turner, managing director, consulting, Americas, Russell Investments in Seattle. Consulting “is so much more varied now.”

“We spend a lot more time with our clients focusing on how to manage risk and ... liability-management techniques than focusing (just) on a range of return-seeking outcomes,” Mr. Turner said. “It's been more work (and) it is focused on more areas.”

Jeffery J. Schutes, senior partner and U.S. investment consultant leader, Mercer Investment Consulting Inc. in Chicago, said derisking and more integration of pension plans with corporate finance is a boon to the consulting industry.

“Even though these plans are frozen and may not be offered anymore, the assets still have to be managed, the liabilities still have to be managed. So unless the plan totally goes away, there is absolutely work for the investment consultant.”

“The trend in the institutional space has been a move away from the classic 60/40-type (asset allocation and) the classic (investment) style boxes and into alternatives,” said Daniel Celeghin, partner, Casey Quirk & Associates LLC, Darien, Conn., a firm that studies the asset management industry for its work in providing strategic business development consulting to money managers.

“That trend has opened the windows for specialty consultants (and) ... more deeper specialized knowledge.”

Now, “different clients need different things,” Russell's Mr. Turner said. “There is no one-size-fits-all anymore. ... Clients are ... focusing on their specific needs and objectives that lead to different ideas, different allocations, different strategies and so on.”

These deviations are “actually causing a real problem with folks that still want to do a lot of peer comparison-type work,” unlike the recent past when comparisons were easier because “true 60/40 tended to be a pretty decent description of what an average asset allocation was, at least for a corporate plan,” Mr. Turner said.

“The classic 60/40 approach doesn't work,” Mr. Celeghin said. “In a world of tremendous instability ... we cannot use classical financial methods.”

Plan “sponsors and (other) institutions more broadly are seeking advice more than they ever had,” said Kevin P. Quirk, a partner at Casey Quirk.

“I think the consultants have begun to really make changes to their business model,” he said. “Some have continued to operate in more of a pure consulting model, acting as advisers to clients but leaving decision-making to clients. Others have put more energy to help clients implement the portfolio (strategy) — or outsourcing — the idea the consultant would have more discretion with decisions and be tied more to the performance of the portfolio.”

“The investment consulting industry has been very challenged from an economic standpoint,” Mr. Quirk said. “The business model has not been one that allowed (consulting firms generally) to retain and develop their people. Frankly, they are not paid very well. That is part of the reason you see a transition” to outsourcing. “They will be able to garner a better fee proposition than they would in a traditional consulting model.”

This model change has the possibility of making consulting more lucrative, Mr. Quirk said. “Whether they are able to (realize) that opportunity is something else. Consultants have a positioning challenge.”

In outsourcing, “fees they garner initially are not that (much) higher” than traditional consulting, Mr. Quirk said. “It remains to be seen if consultants can migrate the fees upward.”

“Some consultants are accepting lower fees today with the hope they will be able to increase fees in the longer term,” Mr. Quirk said. “A lot will depend on how an investor feels about the transition and (whether) they can see a marked difference from the prior relationship.” If so, “the higher fees will seem reasonable to the investors.”

Mr. Schutes of Mercer said fiduciary outsourcing, also called implemented or delegated consulting, “is very important to the consulting industry.”

It “absolutely continues to be one of the fastest-growing segments of our business, both at Mercer and at (other) broader consulting firms,” Mr. Schutes said. “It appears everyone is starting to hire folks in that space.”

A key reason is clients “have learned they have to be more nimble when we get into an (investment) environment like this where the markets are volatile. It's very hard for a committee process to work. One thing that delegated consulting allows is the (investment) process to work much quicker.”

Fiduciary outsourcing “is a small percentage of the overall relationships,” Mr. Schutes said. “It's probably less than 10% to 15%. But I would suggest in the next five years it could be as high as half of our business.”

Joseph Gelly, managing director, fiduciary solutions with Russell in New York, said fiduciary management solutions, which is Russell's term for outsourcing, “is a major part of our business” and a “very meaningful part” of the firm's revenue, although he declined to provide amounts.

The “business has really expanded over the past four or five years in large part around the Pension Protection Act and the economics of the market,” which have combined to put more focus on the impact of the pension plan to the overall corporation, Mr. Gelly said.

“Historically, our fiduciary management team focused more on the asset side,” Mr. Gelly said. “If I go back 10 years, outsourcing was defined by a lot of organizations as just implementing a kind of black-box approach of funds,” he said. “Everyone was seeking (a) 60/40” allocation.

“It is very different today. It's a much broader discussion,” he said.

“We'll talk about pension finance as part of the discussion, but we will also talk very heavily around corporate finance and what is the impact of the risk of the decision to, not only the pension plan, but on corporate finances. I think that is why you hear of a lot of consultants sticking their toes into the fiduciary management business,” Mr. Gelly said. “Part of it is a little self-preservation. The economics of consulting is challenging.”

Mr. Gelly said the economics of outsourcing is “definitely better” than advisory consulting. Outsourcing has been a big part of Russell's staff hiring this year, said Mr. Gelly, who sees the business growing.

“Plans between $50 million and $300 million and $400 million will always be the easier adopters of this,” Mr. Gelly said. “But I absolutely plan on pretty significant growth (from plans in) in the billion-dollar range.”

“Clients ... are looking to take risk off the table,” said Russell's Mr. Turner. “A corporate DB pension plan that may have a fairly decent funded status and ... frozen accruals ... may be looking to reduce equity risk in favor of liability-hedging solutions.”

“Other clients may still want or need returns,” he added. They “may still want to derisk from the point of view of not being so exposed to equities,” but also want to “diversify into a range of other return-seeking asset classes.”

“Regardless of what your objectives are, I think there has been a real trend to try to decrease the contribution of risk coming from equity,” Mr. Turner said. “That general theme of reducing equities in favor of something else is pretty strong across all types of clients and all market segments.”

Consultants “have to understand what the client is trying to achieve and pull solutions for it,” Mr. Turner said. “I think that is the biggest change in the industry — customization and individual client focus.”

Consultants now are dealing with higher-level corporate executives in pension plan discussions, Mr. Gelly said. A while ago, it was rare for a discussion on the pension side to involve anyone higher than the assistant treasurer or treasurer. Now it's unusual not to see the CEO and CFO in the discussion.

“The old ways talked about excess return and buy and hold,” Mr. Gelly said.” Now it's mark-to-market, very dynamic investment. What's my funded status and surplus volatility? There are lots of things in play that create a much deeper dynamic decision. ... To be able to inform clients at a CEO and CFO level has become very important.”

Mr. Schutes said Mercer now monitors liabilities and assets on a daily basis to look for funding changes. With that more sophisticated monitoring system comes the ability to make investment or allocation changes quickly.

“It really makes the consultant much more strategic,” he said. “It's really much more about helping the client manage the corporate finance implications of the plan.”

“The fact is, now on a daily basis we can take a snapshot of someone's liabilities and a snapshot of their assets and determine (changes in) strategy” he said. “That is a much more nimble, more proactive approach than we have ever had.”

More sophisticated consultants have a sharper focus on the overall corporate finance perspective and strategy, he said. “If (the pension fund) is creating a lot of volatility to their (corporate) financial results, we can help them resolve those issues. I would say that is an area that is definitely new.”

What is prompting the concern is a greater sensitivity toward cash and funding levels, Mr. Schutes said. “Companies are much more sensitive to the amount of cash they may have to put in a plan and may try to plan better.”

Risk management has become a bigger part of consulting, consultants said.

Mr. Turner called risk management “one of the headwinds to specialty consulting. The demand for holistic ... strategic advice has never been higher.”

“Folks don't have a good handle on what risk management actually means,” he said. “Plans at least need to measure risk and understand what's driving that risk.”

Risk management “innovation comes in as translating what that (risk) means for the overall entity, not just the (pension plan itself) but the sponsor of that plan,” Mr. Turner said. “For example, if you have a downside risk event, what does that mean on the cash flow of the company, the earnings per share of the company?”

Clients now demand more specialized services, such as in alternatives such as hedge funds, private equity and real estate, Mr. Schutes said. Mercer addressed that growth by acquiring Hammond Associates in a deal that closed early this year. Hammond's consulting expertise included private equities and hedge funds, and clients included endowments and foundations as well as pension funds.

Mr. Schutes called it “very much a strategic acquisition.” Hammond brought to Mercer “a lot of resources around alternatives we didn't have. ... They had a very strong alternatives team. They had very strong hedge fund and private equity research.“

Firms that don't offer a breadth of specialized consulting services will see clients go elsewhere, Mr. Schutes acknowledged.

And Mercer isn't the only firm beefing up on alternatives. Russell also has added significant resources over the past few years, Mr. Turner said. The expansion provides “more practical advice to clients.”

Another growing area is defined contribution plan consulting. At Mercer it is one of its five key business areas targeted for growth over the next three years, Mr. Schutes said.

“It is becoming the main retirement tool for sponsors and participants. I think DC will continue to expand from a sophistication perspective.”

“So you have to look at what tools (participants) need to grow their portfolios,” he added. “That may require more than just your traditional few mutual funds.”

Mercer is seeking changes in the way DC plans build investment options. It “will become more sophisticated. ... We may not use traditional mutual funds. We may use collective trust funds, we may use separate accounts, we may use a collection of funds. We may go out and hire three managers and create an option.”

In addition, defined contribution is a target for outsourcing, Mr. Schutes said. “There are clients who are saying: "We want more help in the DC space. So we're going to delegate our investment options piece out so you can help us develop them and maintain them.'”