Investors putting consultant-managers on short leash

Updated with correction

Increasingly concerned with the potential conflicts that arise when consultants straddle the line between investment manager and impartial adviser, institutional investors more and more are putting restrictions on how they use these firms.

The board of the $229.6 billion California Public Employees' Retirement System, Sacramento, last summer adopted a new policy that allows outside consultants for its private asset classes “to fulfill one of two roles — either offering opinions on the merits of an investment or assisting in the monitoring of the investment once CalPERS makes it,” stated Wayne Davis, CalPERS spokesman, in a written response to questions.

The policy specifically bars alternative investment consultants from managing investments, working on special projects for staff, or providing opinions to staff on specific investment transactions.

Other funds, including the Washington State Investment Board, Olympia, prohibit consultants from offering investment management services to the funds. Still others — such as the £5 billion ($12.7 billion) Merseyside Pension Fund, Liverpool, England — have established policies barring a consulting firm that offers investment strategy and asset allocation services from also recommending investment managers.

The concerns about conflicts apply to any investment consultant that also offers asset management, and aren't new to institutional investors. Still, experts say those concerns are heightened with alternatives consulting because investment management is more prevalent among alternatives consultants and because of the complexity of the investments. Increasingly, alternative investment consultants are adding co-investment funds, secondary-market strategies and fund of funds. Conflicts could arise if a pension fund wants to buy an investment for its own account that its consultant also wants to buy for its asset management arm.

"I think there are some large investors that would like their consultants to be pure-play consulting firms, rather than firms that may have conflicts. They want to make sure the consultant is working in the client's best interest without any issues of conflict surfacing,” said David I. Fann.

Mr. Fann is president and CEO of TorreyCove Capital Partners LLC, which was formed when a group of executives at alternatives manager and consultant Pacific Corporate Group did a management buyout of part of PCG's consulting unit. The new firm —based in La Jolla, Calif. — is offering consulting services only, Mr. Fann said.

“Almost every RFP or search (now) has some discussion about conflicts of interest. It's not new, but there is more emphasis on this than in the past,” he said.

The buyout that resulted in TorreyCove came 13 months after CalPERS fired PCG, which had served as its longtime consultant and also managed $2.5 billion in investments for the fund. According to a release from CalPERS at the time, the fund “severed all ties” with the firm.

Sources point to CalPERS' actions as a result of the large pension plan's discontent with consultants that advise and consult.

CalPERS officials declined to comment on why they fired PCG, except to say the change was part of an overall restructuring of its $ 31.9 billion private equity portfolio, according to a written statement released at the time by Chief Investment Officer Joseph Dear.

In Washington, Gary Bruebaker, CIO of the $79 billion fund, said his fund's policy not only bars consultants from offering investment management services to the fund, but also stops investment managers from offering it consulting services. “We think there is an inherent conflict in getting advice on the one hand and getting investments on the other,” he said.

The board does not prohibit consultants from offering investment services, “just not to us,” Mr. Bruebaker said.

California State Teachers' Retirement System likewise does not bar consultants from also managing investments.

“We PREFER consultants who do not also manage investments, but we do not REQUIRE it,” wrote Ricardo Duran, spokesman for the $144.8 billion in an e-mail.

Executives at other funds — while not adopting explicit strategies — say consultants that also make investments raise red flags during searches.

“It's one of those things that, when we do a search for a private equity consultant as part of a periodic review, if they do run funds of funds, we ask them about their allocation policy, conflict issues and access issues,” said David Kushner, CIO for the Los Angeles County Employees' Retirement Association, Pasadena, Calif.

The concern is whether, for example, the consultants would give serious consideration to managers that might be good for the $37.5 billion LACERA, but not good for the consultant's fund of funds.

The New York City Retirement Systems will not toss out a consultant that manages money from a search, but there's a catch.

“The fund seeks best-in-class advice that is conflict free, but the fund does not require that its consultants provide only consultant services,” Eric Sumberg, spokesman for the $133.8 billion New York State Common Retirement Fund, Albany, stated in an e-mail. “Where overlap (within the firm) may exist, the staff that oversees the applicable asset class provides independent oversight to ensure that any investment management or consultant services being provided will be conflict free.”

Fatter fees are a great motivator for any consultant to add investment services. Few firms get wealthy offering purely consulting services, Mr. Fann said; there is a lot more money made from the investment management side.

For that reason, a number of alternative investment and general consulting firms are hybrids. Just last year, NEPC LLC, a general and alternatives investment consultant, decided to add investment management after a history of being a pure consulting firm. Other firms that offer both include Hamilton Lane Advisors LLC and Portfolio Advisors LLC.

“Very few alternative investment consultants these days do not offer some investment services,” LACERA's Mr. Kushner said.

Some consultants say investor concerns about conflicts are not an issue they are coming up against.

“That used to be voiced more often 10 years ago than it is now,” said Mario Giannini, CEO of Hamilton Lane. “There are some institutions that prefer it (separation), but not many that I'm aware of at this point, at least on the private equity side.”

Other investors are fine with consultants providing both advice and investment services, but only to a point.

The New Mexico Educational Retirement Board, Santa Fe, has two alternative investment consultants that also manage investment portfolios. Real Asset Portfolio Management runs a secondary fund, and officials at New Mexico Educational are discussing a co-investment fund with its new infrastructure consultant, Caledon Capital Management, said Bob Jacksha, CIO of the $9 billion fund.

But the Caledon fund would be a separate account or a fund of one. There are no other investors, he said. “We view it as an extension of the consulting work,” Mr. Jacksha said.

It's not an issue that comes up very often, he said. The last time was when the Macquarie Group unsuccessfully competed for the infrastructure consultant opening, he said.

Whether Macquarie would have a conflict came up during discussions, Mr. Jacksha said.

“The fact that Macquarie had billions of dollars and who knows how many clients on its fund side … if they were consulting, there could be potential conflicts of one side of the house with the other side of the house,” he said.