Advice-only business still dominates but cedes growth to OCIO sector
Investment consultants have seen revenues from outsourced investment services increase in the past year at a faster pace than fees from advice-only services, but the business model for firms that offer both generally has stayed the same, based on a flat fee.
How and whether that will change is anyone's guess.
“It's still a topic that's evolving,” said Andrew McCollum, managing director at Greenwich Associates, Stamford, Conn. “We don't have an endgame yet. Fees vary by competitor. It's more company-based than service-based. Two firms can structure the same service at a different price. I don't know if any fee model will win out.”
Consultants saw a greater slice of the revenue pie come from investment outsourcing in the 12 months ended June 30, according to Pensions & Investments' annual survey of consultants. While the vast majority of total revenues for the 107 consultants surveyed — 80.8% — came from investment management consulting services for institutional asset owners, the 9.1% that came from investment outsourcing was more than twice the percentage reported for the 12 months ended June 30, 2013, at 4.1%. In the 2013 survey, 83.2% of revenues came from institutional advice-only services.
While investment outsourcing is accounting for more of total revenues, investment consultants and those who follow the industry say there have been increases in fees from advice-only services as well, even as the share of revenue from those services has dipped.
The margins for both outsourced CIO and traditional consulting at DiMeo Schneider & Associates LLC, Chicago, are similar, said Matthew P. Porter, principal, director of research analytics. “All is customized no matter which kind of consulting (clients) receive. It's all based on their risk tolerance and objectives.”
Kevin Turner, managing director, consulting, at Russell Investments, Seattle, said revenue growth for OCIO and advice-only “has been on parallel tracks,” although Russell's OCIO offering is the driver of overall growth. He would not provide specifics, citing the quiet period during the acquisition of Russell by LSE Group.
Jeffrey B. Stakel, partner, Casey, Quirk & Associates LLC, Darien, Conn., said that trend — growth in both advice-only and OCIO revenue — is prevalent across the industry, but the variance in OCIO fees is much greater than with investment consulting. “Fees aren't an overriding factor in choosing whether to go traditional vs. OCIO,” Mr. Stakel said, “but if you've already decided to go to an OCIO, fees do have a big impact. The dispersion within the OCIO space is vast. Fees are all over the place.”
Fees in basis points can range from the low single digits to as high as 60, Mr. Stakel said, with the size of the asset owner and type of desired outcome influencing the overall fee.
Robert A. DiMeo, managing director at DiMeo Schneider, said whether it's OCIO or traditional consulting, “we submit our proposal in the door” with prospective clients, “and then we ask what they want.” Mr. DiMeo said the firm charges for all services based on basis points on client assets, but charges 50% or more above advice-only for OCIO-related services. The difference, he said, is “because of the research, because you need to marshal more legal requirements as an outsourced CIO, and because of the audit expenses, all of which make OCIO more expensive.”
Value-added is up
Rich Nuzum, investments business leader-North America at Mercer LLC, New York,said advice-only fees aren't necessarily down “but value-add is definitely up” for traditional clients “as a result of our work as an OCIO.” He said Mercer leverages the knowledge gleaned from its OCIO service. As an example, an OCIO sees manager trades daily and in real time, as opposed to looking at investments after the fact with traditional consulting. “That benefits advice-only clients because we leverage our knowledge of the managers we get through our OCIO business.”
At Wilshire Consulting, advice-only clients pay a retainer while OCIO client fees are based on the asset size of the client, and are generally higher than for advice-only, said Julia Bonafede, president of the Santa Monica, Calif.-based consultant. While the research for advice and OCIO is the same, the higher cost for OCIO covers the fiduciary duties as well as higher costs for legal services, compliance and operations. “OCIO requires a significant investment in governance. It's a far more involved service, and thus has higher fees.”
Fees for OCIO can still depend on what each client wants, from the kind of advice they want to how much discretion the client wants to keep or delegate, Russell's Mr. Turner said. “There is no black line; rather, there's a spectrum of discretion among clients. It's not all or nothing with OCIO. There are levels of serving. The bottom line is clients often don't know exactly what they're asking for, whether that's help in selecting a manager or going to the all-inclusive model. Each client's needs are different, and the fees reflect that.”
“It really depends client by client,” added Paul Berriman, CEO at Towers Watson Investment Management, London. “Every time you do a business pitch, sometimes you know what a prospective client wants; sometimes that changes. We don't go in with any predetermined idea as to what we will charge. It always depends on the client. But we will charge for the amount of work we think we will do.”
Ultimately, the fees agreed upon by the client can depend on what rivals are offering, Mr. Berriman added. “It's always a market-based decision,” he said. “There aren't more than six or seven firms that are our rivals for what we offer. All of us are aware of what the market is. We might try something different from the market.” He said such fee competition isn't exclusive to OCIO, “it's been the same over the past 25 years in regards to competition.”
Flat fees, despite the dispersion in value in OCIO, are fairer for the client than a more performance-based regime, Mr. Berriman said. “We forensically dissect what the (underlying) fund managers charge. You need to do the work, all the things that good consultants do. What we care about are the proposals; we do the same with ourselves that we do with the managers. We know what managers do, and we let clients know, and we tell them there are various ways they can compensate us. These agreements have a tendency to get devilishly complicated, but most of the time we tend toward simplicity. If fees were purely performance-based, sometimes that can seem right in theory, but you have to be very careful that everyone understands what is being measured. Performance relative to what? An index? Inflation? There are so many things you can peg it to, so many unintended consequences. You have to be really careful in dealing with managers and then fairly explain that to the client.”
Casey Quirk's Mr. Stakel said that despite the fee dispersion, there are two general pricing methods for OCIO: Cost-plus, in which clients pay fees for underlying managers chosen for the OCIO program plus a flat fee to the OCIO provider; and bundled, where an overall flat fee is assessed and the OCIO firm is responsible for paying the fees of the underlying managers. He said both kinds might have additional performance fees, but “there's no strong trend toward that now.”
Also, there might not be much difference ultimately between one pricing method and another. “Either way you'll have to pay the underlying managers,” Mr. Stakel said.
Added Gerry Cosgrove, managing director and head of consultant relations, RBC Global Asset Management (U.S.), Boston. “The fee sizes depend on how the consultant uses a manager, but it's not very different between advice-only and OCIO,” Mr. Cosgrove said. “For example, emerging markets, because of the due diligence required, is more expensive (than less research-intensive strategies), but that's whether a consultant uses it in an OCIO package or an asset owner hires a manager directly.”
In advice-only relationships, managers discuss their fees with both the consultant and the asset owner in the RFP process. Mr. Cosgrove said OCIO, on the other hand, “is, to us, a subadvisory opportunity, and like most subadvisory negotiations, managers expect to get a smaller fee. Generally, our OCIO fees are lower except in asset classes that are alpha-rich and capacity-constrained. That you can charge more for. But in all cases, the relationship, whether with the asset owner or the consultant, is similar for the manager.”
Those “alpha-rich” investments have meant a higher fee charged by consultants, particularly when offering only advice. Greenwich's Mr. McCollum said consultants charge more for work on those asset classes, like hedge funds, private equity, real estate. “With the shift to OCIO, what remains for traditional consultants is expensive work.” That added revenue from alternatives advising would make up for any potential decline in the number of clients.
Also, as traditional consulting has focused more on alternatives, the move to OCIO has also led to a shift in personnel as more money management professionals have left for consulting firms, and that expertise has also helped to boost OCIO fees, said Jeffrey MacLean, CEO, Wurts & Associates, El Segundo, Calif. “There are higher margins in the business, but now OCIOs are attracting high-caliber people from the money management side. There have always been consultants who've left for money managers, and that still happens today. But now there are more manager people coming to consultants.” n
This article originally appeared in the November 24, 2014 print issue as, "Revenue from outsourcing steams ahead".