Client changes push consultants to new paths

Corporate and public pension plans are taking two different paths, which is bifurcating the investment consulting industry, sources said.

Corporate plan sponsors want to leave the pension management business, which has increased demand for outsourced chief investment officer services. Most public defined benefit plans are turning to their investment consultants to find high returns in a low-return environment.

"From a consultant's standpoint, many firms are deciding whether to focus on the total-return marketplace only or just the corporate DB marketplace," said Russell K. Ivinjack, a senior partner at Aon Hewitt Investment Consulting Inc., Chicago.

Mr. Ivinjack added that OCIO has taken hold of the corporate DB marketplace, and it's "been surprising to see the size of some of the plans that have decided to outsource. We're seeing multibillion-dollar plans wanting to outsource."

Several consultants speaking to Pensions & Investments agreed the divergence in strategy and focus between corporate and public DB plans is a big development for the industry.

As managing corporate pensionplans becomes more complicated and more resource-intensive, many corporate officers are trying to figure out how to get out of the business. This is leading more corporate sponsors to seek OCIO services, which in turn, is leading more consulting firms to provide OCIO services.

In fact, the demand for OCIO is growing so fast that even some large actuarial firms and investment banks are amending their business models to provide such discretionary services, said Brad Smith, a partner in NEPC's corporate practice in Boston in a phone interview. "There's this huge gravitational pull towards OCIO."

Concerns about market returns and rising interest rates have led corporate treasurers and corporate chief financial officers to embrace a different philosophy, said James Callahan, a San Francisco-based executive vice president at Callan LLC and head of its fund sponsor consulting group. "Most are not thrilled to be in the pensions business."

Steve Carlson, head of investment, Americas, at Willis Towers Watson PLC in Chicago, said his firm, which specializes in advising corporate plans, is "seeing the continued acceleration of plan sponsors looking to how they can better oversee their programs. And often, that's leading them more to OCIO."

Mr. Carlson added the pace at which corporate plan sponsors have turned to OCIO has been faster than anticipated. "Corporate plans looked around and said: 'This isn't my core competency, so why am I doing this? Why not outsource it to a firm doing this 24/7, 365 days a year?'"

Willis Towers Watson's OCIO business had $88 billion in total worldwide outsourced AUM as of June 30.

Meanwhile, on the public DB side, sponsors are focusing more on researching alternative investments to get good risk-adjusted returns. Several consultants have had to expand research coverage to include private debt, private equity and multiasset strategies.

That's not to say that the public sector isn't also interested in OCIO. Many public plans also are looking to hand over the responsibilities of managing their investment portfolios to a consultant. "Increasingly the market is looking for consultants to take over the day-to-day management of the investment program," said Callan's Mr. Callahan. "OCIO is probably the most popular moniker for it. Asset owners just want to get rid of that responsibility and many believe consultants can do a better job of it."

Callan had $24.15 billion in total OCIO AUM as of June 30.

Whether it's through OCIO or creating customized models, consultants are seeing a desire among asset owners for increased engagement from consultants.

"Most plan sponsors recognize that somebody has to be thinking about their portfolio every single day, so there's an increased trend toward outsourcing," said Brian McDonnell, head of the global pension practice at Cambridge Associates, Boston. "It does not have to be complete delegation of discretionary investment authority. Some want outsourcing with some veto power."

Institutional investor appetite for investment consulting continues to grow. P&I data show investment consultants advised on $20.5 trillion in U.S. institutional tax-exempt assets as of June 30, up nearly 9% from $18.9 trillion a year ago. Total outsourced CIO assets in P&I's universe reached $907.3 billion by June 30, a 12.4% rise from the $807 billion year before.

That OCIO figure is projected to accelerate. New research from Cerulli Associates Inc. predicts global OCIO assets under management could reach $2.3 trillion by early 2022.

As assets under advisement are growing, so are searches for investment consulting services. P&I tracked 101 general investment consultant searches in 2017 (as of Nov. 2), vs. 118 in all of 2016. For actual hires, meanwhile, P&I tracked 54 general investment consultants being hired this year (as of Nov. 2), vs. 75 in all of 2016.

RFP activity seeking investment consultant services continues to grow.

One consultant said his firm has seen RFP activity increase due in part to plan sponsors' growing need for governance.

"Not only is the number of RFPs that are coming to us increasing, but the things we're being asked to do is also increasing," said Michael Hall,​ managing director, Americas institutional, Russell Investments, Seattle. That list includes things like total currency management, transition management and rebalancing services.

Mr. McDonnell said that Cambridge Associates has also "seen a fair amount (of RFP activity) lately," adding that he's also seen "a general frustration around a lot of plan sponsors that have put a ton of money into their plans and have barely made any headway in their funded status," which could be one factor for the increase in RFP activity.

Besides the accelerating demand for OCIO, industry experts agree the investment consulting landscape is evolving in other ways.

"The consulting industry itself is going through a dynamic change and will continue to evolve," said NEPC's Mr. Smith, adding he has seen significant M&A activity within the industry over the past few years and expects to see more acquisitions "in the mid- to small space."

With the industry seeing more consolidation, that means there are fewer consultants advising on more assets, and increased competition within the industry.

"Because of the reality of demographics, you continue to see some consolidation in the industry as smaller firms are seeking exit strategies," said Tim Barron, chief investment officer of Segal Marco Advisors, Darien, Conn.

Cambridge Associates' Mr. McDonnell said he's not just seeing increased M&A activity within the legacy consulting industry. Institutional investors also are looking to reduce their number of relationships.

"This is a positive trend for those (consultants) who can bring expertise across all asset classes," he said and noted that to compete in this industry, consultants "need to bring a bigger toolkit to the table," Mr. McDonnell said.

This more complex investment environment not only requires a more sophisticated toolkit from consultants, but also a more complex view on risks and interaction with those risks, noted Russell Investments' Mr. Hall, adding that in this more complex investment environment, his consulting firm is being asked to do more complex things for clients, including managing and reducing their costs and risks, as well as spending risk more efficiently to generate more outsized returns.

Another big major change within the industry is that more data is available to consultants.

"All the tools we have run much more quickly, and the process has gotten better. Everything's more automated," said Jay Love, Atlanta-based U.S. director of strategic research for Mercer Investment Consulting.

With the industry evolving at a rapid pace, most investment consultants are preparing for what the institutional landscape will look like in the years ahead.

"We've had good returns on markets for last 10 years. We're now approaching the end of an era. So, there's some potential economic headwinds coming through, though we don't think they'll be dramatic," said Deb Clarke, Chicago-based global head of investment research at Mercer Investment Consulting.

Ms. Clarke also expects to see more derisking in the defined benefit space, a continued move toward defined contribution and more consolidation via M&A.

"As we enter this environment where active management should do better, there's a shift away from indexing, but asset managers need more freedom to just generate returns rather than just build against an index," she added.

Russell Investments' Mr. Hall said that for years, consultants advised on distinct asset classes and on separate investment styles. In the future, he believes "those silos between traditionally very distinct implementations in a portfolio must be blown away."

"In the future, the leaders in this space will recognize it's about looking at the whole picture, not just at a bunch of silos," said Mr. Hall.

A big challenge for consultants going forward will be managing a continually growing degree of complexity and risk.

"The common thread for the entire industry is, in a world where expected returns are going down, what do we have to do to help clients make their number?" Segal Marco Advisors' Mr. Barron added.n

Consultants pushed to new paths