Pure-play consultants become rare breed amid consolidation

(updated with correction)

The ranks of pure-play alternative investment consulting firms are thinning as the consulting industry consolidates and firms add money management to their services, a trend that winnows investors' choices and opens up consultants to potential conflicts of interest.

Alternative money managers earn much higher fees than investment consultants. At the same time, alternative investment money manager fees are inching up due to investor demand while alternative investment consultants are being pressed to lower their fees, straining investment consultants' already low-profit margin businesses. Buyout funds closed or in the process of being raised in 2019, for instance, have a median management fee of 1.99% of committed cap- ital, an increase of 15 basis points from vintage 2015 funds, Preqin data shows. Meanwhile, proposed alternative investment consulting fees ranged from an annual $990,000 for two alternative asset classes to $747,200 for three alternative investment portfolios, according to an analysis of proposals by Los Angeles County Employees' Retirement Association as part of its recent search process.

Faced with increasing competition from general investment consultants and pressure from asset owners to reduce fees, alternative investment consultants are adjusting by merging with other consulting firms or augmenting services with higher-profit money management and managing discretionary assets.

The industry has been changing as consultants strive to increase earnings, leaving very few specialist alternative investment consulting firms that do not manage money. While the consolidation produces larger consulting firms with more expertise and investment offerings, the trend also brings greater potential for conflicts of interest, industry executives say.

A review of Preqin's top 20 list of nondiscretionary investment consultants and Pensions & Investments' database revealed only two pure-play alternative investment consultants that do not manage capital: Albourne Partners Ltd. and TorreyCove Capital Partners LLC.

Consolidation of investment consultants — both specialist alternative investment consulting firms and general investment consultants that advise on alternatives — does not to appear to be abating any time soon. Among the most recent deals, some of the mergers resulted in combining pure-play consultants and consultants that had a money management, discretionary accounts and/or outsourced CIO businesses. Recent deals include:

• General investment consultant Meketa Investment Group Inc. in April closed its acquisition of general investment consultant Pension Consulting Alliance LLC. Meketa now has about $1.8 trillion in assets under advisement, including more than $100 billion in alternative investment and real estate assets. Before the merger, PCA provided only non-discretionary investment consulting. Meketa has an outsourced CIO business.

Professional services firm Aon PLC last year completed its purchase of iconic real estate consultant The Townsend Group, bolstering Aon's alternative investment offerings. At the time, Townsend provided non-discretionary real estate advisory services for clients that had $76.3 billion in real estate allocations. The combination with Aon made Townsend, which already managed $14.8 billion in AUM, part of a firm with a large outsourced CIO business — $167.7 billion as of March 31. At the time, Townsend had been majority owned by real estate money manager Colony NorthStar Inc. The Townsend transaction marked Aon's first foray into real estate.

Also in 2018, StepStone Group LP's real estate business merged with real assets consulting firm Courtland Partners. Courtland had about $95 billion in assets under advisement and had not managed money. At the time, StepStone had $2 billion in assets under management.

And in 2018, Mercer scooped up Pavilion Financial Group's investment consulting business including its $5.3 billion in outsourced CIO assets. At the same time, Mercer also acquired the $3.8 billion outsourced CIO business of Summit Strategies Group. Both acquisitions doubled Mercer's global footprint for alternative investment consulting and bulked up its $242 billion outsourced CIO business. Pavilion created its alternative investment consulting business in 2016 by acquiring specialist consultants Altius Associates, which had a fund-of-funds business, and LP Capital Advisors, which did not manage money before the merger.

"As soon as investment consultants have more than one line of business, you have to worry about potential conflicts," said Christopher E. Palmer, a Washington-based partner and co-chairman of law firm Goodwin Procter LLP's financial industry practice.

If there are potential conflicts, consultants need to eliminate the potential conflicts or disclose it, Mr. Palmer said.

The consulting business can have potential conflicts that are not obvious, he said.

"Even if a consultant does not have its own money management business, it might have a business partnership, joint venture or revenue sharing (arrangement) with other investment advisers," Mr. Palmer said.

"It has to do with incentives," he said. If the other business relationships might be enhanced if the consultant recommends that business to a client, then the consulting firm needs to tell clients about the business relationship, he noted.

Institutional investors are aware of the pitfalls of fewer choices and increased exposure to conflicts this trend brings.

"The last time we issued an RFP for our consultants, we asked about the percentage of revenues coming from consultancy vs. asset management businesses," said Jonathan Grabel, chief investment officer of the $56.5 billion Los Angeles County Employees Retirement Association.

As part of LACERA's search process earlier this year for a specialty investment consultant for hedge funds, illiquid credit and real assets, the Pasadena, Calif.-based pension fund scored bidders on potential conflicts of interest. In materials to the board of investments, pension fund officials highlighted the size of each of the semifinalist's legal and compliance teams, whether the consultant offers investment products and the percentage of their client accounts that are discretionary.

"You have to go in with your eyes wide open. You have to ask the questions," Mr. Grabel said.

LACERA in March hired Albourne Partners Ltd. as the best fit. Albourne had scored the highest of three finalists based on a number of factors that also included fees and services offered. Among its strengths, LACERA officials noted that Albourne was solely focused on alternative investments and that it had the least potential conflicts because it has a pure non-discretionary advisory model. The other two finalists derived a portion of their income from discretionary clients.

Alternative investment consultants are also edging into other businesses beside strictly non-discretionary consulting. In June, alternative investment consultant Cliffwater LLC launched its first fund, an evergreen private debt fund aimed at high-net-worth investors through its registered investment advisers, family offices and smaller institutional investors.

"We were seeing significant demand from RIAs and family offices for our services (specifically private debt) and felt we could deliver them more cost effectively through a registered fund," said Stephen L. Nesbitt, CEO of Marina del Rey, Calif.-based Cliffwater. "We had past experience with serving as a subadviser to registered vehicles so we were familiar with how these are implemented and regulated."

So far, the fund has amassed $160 million, all from RIAs and family offices, he said.

Cliffwater executives take steps to avoid conflicts of interests. For starters, they cannot recommend their fund to clients because it is a conflict, Mr. Nesbitt said.

In addition, Cliffwater clients choose whether they wish the firm to provide non-discretionary or discretionary services before they hire the firm, he said.

"We cannot recommend a switch from non-discretionary to discretionary," Mr. Nesbitt added. "Regarding investments, all Cliffwater clients receive equal treatment on investment allocations, consistent with our allocation policy."

TorreyCove Capital Partners LLC can avoid potential conflicts because it does not manage investment funds, said David Fann, TorreyCove's New York-based president and CEO.

The firm does serve as a non-discretionary adviser to an affiliate, Alternative Investment Capital Ltd., and receives a portion of the management fees and carried interest, according to a LACERA staff report to the board. However, the report noted that this is a relatively small portion of TorreyCove's business.

Indeed, LACERA's new alternative investment consultant, Albourne, were ranked with the least potential conflicts of interests on a spectrum from discretionary-more potential conflicts of interests to non-discretionary, less potential conflicts of interests, according to staff reports to the board.

Semifinalist StepStone was the most discretionary on the LACERA scale. A table of strengths and concerns highlighted StepStone's four-person compliance team as a strength. But, the table noted as a concern that StepStone has "inherent conflicts with regard to fund allocations between their managed separate accounts and fund of funds, and their non-discretionary advisory clients."

Aksia LLC, which has a $4.7 billion money management business while consulting for $52 billion in assets under advisement, and Cambridge Associates LLC, with 20% of discretionary client accounts, were ranked in the middle of the conflict of interests scale. Cambridge Associates had $2.4 trillion in institutional assets under advisement as of June 30, 2018, according to Pensions & Investments' database.