SAN FRANCISCO -- InvestorForce Inc. has flunked its first test of whether money managers will pay to gain pension fund business.
In a global fixed-income search now under way at the $12 billion San Francisco City & County Employees' Retirement System, InvestorForce quickly waived the 5% finder's fee after money managers queried the pension fund, and pension officials protested.
San Francisco is seeking to hire probably two global fixed-income firms, allocating a total of $800 million.
While the circumstances in San Francisco's case are unusual, some say the situation reflects growing resistance to fees InvestorForce is seeking to impose on managers.
"If this is the wave of the future, it could drown a few folks," one pension executive said.
For the past five years, the San Francisco fund has been a client of Asset Strategy Consulting LLC, Los Angeles, which sold itself in late February to the firm that became InvestorForce.
In its late March global bond search, San Francisco fund officials became the first users of Search Exchange, InvestorForce's online search process. More than 60 bond managers were invited by e-mail to participate in the search, but the e-mail stated managers must agree to the Search Exchange's terms and conditions, which included paying InvestorForce 5% of their first year's revenue from San Francisco's account.
"If you do not accept, you will be unable to participate in the search through the Search Exchange," the e-mail said.
(eFrontiers Inc., a rival online venture, also seeks to charge an initial 5%, plus smaller fees in the following two years.)
However, the 5% fee came as a surprise to San Francisco pension officials, who started receiving inquiries from bond managers about the fee.
Clare Murphy, executive director, said a pension fund staffer on vacation had received an e-mail from InvestorForce about the fee. When the staffer returned from vacation, Ms. Murphy called InvestorForce officials, saying the fee was not part of the fund's existing contract with the consultant. The fee was waived immediately.
Ms. Murphy said fund officials had "a fruitful meeting" with InvestorForce officials April 12; fund officials are performing due diligence on the firm's new ownership and structure. Under a proposed contract revision, InvestorForce could slash San Francisco's fee to about $50,000 a year from $300,000. Inclusion of the 5% fee in future searches is under discussion, she said.
Lawrence E. Davanzo, president of investor services at InvestorForce, said it is the firm's practice to explain its new fee structure to all managers invited to participate in online searches. That didn't happen in San Francisco's case because of the large number of managers in the search, he acknowledged.
Since that time, the firm has added explicit explanations of its fee structure to its website.
In addition, when InvestorForce acts as consultant -- as it did in San Francisco's case -- Mr. Davanzo said the firm would not exclude managers that don't agree to the terms.
And, by keeping the Search Exchange process as a separate entity that does not render advice or recommend managers, InvestorForce seeks to avoid certain legal conflicts under the 1974 Employee Retirement Income Security Act and the 1940 Investment Advisers Act.
When non-consulting clients or their consultants use the database, it's up to them to choose how they run a search, he said.
Without a doubt, InvestorForce's goal of being "the community of choice for institutional investors," as Colin Wahl, Investor- Force's chairman and founder puts it, is hitting some serious growing pains, stemming from its complex and evolving structure, its assorted fees, and potential conflicts of interest.
"I worry about conflicts of interests. And I'm not quite sure what this InvestorForce is. I keep hearing they have all these different things with different costs associated with them," said Joan Payden, president and chief executive officer of Payden & Rygel, Los Angeles.
What InvestorForce is attempting to do "is shift the cost of using an investment management consulting firm from the plan sponsor to the money manager," said one money manager, who asked to be unnamed.
InvestorForce's quickly changing strategies also are generating confusion. "There seem to be a lot of moving parts," said Chris Scibelli, director of marketing at Metropolitan West Asset Management, Los Angeles.
And, some consulting clients of the former Asset Strategies are said to be upset over how InvestorForce is handling the transition, worrying about loss of quarterly reports and potential conflicts in fee negotiations.
The 5% solution
But it's the 5% fee issue that has become a lightning rod among investment management pundits. Among the concerns:
* The 5% fee creates a murky legal situation where InvestorForce is collecting fees from both plan sponsors and money managers, although company officials said they have designed a structure to avoid pension and securities law violations.
* Non-consulting pension clients, relying solely on an online search, might be at risk if only a limited number of managers agree to pay the fee. "Ironically, this could be more of risk for the hiring fiduciary than for the consultant," said Ian Lanoff, principal, Groom Law Group, Washington.
* Smaller managers are worried they will have problems paying the 5% fee within the required 30 days of signing a contract -- well before they collect revenue from clients. Mr. Wahl said the firm will work with managers on this issue.
In addition, some managers are declining to pay a $7,000 annual subscription fee for using analytics on InvestorForce's online database, saying they already get the data from other sources. (The database is free to plan sponsors and consultants.)
Some observers believe the firm is trying to hang onto most of its 50-plus retainer clients -- except for some time-consuming public fund clients -- while it develops its online model for the future. The consulting unit has closed its doors to new business, and some think it's just a matter of time before it phases out the traditional consulting business.
"We will see what happens as time plays out," Mr. Wahl said, adding the firm is 100% committed to supporting existing clients.
Some managers OK with fee
Mr. Davanzo said most managers are accepting the firm's new fee structure.
Aside from the San Francisco situation, which Mr. Davanzo views as a special case, 23 of 25 managers involved in four or five other searches have agreed to pay the 5% fee, he said. And response to paying the $7,000 annual database analytics fee has been "very, very positive," he said.
The online service enables managers to redeploy their marketing resources, Mr. Davanzo said. Instead of making hundreds of calls to generate a single qualified lead, managers are receiving solid queries through the new system, he said.
"If I were the CEO of the money management firm, this (would be) another opportunity for us to develop a (wider) distribution system," he said.
"Marketing is a big, big percentage of a firm's overhead. To the extent we can make it more efficient, that's a win. And that's why most managers get this," Mr. Davanzo explained.
A rival consultant, who asked to be unnamed, said pension executives will reject InvestorForce's multisourced fee structure. Plan sponsors "prefer to pay a flat price, boom," he said. "This is like (drawing) a line in the sand."
William Jacques, chief investment officer of Martingale Asset Management, Boston, said he had no problem with InvestorForce's $7,000 database usage fee. "These guys have to make some money somehow," he said, adding he was less comfortable with paying a finder's fee.
Noting that InvestorForce is still developing its model, he said: "I'm usually on the side of a pioneer until they start collecting from me."
