Consultants weighing impact of global financial challenges

Investment consultants are focusing on the lasting impacts that macroeconomic trends — the growing wealth gap, longer life expectancy and political uncertainty in an unprecedented bull market — will have on institutional investors and the asset management industry at large.

Stephen Cummings, Chicago-based CEO of Aon Hewitt Investment Consulting Inc. and global investment officer, head of North America investments at parent Aon PLC, said his top concern is the stock market approaching an 11-year bull run.

"Everyone is holding their breath wondering how much longer will this bull market run," Mr. Cummings said. "To be in the longest sustained bull market that we've ever known, while also being in an unsettled political environment — it's just an interesting juxtaposition."

Adding to that are concerns about global wealth inequality and the fact that governments and employers need to grapple with the possibility of many people outliving their wealth. Additionally, a "sandwich generation," which often refers to those simultaneously caring for elderly parents and their children, is emerging, Mr. Cummings added.

"Inequity and longevity will have big implications on how we think about investing," he said.

As of mid-2019, the bottom 50% of wealth holders collectively owned less than 1% of total global wealth, while the top 1% owned 45% of global wealth, an October report from Credit Suisse found.

"These are global macro trends that I believe investors ignore at their own peril," Mr. Cummings said.

As consultants serve in the capacity of advisers — and increasingly as discretionary managers under the growing outsourced CIO trend — these are "big-picture trends" firms should be looking at, he said.

Data from Pensions & Investments show that worldwide institutional investors are increasingly turning to consultants for both advisory and OCIO services.

For the year ended June 30, institutional assets under advisement grew 9.2% to $41.4 trillion, P&I's annual survey of investment consultants found. During the same period, U.S. institutional tax-exempt AUA also grew 9.2% to $22.67 trillion.

OCIO, or discretionary, assets grew at a quicker pace over the year, rising 15.2% to $1.42 trillion as of June 30.

Over the five-year period ended June 30, OCIO assets near doubled, growing 94.8% from $731.5 billion. In comparison, institutional AUA and U.S. institutional tax-exempt AUA grew 16% and 19.2%, respectively, over the same period.

The growth of OCIO use brings forth other considerations for investment consultants, which have historically had low client turnover in their traditional investment advisory businesses, said Tyler Cloherty, senior manager and head of the knowledge center for Casey Quirk, a practice of Deloitte Consulting LLP, New York.

While consultants have generally had client turnover of around 5% per year, money managers see higher turnover, around 17% per year, among institutional investor clients, Mr. Cloherty said.

Consultants have targeted growth through their OCIO businesses, but Mr. Cloherty believes there's "an underappreciation for the revenue volatility this could cause" for consultants since they "are moving into a more performance-dependent relationship" with institutions.

"As the investment consultant business shifts more toward OCIO, there could be a potential for relationships that were long in duration (to be) shortened," he said.

This year, 52 investment consultants in the survey reported offering OCIO services, inclusive of two firms that did not offer them the year prior: CBIZ Inc., which acquired Memphis-based investment consultant Gavion LLC in July; and Fiduciary Investment Advisors LLC, Windsor, Conn.

Despite the growth of OCIO assets, P&I's survey showed that investment consultants still garner the majority of their annual revenue from traditional investment management consulting services for institutional asset owners, which on average accounted for 80.7% of their revenues. In comparison, investment outsourcing services accounted for 7.8% of firms' total revenues.

The revenue breakdown was similar in 2018 among reporting firms, with 79.6% of annual revenues derived from investment management consulting services for institutions, while 9.3% came from investment outsourcing, on average.

Michael C. Patanella, a New York-based audit partner and asset management sector leader at Grant Thornton LLP, said the consultant industry's move toward OCIO services could also introduce risks when the extended bull market comes to a halt.

"We will see how (OCIOs) do in a downturn," Mr. Patanella said, explaining that investors will be watching whether OCIOs do a better job of selecting external money managers.

Richard Nuzum, the New York-based president of Mercer's global wealth business, said that as other consultants have shifted their focus to OCIO, the trend "left some openings" for Mercer in the traditional advisory space.

Mercer retained its position as the largest consultant by worldwide institutional AUA, with $15.04 trillion as of June 30, P&I's survey found. Over the year, Mercer worldwide institutional AUA grew 29.3%, widening its lead over the second-largest consultant, Aon, which reported $3.52 trillion in worldwide institutional AUA as of June 30, up 13% year-over-year.

Mercer's assets were boosted in part by its acquisitions of Pavilion Financial Corp. and most of Summit Strategies Group in deals that were completed in the fourth quarter of last year. With the acquisitions, Mercer acquired the investment consulting, alternatives consulting and wealth management operations of Pavilion, which had around $716 billion in AUA as of June 30, 2018, according to P&I data. With the Summit Strategies deal, Mercer acquired all of Summit's businesses except for its public defined benefit plan consulting unit.

The Summit and Pavilion businesses had a combined $5.5 billion in discretionary AUM as of Dec. 31, a Mercer spokeswoman said.

"We see a lot of our competitors focusing on OCIO at the expense of focus on consulting. Probably the best way to grow your OCIO business is to do a good job in your (non-discretionary) consulting," Mr. Nuzum said.

Mercer's managed assets in discretionary products as of June 30 were $282.9 billion, up nearly 17% from a year earlier. The firm ranked second in assets in this universe, following Russell Investments, which had $297.8 billion in managed assets in the No. 1 spot, up 2.7% from last year.

Moving forward, consultants can expect to focus more of their manager research efforts on environmental, social and governance issues, which often includes assessing implementation of ESG in the investment decision-making process as well as vetting firm's corporate culture and diversity and inclusion practices, multiple sources said.

"In general, and this is particularly for their endowment and foundation-type clients, (institutions) are interested in ESG support other than just a negative screen on the underlying investment," said Laura Levesque, senior analyst for the institutional practice at Cerulli Associates, Boston.

Not only that, consultants are being asked to research "how many women and minorities are on the senior management team" at money managers.

"They are looking at the culture of the entire firm" and how managers are integrating ESG throughout the organization and not just on investment teams, she added.

Steve Carlson, head of investment, Americas, at Willis Towers Watson PLC in Chicago, said that over the past couple of years the firm has done much more talking with money management firms to see how they are thinking about a range of factors that can impact culture, such as workforce diversity, pay structure and hiring practices.

Over the year ended June 30, Willis Towers Watson's worldwide institutional AUA grew by 18.2% to $2.6 trillion, propelling the firm to the No. 3 spot in the ranking of the largest consultants, up from No. 7 last year. Willis Towers Watson reported $536.3 billion in U.S. institutional tax-exempt advisory assets as of June 30, down 15% from the year prior.

The tough competitive landscape for managers today also means that consultants' clients are often invested in products that might be subject to consolidation, which creates additional due diligence for consultants and can also impact a manager's culture, said Gregory Allen, CEO and chief research officer at Callan LLC, San Francisco.

Callan was the fourth-largest investment consultant ranked by worldwide institutional AUA, moving up one spot from No. 5 last year. The firm had $2.51 trillion in worldwide institutional AUA as of June 30, up 7.6% from the year earlier.

"We do have to be cognizant more so than in the past of the risk of a firm closing a product because it doesn't make economic sense for them (to keep it open)," Mr. Allen said.

Money managers are focusing company resources on products with a competitive advantage, and have "limited time and money to spend on promoting products," he said. This can all carry its own impact on organizational culture, he added.

"It's much easier for everyone to be happy when there's more than enough to go around. The really talented people are going to be attracted to growing organizations," Mr. Allen said, adding that a firm that is getting smaller every year "can create (staff) turnover, and clients don't want that."

Consolidation among money managers, which is ramping up in the industry, can also have this same effect. When mergers and acquisitions occur, money managers will often "merge" similar products together, resulting in closures, requiring consultants "to go in and look at each one of those situations individually," Mr. Allen said.

PricewaterhouseCoopers LLP recently predicted that 2019 will be a year of record merger and acquisition activity for asset and wealth management firms, according to an October report. So far, total deal value for the first nine months of 2019 was $13.7 billion, nearly three times the total during the same period in 2018, the report said.

"Generally speaking, clients feel more comfortable when there's not change. … All of that creates the potential for negative outcomes. Every time there's one of these mergers, our manager research people are (looking), so that's actually creating new work," Mr. Allen said.