The Consultant will see you now.

“A consultant is someone who saves his client almost enough to pay his fee”. -Arnold Glasow (US Businessman, Humourist). 1905-98.

Amidst an avalanche of comment regarding the FCA’s recent report on the Asset Management industry, one area of interest was the section which looked at the investment consulting sector, which has long been under the radar, despite having a significant impact on many areas of the financial world. Indeed, as the FCA report made clear, it is a £1.7 trillion business, not far from £7 trillion size of the asset management industry it nominally supports. Furthermore, there are basically only 3 players- Aon Hewitt, Mercer and Willis Towers Watson, who together control 70% plus of the revenues from Consultancy. The FCA is understandably concerned by this Industry concentration, as predictably it has led to suggestions of conflicts of interest and a lack of transparency, particularly in their charging structures. The Big 3 had put forward a series of proposals (in February 2017) in an attempt to head off FCA regulation, but it was dismissed by the FCA as inadequate; Christopher Woolard, the FCA’s Director of Competition said that “virtually all” activity undertaken by consultants was outside its regulatory permit. “This is a sector whose activity impinges upon the kind of returns millions of consumers receive”.

But what is it that Consultants do and more importantly, for whom?

Therein hangs a tale (or two) [1].

Investment consultants are hired by organisations that require help and advice on their investment strategy, asset allocation etc, most often Defined Benefit Pension schemes, either Local Authority or smaller company schemes. They thus have a large influence on where and with whom large amounts of money is invested, If they were all Individual consultants, like the ones at the Pension funds highlighted below, this might be OK, (though the quality of the advice was somewhat lacking), but they are not. In addition, in recent years, many of them, like the Big 3 mentioned above, have started to offer Asset management services to their clients, which they label “Fiduciary management” (see here for Mercer’s offering). According to a KPMG report, they now manage around £123 billion. Consultants are not subject to the same level of regulation that other players in this segment endure. which gives them a clear advantage and the lack of transparency has allowed them to offer “in-house” investment services even if there are better, cheaper options available elsewhere. They are, after all, now in direct competition with the very Fund Managers that they are supposed to “independently ” assess!

Ben Gold, Head of Pension investment at Xafinity (a smaller competitor ), puts the boot in: “In its interim report the FCA found that on a per-client basis, fiduciary management generates more than twice the revenues than traditional advisory services generate. However the opaqueness of fiduciary managers’ performance and fees comes in for criticism, and the level of fees compared to traditional services can create perceived conflicts. A lack of publicly available, comparable performance information on fiduciary managers also makes it hard for investors to assess value for money.” [both in terms of its quality AND its efficacy].

So it appears that the FCA intends to refer the sector to the Competition and Markets Authority, who can impose the spin off of segments of the firms involved to promote business diversity, but this will only happen by September at the earliest, leaving the Industry plenty of time to whisper in the right ears…

Why do Pension schemes etc use them?

Ostensibly, the main reason for their use is to “out-source” the required investment expertise, which smaller pension schemes inevitably do not possess; indeed, UK rules require them to seek Investment advice but for larger (Local Authority) schemes, this is not an issue – they have (supposedly) in-house investment analysts etc on whom they should be able to rely. But they don’t and the reason is fairly straight forward – they lack the confidence to back their own judgment. This feeds into the other reason why they use Consultants, which is blame displacement; if the investment strategy goes wrong, the pension fund committee can say that they were advised by “experts” to do such and such and thus they were not to blame for the failure of the policy; (in the City, this is known as “career risk”). Investment consultants thus serve as the scapegoat for due diligence failures or simple ignorance of market risks. In return, they can be assured that their advice will be heeded, with no (negative) consequences should it all go the way of the pear. Apocryphally, it is said that the Auditors response to questions from Enron executives as to what their Quarterly numbers looked like, was “What do you want them to be?”- it seems that all parties have an interest in perpetuating the game, whilst none of them have to take responsibility for their failures.

And when it does go wrong, all sides are quick to apportion blame to all the other players, as in this example of the fall-out from the Dallas Pension scheme fiasco. In another example, an Investment Board member came up with the idea of raising large amounts of cash in a bet against the markets; this, predictably, also went wrong, with a large opportunity cost for the Trust fund involved. As the article says, “It’s worth noting that the two investment firms the county uses to manage the trust fund neither recommended nor objected to converting the investments to cash. That, they said, was up to the supervisors”. They were clearly not going to get involved one way or the other!

The role of consultants in the rise of Hedge funds in US Local Authority schemes is chronicled (here), but it applies equally over on this side of the pond. There is no evidence of actual collusion between Hedge Funds and Consultants (as of yet), but it can at least be said that they have failed to protect the interests of the Pension fund beneficiaries, thus endangering the futures of those whom they were supposed to be safeguarding [2], potentially to further their own interests.

We have long railed against “experts” and their capacity to get things (sometimes) spectacularly wrong; this may be a case of a different form of the same problem. In this instance, we don’t have experts at all- just a cosy cartel who don’t feel the need to work on behalf of their “clients”, because, like in many cases in the financial industry, there is no incentive to do so. If the FCA have finally got their act together, it should help pension fund beneficiaries, but like many other examples of recent times, this may be another false dawn. Recent figures suggest that 67,000 people have left Defined Benefit schemes in the year to March 2017; transfer value rises have contributed to this, but is it a sign of another issue – the continual ebb in confidence in the pensions system? Despite the barrage of conventional opinion that one should stay in a DB scheme, people appear to be voting with their feet. Only time will tell whether this is the wisdom of crowds or a popular delusion.

[1] I have direct experience of some of them, as both West Yorkshire and East Riding Pension funds made extensive use of them whilst I was working there. They were, without exception, middle-aged ex-City gentlemen, who had never knowingly failed to recommend a “hot” investment strategy; thus, they were keen advocates of Hedge funds around the 2000 top and were recommending the same 7 years later. In both cases, the Investment Committee, of which they were part, proposed large investments in these “assets”, which then promptly dropped like a stone. As a result, the Pension funds saw their funding status go from positive (or neutral) to deeply negative; (at one point, the West Yorkshire pension fund was only 45% funded), but it didn’t seem to phase them in the slightest. They will have retired by now, but the Pension funds are still living with the consequences; there appeared to be no repercussions for them, however.

[2] This study, from 2013 highlights the problem; it is damning, but has the FCA has only just caught up to it ?