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As the financial world emerged from the rubble of the Lehman Brothers collapse, the initial reaction of the investment consulting big guns was to come together.
Mercer bought Hammon and Evaluation Associates; Towers Perrin and Watson Wyatt merged; Aon bought Hewitt Associates, which had previously bought Ennis Knupp; Segal bought Rogerscasey; and JLT bought HSBC’s actuarial and consulting arm. And there were other deals along the way.
“Consolidation was being driven by an increasing complexity of markets and the demands of plan sponsors in a more challenging environment,” says Erik Knutzen, CIO of NEPC.
Sunil Krishnan, CIO of the BT Pension Fund in the UK also noted this amalgamation drive. “It’s clear that consultancy has become more resource intensive as the investment universe broadens and more schemes consider more complex strategies, such as LDI [liability-driven investment]. So, in that sense, some consolidation was inevitable,” he says.
And bigger means better, right?
“In principle, consolidation always weakens customer choice—but in practice there was a degree of herding in historic consultant behavior anyway,” Krishnan says.
Despite these newly formed powerhouses dominating the skyline, Lehman Brothers’ demise also helped independent investment consulting boutiques to emerge.
One such boutique, Redington, even believes that, without the turmoil caused by Lehman Brothers’ failure, it would not be enjoying its current escalating status. “In 2007, people were telling us we had missed the investment-consulting boat because everything was okay. Real yields were 1.5%, credit spreads were about 60 basis points, UK equity markets were up to 6,800, and basically it was clear, blue skies,” Redington’s Co-CEO Rob Gardner says. “Our point of differentiation was, and still is, that we’re the destination for asset liability management [ALM] modelling, and risk management is in our DNA. People would say to us, ‘That’s interesting, but we’ve done our ALM study.’ And we’d say, ‘What if equities fall by 25%? What if interest rates fall 1%? What if inflation goes up 1%?’ But it all fell on deaf ears in 2007.
“Lehman triggered the anticipation of bad things happening and the profound impact it can have,” he adds. “Had the world continued in a benign way, we’d have struggled to have gained traction. What Lehman Brothers did was bring into question conventional thinking. The Big Three [Aon Hewitt, Mercer, and Towers Watson] were the major proponents of conventional thinking, and people started to say, ‘Maybe there’s a different way.’”
LCP’s senior partner Bob Scott agrees: The orthodox strategies of the larger consulting houses were questioned after 2008, and, consequently, “projects that might previously have been undertaken by schemes’ original actuarial adviser were increasingly offered to firms that could demonstrate specialist knowledge.”
Clinton Cary, head of US delegated investment solutions and CIO at Hewitt EnnisKnupp, believes the rise of the outsourced CIO is directly linked to Lehman Brothers and the subsequent financial crisis. “The outsourced CIO sector has specifically benefited from market volatility,” he says. “In particular, the 2008 crash was the last push many plan sponsors needed to move in this direction after the dot.com bust.” But, Cary adds, even without the financial crisis, the outsourced CIO trend would have grown, as investment complexity and pension funding rules made the role more attractive.
Chetan Ghosh, CIO for Centrica’s pension funds, believes the attention to detail offered by these newer boutiques means they would have gained ground even had the crash not happened. “The new kids on the block are much more focused on positively improving the financial health of pension schemes—and that message would have won regardless of Lehman,” he says.
But are boutiques ready for the big time? “The future for these firms hinges on whether they seek out the higher revenues that come from originating deals with their clients or see that as compromising their incentives,” BT’s Krishnan suggests.
And there are those who believe the big boys are still too far ahead.
“Even if I look superficially at ‘the Big Three’ consultancies, it’s clear they have all grown since Lehman fell, whether judged by head count, revenues, service lines, et cetera,” argues John Belgrove, partner at Aon Hewitt. “Such a trend has not excluded growth for other consultants operating at a more national level nor the opportunity for more niche specialists to advise on part of, rather than the whole, solution. This creates healthy choice and competition.” He adds that the technical depth and breadth required to compete since Lehman Brothers’ collapse present obstacles to boutiques, but he expects continued growth for all sizes of consultants.
And the driver of this growth? The size of pension plans’ financial problems and the speed with which these need to be solved: hence, the need to embrace more complex financial solutions and to uncover value in niche asset classes.
Some investors embrace this new world of choice. Mike Taylor, the recently retired chief executive of the London Pensions Fund Authority, dropped all consultants for everyday use but said he would hire specialists for specific projects “if we felt their knowledge and expertise could assist us.”
Unless another Wall Street giant collapses, of course. Then all bets are off.