The FOMO Element of Discretionary Consulting

As more and more investment consultants crowd into the discretionary consulting space, perhaps spurred by a fear of missing out (FOMO) mentality, some within the industry say the potential cost of not following the herd could be a problem.

(September 25, 2012) — Investment consultants are increasingly pursuing the discretionary consulting space, which they say is a “natural evolution” of the business.

In March, Rocaton announced that it would begin offering the service, as it had approved its first discretionary consulting client, allowing the consulting firm to oversee total portfolios for their clients. According to the firm’s founder Robin Pellish, its decision to pursue the outsourced CIO or discretionary consulting business stemmed largely from its hiring of John Nawrocki — who joined in 2011 from Rogerscasey (now Segal Rogerscasey) where he led the outsourcing arm. Nawrocki currently oversees Rocaton’s discretionary consulting business.

But as more and more consulting firms jump on the discretionary consulting bandwagon, what is the opportunity cost for not getting into the space? Are consulting firms propelled to offer such services by a fear of missing out (FOMO)?

“The opportunity cost for not taking on those responsibilities is that you’re not going to be able to work with the clients that you have in the past,” Rocaton’s Nawrocki told aiCIO, noting that investment consultants are increasingly interested in outsourcing, as a result of the constraints asset owners are facing in terms of resources. “There’s more and more complexity on the plate for asset owners in dealing with alternatives along with derivatives and the consequential counterparty risk involved,” he said.

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To put it differently, according to many consultants offering the discretionary consulting service, which they generally deem as hugely more profitable than the litigious world of traditional investment consulting, the opportunity cost is not only lost profit, but also potential loss of clients who will look elsewhere for their needs. “There are more and more asset owners going into this route, so the number of new business opportunities for non-discretionary services will become less,” Nawrocki added.

As asset owners face the challenges of higher complexity throughout their investment portfolio, leaning on a consultant for the outsourced CIO role is simply a lever they can use to alleviate challenges, Nawrocki said.

Yet there are still consultants left in the industry that are holding out, remaining “independent,” as they say. In April, aiCIO interviewed Lisa Needle of Albourne Partners, an alternatives-focused investment-consulting firm and one of the few truly independent investment consultants left. “Albourne will never be discretionary,” Needle stated at the time. “We solely provide advice. In our mind, providing both discretionary and non-discretionary advice to clients represents a conflict of interest.” In the long-run, reputation is more valuable, the firm said. The firm is adamant about offering a fixed fee model, while refusing to take discretion for the advice they offer on investing in a hedge fund manager. In other words, the firm feels strongly that there is a Chinese wall between discretionary and non-discretionary advice on managers.

Other consultants that have avoided the discretionary consulting arena include Boston-based New England Retirement Consultants (NERC), a specialized retirement consulting firm not to be confused with NEPC, and Portland-based RV Kuhns & Associates. Two years ago, NERC chose to dip its toes into the outsourced CIO role by not offering the services to their client themselves, but instead by conducting requests for proposals for discretionary services. In other worlds, they act as a gatekeeper for evaluating and choosing outsourcers. “So if an organization wants to go from the traditional consulting model to the outsourcing model, we come in and find out what their needs are and match them up to candidate firms, such as investment management companies and other consultants, for discretionary services,” New England Retirement Consultants’ Jay Gepfert told aiCIO.

According to Gepfert, who was previously with Russell Investment’s outsourced CIO business for seven years, a FOMO mindset may be a factor pushing consultants to offer an expanded array of services. “But there is still a relatively small percentage that outsource — just around 10%. In the last two years there has been a gold rush of consultants getting into the space because either 1) they have a client lost to an outsourcer or 2) they think this is a model going forward,” he asserted, highlighting that the upfront cost of providing the service is “not cheap.” “For us, we have a lot of other revenue areas that differentiate ourselves from the market. We’re not a Mercer. We’re a small boutique.” He added: “I tell clients that frankly there’s an overcapacity of outsourcers compared to the firms that want to outsource. It went from 10 outsources five years ago to around 60 today.”

So, is the FOMO justified? Perhaps, for some consultants–namely boutique or specialist firms–missing out on the discretionary consulting bandwagon is in their best interest.

A pull-back in the use of contingent assets by corporate sponsors has seen the levy imposed by the United Kingdom’s lifeboat for bankrupt company pension funds, the Pension Protection Fund (PPF), rise by almost 15% for the next financial year.

The estimate set by the organisation has risen to £630 million for the financial year 2013/2014, from the £550 million originally budgeted earlier in the year, the PPF announced today.

The levy is imposed on all corporate defined benefit funds in the United Kingdom, the proceedings of which are pooled and managed by the investment team. This fund will cover the cost of providing a pension to members of plans whose sponsoring employers collapse and are substantially underfunded.

One of the major reasons for the increase cited by the PPF’s CEO Alan Rubenstein was a reduction in the use of contingent assets – which had reached record levels last year.

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Use of these assets – which can take the form of company property, physical assets, or written guarantees – serve to reduce risk and thereby push down the levy imposed on employers.

Last year aiCIO reported that UK employers were using a record level of contingent assets to reduce risk in their pension funds and plug shortfalls.

A consultation document released with today’s PPF announcement said: “In addition to the impact of market movements, it now appears likely that the level of risk reduction provided by contingent assets will be lower than had been anticipated, as many have been withdrawn and new certifications have been at a lower rate than in previous years for 2012/13.”

However, the document asks for feedback from pension funds and their employers on what can be used as a contingent asset and how they would be used for levy purposes.

Milan Makhecha, principal consultant at Aon Hewitt, said: “The stricter guidance issued last year by the PPF for Type A contingent assets (group company guarantees) seems to have acted as a deterrent – it appears that a notable number of schemes have certified a reduced obligation or not recertified their contingent asset at all, if there was any doubt as to whether the guarantor could meet its full obligation under the guarantee. As a result, the PPF expect to collect more in levies this year than they originally anticipated.”

One aspect welcomed by the industry was the announcement that the levy would not increase to more than where it sits this year.

Joanne Segars, CEO of the National Association of Pension Funds, said: “The PPF’s decision to keep a lid on the increase in the levy is realistic. It strikes a balance between protecting schemes from major extra costs and ensuring the PPF’s finances are strong and sustainable. It also recognises that schemes are facing extra pressures as a result of low gilt yields and quantitative easing.”

However, Rubenstein warned that levy increases in future were inevitable if the current high risk conditions persisted. He said: “People should bear in mind that, if our protection regime in the UK is to be credible, then it needs to be funded. The alternative, an inadequately resourced PPF, would fail to offer the security that pension scheme members deserve, and would strengthen the hand of those who argue for more radical measures to deal with risk such as the imposition of insurance style solvency requirements for pension schemes.”