NEPC Embraces Discretionary Consulting

(June 27, 2011) — Amid growing client demand, Cambridge, Massachusetts-based NEPC is making its way into the field of discretionary consulting.

The firm announced its decision in April to pursue the field of discretionary consulting — which involves implementing investment decisions on behalf of clients as opposed to offering advice — following insistence that its expansion into the arena would not undermine the firm’s “unconflicted” advice.

“We’ve been forced to look into this business for many years now,” NEPC’s Steve Charlton told aiCIO when asked about what spurred the decision to move into the space. “A lot of our clients are choosing to go the outsourcing route. For many years we felt it wasn’t that big of a deal,” he said. “But that started to change last year when we received more requests for proposals (RFPs) asking for discretionary services.”

According to Charlton, NEPC’s decision to provide discretionary services was largely fueled by big changes in the oversees market. In Australia, for example, about 50% of the consultant business is discretionary. In Europe, regulatory changes are driving an expansion into discretionary consulting as well. “Long story short, we concluded earlier this year that this is something we need to look into.”

The firm is relatively late in expanding into the arena. “Russell, SEI, Wilshire, Mercer, and ourselves have provided discretionary consulting services for quite some time,” Rogerscasey’s Beth Henderson told aiCIO. “It’s a pretty successful model, and I think more and more clients are recognizing that there are benefits with discretionary consulting,” she said.

Henderson noted that corporate pension funds, endowments and foundations, and Taft-Hartley plans have been embracing discretionary consulting. “It’s still a decision that doesn’t come easily to clients because they are giving up control over something they had control over for decades,” she said, noting that Rogerscasey began offering outsourced solutions for clients more than three years ago.

NEPC’s move into the investing outsourcing business is unsurprising to many industry analysts as consulting firms worldwide search for more robust revenue streams. While there are large upfront costs to creating discretionary units — “If you do it right, there are big upfront costs with pursing discretionary consulting and it can take years to get it up and running to do it right,” Rogerscasey’s Henderson says — the longterm benefits of charging higher fees are often seen as making this business worth the initial price.

All has not been rosy in the investment outsourcing world, of course. Recent examples of this tension that arises from outsourcing is prevalent at public pensions, such as the San Diego County Employees Retirement Association (SDCERA) and the Ventura County Employees’ Retirement Association (VCERA). They highlight the difficulties and questions that arise when public pensions in the US, strapped for cash and faced with limited resources, rely on external investment expertise.

In March, internal emails obtained under the California Public Records Act showed that having both an internal chief investment officer and a contracted portfolio strategist at the nearly $8 billion SDCERA raised questions about their independent roles and how they should cooperate. About three months after Needle indicated her questions about blurred roles and responsibilities at the fund — which stemmed from SDCERA’s decision to outsource to Salient Partners’ CIO Lee Partridge — Needle resigned to work at Albourne Partners Ltd, a London-based alternative-investment consultancy.

In February, following the departure of the chief investment officer of VCERA in California, consultant firm EnnisKnupp bid to provide outsourced CIO services, yet the fund denied the proposal due to costs and perceived conflicts of interest. Hewitt EnnisKnupp had bid on the position following the recent departure of Ventura County Retirement Board’s chief investment officer, Tim Thonis. “The Ventura board voted ‘no’ because the price was too high, and they perceived a conflict,” Ventura Chairman Tracy Towner, a senior district attorney investigator, told aiCIO earlier this year. “There seems to be an internal conflict that board members aren’t comfortable with when outsourcing to a consultant firm.”

In response to tensions over investment outsourcing, Eastman Kodak’s Director of Pension Investments Worldwide Timothy Barrett, who worked previously at the San Bernardino County Employees’ Retirement Association (SBCERA) for nearly 15 years, a majority of which was as the fund’s executive director and chief investment officer, told aiCIO that the decision to outsource should be an all or nothing approach.

“The decision to outsource should be a decision to fully outsource, or not at all. Any attempt to develop a hybrid approach to outsourcing where the primary decision maker is outsourced and internal employees are left behind to implement creates conflict,” he said. “That conflict will ultimately result in failure without a top-tier manager constantly overseeing the process. The internal staff have no incentive to assist in the success of the external advisor as they view themselves as competition to the external advisor.”