Choosing Consultants: What Should You Measure?
Art by Katherine Streeter
As a group, consulting firms boast many intelligent, phenomenal knowledge brokers. They also play a crucial role at many public pension funds, which might not always have the in-house capabilities to research asset managers internally.
But choosing one over another takes time and effort. Researching firms, meeting with consultants, and finding the ones that align with the goals of your pension fund or fit the personalities of the group is a tricky business. It requires checking the size of the fund and assessing the people you’re working with.
If they are chosen well, however, they can help drive insights into investments and scale the capabilities of what investment teams deal with.
“They’re serving a function that we can’t do internally,” said Marcus Frampton, chief investment officer at the Alaska Permanent Fund (APF).
Who Are You Working With?
Allocators who are choosing consultants might start with a request for proposals (RFP) search or call up some fellow pension fund leaders to see which knowledge brokers have done right by their peers.
But when it comes to finalizing a choice, it’s as important to review the actual consultants you will be working with as it is to go by the reputation of the firm, says Sam Masoudi, chief investment officer at the Wyoming Retirement System (WRS). The firm could appoint someone without the level of experience required by the fund or the consultants might be spread too thin among too many clients.
It’s also important to go over the consultancy’s client list, which could show whether the firm has worked with similar-sized investment funds in the past. Personality also matters: The people at pension funds in the Midwest may respond differently from the retirement program leaders down South.
Review Their Research Capabilities
Some allocators use consultants as a starting point for asset manager searches and build out internal capabilities from there. Hiring consulting firms with broad coverage is key.
Alaska’s Frampton said he reviews the firm’s market coverage and office footprint. Having a physical presence in Europe or Asia means the consultants can check in on asset managers there that his sovereign wealth fund, with its one office location in Juneau, would find more difficult to get immediate, firsthand information on. “We can leverage that,” Frampton said.
Wyoming’s Masoudi evaluates manager research capabilities. He asks consultants how many funds they cover, and how frequently they’re in contact with them. “In some cases, a consultant might say they have done due diligence on a certain manager, but it might turn out that was several years before and the analysis is stale,” Masoudi said.
Ideally, consultants are tracking managers regularly enough to understand their key drivers of performance, and are able to stay abreast of and report strategy changes and staff turnover, the allocator said.
Make Your Own Manager Decisions
That said, if they’re able, allocators should always conduct their own research and make their own decisions on asset managers, instead of solely relying on the recommendations from consultants, pension fund leaders said.
Consulting firms working for many clients have a limited number of asset managers they cover, so they may prefer large investment funds that are open to new investors, which does not always correlate to performance. “It’s generally the smaller managers that can do a little bit better,” Frampton said.
Allocators may seek entry into smaller, closed funds that have a better track record of outperformance and don’t raise assets beyond what they can manage effectively, instead of high paying fees to bloated funds for what could be index-like performance.
“We are constantly searching for premier funds. If we find one and it is closed, we will put our name on their waitlist and stay in regular touch with them, even if it might be four or five years before we get in. We can afford to be patient,” Masoudi said.
“If you just invest off of their recommended list, it’s probably not a great outcome,” Frampton said.
Build Out Internal Capabilities
Consultants can help investment teams fill out the weak spots in their investment knowledge and build out their asset classes.
At Frampton’s fund, which has an investment policy that requires consultants to sign off on all investments, specialists like RCLCO are helping the sovereign wealth fund enhance its real estate portfolio. The APF has a five-year plan to get it to 12% of its portfolio, up from 7%.
At the Missouri Local Government Employees Retirement System (LAGERS), CIO Brian Collett takes it a step further. The investment team got interested in building out its private asset class, up to 45% of the portfolio from nearly a decade ago when Collett first joined Missouri LAGERS. So the investors on his team hired consultants on a project basis and worked closely with them to learn more about private manager selection. Then, they went and did it themselves from then on.
“So far, I don’t think we’ve engaged anybody for the same thing twice,” Collett said. “Meaning that we’ve learned what they did, and know how to do it now, so we now do it internally.”
Building Trust: Delineate Roles
Building trust is crucial, particularly at pension funds where investment consultants are kept on retainer to advise the board. Consultants often have the tricky position of acting as a third party between trustees and investors. In those cases, it’s useful to delineate roles between the investment chief and the consultant, so there are clear expectations. In cases where communication breaks down, it never hurts to listen to criticism or to address issues directly.
Ultimately, though, building trust between a fund and a consulting firm is a matter of time. Frampton, whose pension fund has retained the same consultants it had before he became investment chief in 2018, said he prefers working with the consultants over the long term.
“We found that working with one for a while, they get to know our strategies and what we’re trying to accomplish pretty well,” Frampton said. “So that tenure to us is important.”
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