How and Why Large Funds Are Increasingly Walking Alone

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Chief investment officers of pension funds have to be many things: accountants, strategists, economists, political observers, currency traders, longevity experts, and regional and geographic sociologists—and that’s before they have tackled the running of their own team (personnel and human resource specialists) or spoken to their trustee board about why their chosen path is better than the last one (teacher). This is why they need assistance.

For many years, investment consultants and actuaries have been the helping hand CIOs have relied upon to keep these various plates spinning and come up with plans to make the job easier.

Liability measurement? Check. Investment strategy? Check. Manager selection? Check. Trustee education? You got it!

So what’s the problem? The problem, according to many in the top ranks of pension fund management, is that consultants have stopped being such a help and, in some cases, are more of a hindrance.

“Some of them are so behind the curve, it’s unbelievable,” said the head of investment for one large UK pension fund. “It’s like we, the pension funds, have all caught up. Often we are going to them with ideas rather than the other way around and we are still paying them the same—or we are paying more if we want something more complicated than plain vanilla bonds or equities.”

Before going any further with this conversation, the investor had to be assured that his name would not be published. The relationship between the pension fund and its consultant is still ongoing, despite his reservations, and calling them out in public would do more harm than good.

This was the situation for all the conversations in this article. CIOs may be frustrated with their consultants, but it will take an exceptionally brave one to badmouth them in public.

Consultants’ manpower remains essential. They do a lot of the legwork needed by the relatively small teams of investment professionals who are running the billions of pounds, dollars, euros, kroner, or whatever other currency a pension fund is managing.

Even without this heavy-lifting requirement, for the moment they are (mostly) stuck with them. For example, the financial regulator in the UK, the Financial Services Authority, will only allow pension funds that have been fully vetted, tested, and registered with them—like an investment bank, asset manager, or other financial institution—to operate without the advice of an investment consultant. This is understandable: The trustees and members they represent have to be protected, so until a pension fund can prove it is able to function within the bounds of financial regulation, consultants have to advise every step of the way. Pension funds operating independent investment companies, such as British Telecom, Tesco, and Universities Superannuation Scheme, are still relatively thin on the ground. However, most of the mega-funds—on mainland Europe, at least—no longer rely on investment consultants to help formulate a strategy, and this trend looks set to be crossing the North Sea.

“They haven’t really recovered from the crisis,” said the head of alternatives at a large UK pension fund. “They have too many clients and have been busy explaining to the smaller ones what happened and how they might be able to get out of the mess they find themselves in to come up with anything new for the larger funds.”

So they are oversimplifying things to help out less well-informed investors or trustees? Not necessarily, according to the head of investments at a large corporate fund.

“Our consultant had a session to explain different kinds of bonds to our trustee board,” the investor said. “It was hopeless. The trustees had no idea what they were talking about and were so confused I had to go through everything again after the consultant had gone. They are meant to be doing this to save me time.”

Another investor was critical about the time needed to mobilize their consultant. “We have new ideas, and are approached by other people with them—we often find our consultant either does not have the time to look at them, does not want to consider anything new before thoroughly investigating it, which can take them many months, or they are too cautious to do anything new. Sometimes we want to strike while the iron is hot—we understand due diligence and that we can’t just jump on an idea and hope for the best, but there has to be a better balance than the treacle we have to wade through at the moment.”

It is for this reason that smaller, more nimble consulting firms have been gaining traction over the past couple of years. Yet these companies have their problems, too.

“We work with smaller consulting firms on a project basis,” said the head of investments at a large corporate fund in the UK. “I wish we could do more with them as they have some great ideas, but we are a big fund and they would have to give over so much of their resources to look after our account, it’s just not viable for either of us.”

The constraints some of the large firms present, however, are more infuriating for some.

“It’s all about sales targets for the large firms,” said a high-ranking investor at a UK pension fund. “We are all talking about the long-term—and long-term for us means 50 years—yet our consultant is only too happy to facilitate our three-year manager selection exercise. Okay, so most pension funds are required to look at performance after that amount of time, but is it really necessary to change managers every three years? Call me cynical, but I’d say consultants’ fees play a part in the need to shuffle.”

Then comes one of the biggest bugbears.

“I don’t want to hear that the fund manager I am interested in isn’t on the buy list,” said one exasperated young pension fund investor. “It seems that we are constrained because our consultants have only ever worked with fund manager A, B, or C. We don’t want those types of blinkers for our investments.”

Blinkers come in other forms, too.

“We had agreed to work with a new consultant,” said the head of investments at a multi-billion pound fund, “when they called and said that if we didn’t take their fiduciary product, they didn’t want to work with us. This was never mentioned before as we don’t want to take that route, so we said ‘no’ and had to start the whole process again. It was unbelievable.”

The fiduciary option has caused more than its fair share of angry words uttered by pension funds to the author of this article. In May, several of aiCIO’s Forty-Under-Forty—the next generation of institutional investors—said they considered the consultant model to be broken, with sales targets getting in the way of what the client needed or wanted. This is a topic that this magazine has written on at length.

There is, admittedly, no right-to-reply for consulting firms in the article, as putting the accusations to one or two large companies would unfairly single them out for criticism and getting all to defend themselves would fill the entire magazine. Rather, this piece should serve as a warning to the consulting community that CIOs and high-ranking investment professionals are no longer complaining about asset manager fees, lock-in periods, or not beating the peer benchmark. They are increasingly frustrated about the process that should enable them to reach that point—and about those who are meant to be helping them.

For many years consultants have been in favor with the CIO. They have been the gatekeeper protecting investors from the buy- and sell-side sales teams who wanted a basis point or two from the pension pot. If they are not careful, they will alienate the flock they had worked so hard to protect—and they will not be so easily won the second time around.