The Gatekeepers: Consultants Hold the Key

Many large institutions find themselves with money in employee retirement plans that needs to be managed, but by whom? The senior management of an airplane manufacturer or pharmaceutical company, for example, may not be the most qualified at knowing how to invest the funds of its employees' pensions. In addition, they may not have the expertise to pick the right portfolio manager to do this for them. This is where the institutional investment consultant comes in. These are the "gatekeepers" that allow asset managers the chance to manage money for large institutions. This article will give you a general idea of what an investment consultant does and how they help their clients with manager selection.

An institutional investment consultant provides investment advice to public and private companies, foundations and endowments looking for help with managing their money, or the money in their employees' retirement funds. They are used widely in the U.S., Europe and Australia. The profession started out helping corporations with their pension plans, which is why they are also referred to as pension consultants. Because their role has expanded beyond pension consulting, they are now known as institutional investment consultants.

Today, many retirement plans include defined contribution plans and 401(k)s in addition to, or in place of, defined benefit plans (pensions). Institutional investment consultants use their pension expertise to give advice on defined contribution plans as well as working with other institutions, such as university endowments. In addition, the breadth of available asset classes has expanded. There are now many alternative investment classes (such as hedge funds or private equity) that an institution might need help navigating. (See also: Introductory Tour through Retirement Plans and Retirement Planning Basics.)

The typical large consultant group usually divides its consultants into field consultants and research consultants. The field consultants are the ones who meet with the clients. The research department mainly compiles the performance and other relevant information about the managers. From this the research, consultants provide the "short list" of approved managers that the field consultants use when they are assessing the best portfolio manager for a particular client.

A newer trend is for the research department of a consulting group to be compensated based on the return of the managers they select to be put on the shortlist. This is designed to align the interests of the research team with the interests of the client.

Due to the large number of investment managers, consultants are a necessary intermediary, providing an essential matching function. They match asset managers to their clients' investment needs. Because this is a consultant's area of expertise, they generally have screening methods and extensive contacts in the industry.

Investment consultants are often used in the due diligence process because some firms are either too small or lack the expertise to staff a department to search for investment managers. Even if it is a large, sophisticated firm, an investment consultant may be needed to help it appear unbiased in its decision making. The point is to make sure that people feel that the portfolio manager was selected based on appropriate criteria.

There are several hundred consultants providing a large menu of services. The 20 to 30 major players seek to provide "one-stop shopping" for their clients in relation to the management of retirement assets. (See also: Become Your Clients' One-Stop Shop and New Services Usher In New Clients.)

The most common services provided by these major players include:

• Plan design
• Development of investment objectives and investment policy statements
• Benchmark selection
• Operational audits
• Asset allocation advice
• Manager selection and monitoring

For example, if a client needs asset allocation advice, he or she might be seeking answers to questions such as, "Should we be investing some assets in real estate?" Or, "Should we be investing more of the equity portfolio in emerging market securities?" The institutional investment consultant can help guide clients toward the best asset allocation. A consultant can also help define the formal investment guidelines that will guide asset allocation (an investment policy statement). Or, they can work within the constraints of previously established guidelines, paying attention to the risk/return profile of each asset class. Their main business, however, is to help clients (most commonly pension funds) choose the best portfolio manager.

A consultant who is in charge of finding the right portfolio manager must know what they do and how they do it. Because of this, the remainder of this article will focus on manager selection. (See also: Preparing for a Career as a Portfolio Manager.)

So, how does a portfolio manager get new money? The process can be lengthy. Good performance obviously brings in more money, but there is more to it than just generating good returns. As gatekeepers, if the consultants don't know who the manager is, they will not give the manager access to a client's money. For an asset manager, it is important to know how the game is played—he or she will need to be positioned to get noticed. There are certain measures that one can take to ensure this. One of them is being Global Investment Performance Standards (GIPS) compliant. In the U.S., many investment consultants will not even consider a manager for their clients if he or she is not GIPS compliant. (See also: A Guide to Global Investment Performance Standards.)

Another tactic managers can use is to have people dedicated to dealing with the consultant community. All asset managers have client service departments that help facilitate the manager's relationship with clients. They are the main point of contact with the client and can provide the monthly reports as well as answer one-off questions the client may have. This same relationship management concept is transferred over to departments or individuals that help manage the asset manager's relationship with the consultant community.

From the consultants' points of view, their job in picking an asset manager is to perform all of the due diligence necessary to select the best manager for a particular client. As part of this, many consultants have developed their own databases. These databases track not only a manager's performance numbers, but also other relevant data points such as assets under management, portfolio manager tenure and style information (growth, value, etc.). Most of these databases are set up so that asset management firms send periodic updates to the consultants to refresh their information in the database. (See also: Focus Pocus May Not Lead To Magical Returns.)

There is more to picking an asset manager besides performing screens and crunching the numbers. There are also qualitative factors in addition to the quantitative factors such as long-term returns or total assets under management. Many proprietary databases also have features that allow the consultant to scan in notes from meetings with a manager. This helps consultants keep track of those intangibles that don't make the screens. This qualitative aspect is why it is important for asset managers to worry about their image within the consultant community. It's not that you can fix the game by being "in" with a consultant, but it will give the manager an edge in the due diligence process if all else is equal.

There are several activities that are performed by a consultant when they are conducting a manager search. There is a progression that is followed although the steps may not be performed in an exact order. Some of the major steps that lead up to hiring are:

• setting guidelines
• database screening
• selecting finalists
• performance analysis
• risk analysis
• site visit

There are several other steps and substeps, but they all seek to answer the same question, "What manager is the best fit for this client?"

When people look at their vested pension benefits or 401(k) balance, they probably don't think about the consultant who may have selected the team that is managing their retirement. However, they are there every day working hard for companies everywhere. More than $30 trillion in managed assets has been invested, and consultants have helped to place a majority of that money. These institutional investment consultants go about their business invisible to most of the population, but they have a big impact on everyone's futures.