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Consulting firms, by their very nature, should be crucibles of innovation: After all, they inhabit that rarified space where the best thinking about investing tomorrow meets the reality of investing today. Consultants see the innovations in asset management while they are yet in the womb; they shape, sometimes even dictate, which of these their institutional customers bring to birth. What a perch, one would think, from which to see trends coming into being—and to adjust business models accordingly.
Indeed, we know it can be done. In the late 1990s, Frank Russell, in the fresh air of the Pacific Northwest, and with a restless and hard-driving chief executive in Mike Phillips, saw the future and adjusted accordingly. Transition management was a great business: So, get into it with both feet. Overlay management and portfolio rebalancing, ditto. Move from monitoring and identifying investment talent to packaging it—no one really liked to pay much for the former, but the world was eager for the latter and ready to pay asset-based fees for it. As to the issue of inherent conflicts of interest: If the likes of Goldman Sachs could, for decades, be a living testament to the fact that such conflicts could be managed, Phillips reasoned, then why shouldn’t a consulting firm reach for a better business model? And so, Russell turned itself into a profit machine, for which Northwestern Mutual paid up handsomely in 1999.
Mike Phillip’s Russell turns out to have been something of a singular creature in this regard: No other consulting firm has come even close to reinventing itself. The question, then, that poses itself is why consulting firms have been such tacit observers of the changing tides around them. And, perhaps more intriguing, are we at a new crossroads for consultants, the beginnings of a new dynamism?
If we look back at the specific innovations that have swept through asset management this last decade, it is hard to see where consultants have been more than benign observers. The embrace of alternatives, the emergence of risk parity, the rush to liability-driven investment—in this last, an honorable exception must be made for Rocaton Investment Advisors—were all trends driven by a handful of managers and their more adventurous asset-owner clients. The most radical change of all—the marginalization of defined benefit plans and the growing centrality of defined contribution plans—was simply ignored by most traditional consulting firms until it became truly apparent that doing so meant irrelevance.
So why has the consultant community been, in the main, on the sidelines as our industry evolves? In part because their role is to do exactly that—they guard the guards, stand above the fray, and get paid adequately if not substantially to do so. They are rather like sex therapists—clients (one supposes) discuss their issues and frustrations with them but are rarely interested in consummation with them. Then there is the question of leadership: Sometimes these firms are headed by individuals who enjoy the intellectual pursuit of investment consulting and prefer that to the Darwinian exercise of power that most CEOs are obliged to embrace; sometimes they are headed by individuals who have esoteric pursuits that long ago took them away from running the business (and why not?).
All this explains the past. Whether it explains the future is less clear. It has happened almost in the blink of an eye, but today many of the consulting firms dominating the scene are part of much larger institutions with much larger ambitions. The likes of Aon Hewitt, Mercer, and Towers Watson are as equally interested in margins as any other player in the investment space, asset management firms included—and, if their rapid commitment to the developing investment outsourcing model is any evidence, quite capable of taking on better business models when they present themselves.
Interestingly, what also becomes evident is that, while the delegated consulting business gets Mercer and its peers one step closer to the asset management business, and into asset-based fee territory, it still allows them to work with, and not against, the asset management community. This is not least because open-architecture investment management choice remains key to that deliverable. Asset owners have, in the main, proved somewhat uncomfortable with the hybrid model that BlackRock and Goldman Sachs Asset Management, among others, have adopted in the CIO outsourcing space, which might be described as open architcture up to a point. The consultants might be tempted to stuff their own fund-of-funds models down smaller customers’ throats, but in the large corporate plan space—where the best pickings are to be had—the mandates have tended to be customized and open architecture. All the intellectual capital that consultants have traditionally brought to the table—with manager research to the fore—serves them well here. It is a very natural transition, as long as consultants remember that, at the end of the day, they are not investment managers.
The evolving shape of defined contribution default/qualified default investment alternative (QDIA) solutions presents another opportunity to consultants, and a handful—with NEPC to the fore—seem to be taking it. Large corporate plans will inevitably move toward customized QDIA options, but many of them will shrink from fashioning their own glide paths and open-architecture manager selections. For consultants, it is a singular opportunity to advance up the value chain. But it requires a resource commitment that only the larger consultants can muster.
None of this is to say that boutique consultants are doomed to extinction. Investment consulting practices will always be with us, because this is an attractive lifestyle business, and the demand for that sort of intellectual capital is a constant in an increasingly complex investment world. But, at the new nexus of consulting power, a premium lies with the firms that understand liability management as well as investment management. That requires actuarial horsepower and relationships, which Aon Hewitt, Mercer, and Towers Watson have in abundance. These too were once practices, composed primarily of actuaries; now they are multifaceted businesses with worldwide reach run by highly ambitious executives. They are very happy to compete—although the shrewdest of them are learning how to finesse that—with asset management firms when it suits them to do so. Amusingly, they still have the manufactured ability to raise a self-righteous hue and cry when asset managers intrude on what they consider their turf. But whether their aspirations in this regard actually compete with asset managers or not, one trend is now self-evident: Where the opportunity presents itself to create asset-based services, these giant consulting firms will seize it.
They might well do themselves a favor and call Mike Phillips, who stepped down as CEO from Russell in 2003, and ask him how he did it.