Asset managers turn against investment consultants
UK regulator seeks more control over ‘opaque’ and ‘uncompetitive’ advisory industry
Asset managers have called for stricter oversight of the UK’s hugely influential investment consulting industry after Britain’s financial watchdog warned of conflicts of interest and a lack of transparency in the sector.
The Financial Conduct Authority expressed concerns about “opaque fees” and a lack of competition in the institutional advice sector in a damning interim report on the asset management industry last November.
The regulator said it was considering seeking more regulatory powers over investment consultants, who advise on where £1.6tn worth of people’s savings should be invested. The FCA expressed concerns that a “very important part of the asset management value chain” is currently largely unregulated.
The FCA’s stance has been backed by asset managers, trade bodies and some consultants, which claim greater regulation of the institutional advice sector is vital to improve services and investment returns for pension funds and other big investors.
The Investment Association, the trade body for fund houses in the UK, said in its response to the FCA report: “Investment consultants play a central role in the institutional asset management market and the quality of their advice is likely to be crucial in determining outcomes for institutional investors.
“Ensuring that this element of the investment value chain works well for institutional investors is therefore highly important.”
The trade body added that it “strongly” supported proposals to bring institutional investment advice into the FCA’s regulatory perimeter and backed proposals to refer the investment consulting industry for investigation by the Competition and Markets Authority, a government department responsible for strengthening business competition.
The FCA’s spotlight on the investment consulting market comes as concerns mount about the influence of the sector.
In its 208-page report, the watchdog said consultants, on average, were unable to identify managers that offer better returns to investors and did not appear to have encouraged a rise in price competition between asset managers.
But investment consultants wield huge power in the UK due to rules that require pension funds to seek investment advice. With the exception of the largest schemes, most pension funds turn to investment consultants for this advice.
Consultants typically focus on helping pension schemes make decisions around asset allocation and risk, as well as suggesting suitable fund managers. In some cases, pension funds and other investors will entrust a consultant with the management of their assets, under a model known as fiduciary management.
Because consultants in the UK act as gatekeepers to more than a trillion pounds in assets, investment managers have traditionally been reluctant to condemn them publicly. In private, however, fund houses have been highly critical of the sector, especially its push into fiduciary management.
This move into fiduciary management has meant consultants are often in direct competition with the asset managers they are hired to assess independently.
The FCA said: “We heard a persistent concern from asset managers and institutional investors that once an investment consultant has developed its own product offerings, it will recommend its in-house propositions even if there are better investment products offered elsewhere.”
According to KPMG, the professional services company, three-quarters of all fiduciary mandates went to consultants last year.
One senior executive at a UK asset manager, speaking on condition of anonymity, says: “The problem [with consultants offering fiduciary management] is it creates a massive conflict of interest.
“[The consultants] have some clients who want to make their own investment decisions, but the consultant wants to push them down the route of fiduciary because it is hugely profitable.”
According to the FCA, the value of assets managed by investment consultants under a fiduciary arrangement has tripled in the past five years to almost £60bn.
While dwarfed in size when compared with the £1.6tn in assets under advice, the regulator said that on a per-client basis, fiduciary management generates much higher revenues than traditional advisory business.
The FCA said that of consultants that offer fiduciary management services, 41 per cent of their combined advisory and fiduciary management revenues came from fiduciary management, despite representing just 4 per cent of assets under advice.
The regulator also warned that performance and fees of fiduciary managers appear to be among the most opaque parts of the asset management value chain.
John Walbaum, head of investment consultancy at Hymans Robertson, an investment consultancy that does not offer fiduciary management, says: “We would be in favour of more separation of the two roles [fiduciary and investment consulting]. We think these conflicts are unnecessary and they are too big.”
The UK’s largest consultants, Willis Towers Watson, Aon Hewitt and Mercer, said on Friday said they had put forward a series of proposals to the FCA that are aimed at improving competitiveness and transparency in the investment consultancy and fiduciary management industries.
Over the coming months, the UK’s financial watchdog will have to decide whether to officially ask for regulatory powers over consultants.
Redington, one of the UK’s five largest consultants, backs this approach. It says: “We believe it makes sense to bring those areas of advice that are most meaningful to pension fund outcomes under the FCA regulatory perimeter.”
Patrick Disney, European managing director of the institutional group for SEI Investments, a fiduciary manager, argues that more efforts need to be made to ringfence consultancy work from fiduciary management. SEI stopped offering consultancy services in favour of focusing on fiduciary management because of concerns about conflicts between the two services.
He says: “More regulation is a logical next step, particularly if you have [companies] offering both [fiduciary and investment consulting] services.”
The IA says: “We are particularly keen that, where consultants provide asset management products and services, they compete on a level playing field with asset managers, both in terms of regulatory oversight and client scrutiny of their performance.”
The FCA will also have to decide whether to push the antitrust regulator to carry out a probe into the sector.
In its report, it raised concerns about the dominant “big three” investment consultants: Willis Towers Watson, Aon Hewitt and Mercer. It estimates that the trio collectively control 60 per cent of the market and take an estimated 71 per cent of revenues, down from 78 per cent in 2011.
Consultants have been quick to dismiss suggestions that the sector should be referred to the antitrust authority because of a lack of competition, arguing there has been an improvement over the past decade.
But others are less sure. The Transparency Task Force, a campaign group, believes a probe by the antitrust authority is a “good idea”.
“It will help to shine a light on the workings of the investment consultancy sector and it therefore has the potential identify and deal with issues that prohibit the efficient workings of the market, including conflicts of interest.”
It also backed more regulatory oversight of consultants. “The fact that the institutional investment consulting sector has not been regulated to date may explain many of the suboptimal market practices that have been taking place,” the group argues.
--> Game over for golf
Fund managers and consultants have a reputation for enjoying a game of golf together, but potentially not for much longer.
Last year, the UK’s financial watchdog warned that there is a strong culture of gifts and hospitality in the investment consultant industry, which could be seen to influence the ratings consultants give to asset managers.
In a far-reaching report on the asset management industry, the Financial Conduct Authority said there was no evidence that consultants receiving hospitality or gifts from fund houses benefited the end investors, arguing that it introduced conflicts of interest instead.
The FCA found there was a “statistically positive” relationship between the number of high ratings given to an asset manager and the level of gifts and hospitality received by the consultant.
The regulator said there were a number of factors that could explain the increased level of positive ratings, such as consultants spending more time with fund managers when considering their strategies. But it added: “We cannot rule out the possibility that consultants may have been influenced by their acceptance of gifts and hospitality.”
While the watchdog acknowledged that the value of gifts and hospitality accepted by consultants had fallen in recent years, it said it planned to investigate the possibility further that such benefits were influencing consultants’ ratings of asset managers.