Issue: April/June 2010
Which service providers should be doing what
Trustees bear the ultimate responsibility for investment decisions but frequently lack the specialist knowledge to make them. Andrew Kemp, head of asset consulting at Liberty Corporate, offers a guide and a few cautions through the gamut of roles played by consultants (advisors) and managers (implementers) who come in to help.
Lines of responsibility between asset consultants, implemented consultants, managers and multi-managers have become blurred. There’s often heated debate over potential interest conflicts and about who is best to advise the board of a retirement fund.
Discussion is around the conflict inherent in advising a client and then implementing this advice. By reporting on how well the advice is being implemented, one is marking one’s own homework. On the other hand, allowing the advisor to assist with implementation enhances accountability for achieving the fund’s overall investment objectives.
To explore this properly, let’s divide the advisor/ implementer universe into some broad categories from pure advice to pure implementation:
In the traditional sense, asset consultants provide advice based on an analysis of the retirement fund’s age profile, risk tolerance and liabilities – coupled with a view on which investment managers are appropriate for the client. In this case the consultant purely fulfils the role of advisor and does not implement his own advice. Rather, in consultation with the client, he looks to investment managers for implementation.
Generally in this relationship there are not inherent conflicts of interest provided that the client pays the asset-consulting fee. Also, there must be no connection between how the advisor generates income and why it recommends a particular investment manager.
A potential drawback relates to accountability for the ultimate investment result. The consultant can blame the investment manager for poor performance, and another manager can be appointed, but the issue of why an inappropriate manager was selected in the first place often doesn’t arise.
Then there are implemented consultants. They advise on the policy and strategy components of the fund’s investments in much the same way as a traditional asset consultant.
But they also seek to provide the solution, presented as a packaged “best advice of how to implement” for the fund’s specific needs (generally in some form of a multimanaged solution, often targeting a real return which the consultant has determined to be appropriate based on a needs analysis of the fund).
In some ways, this is attractive. The advisor is taking full responsibility for ensuring that the fund achieves its investment objectives. On the other hand, it introduces potential for selective reporting and agency problems on selection of managers.
This typically can occur when a certain manager might be the most appropriate for a client, but its inclusion might have a detrimental impact on the implemented consultant’s profit margin.
In addition, the implemented consultant typically reports on the performance of the implemented solutions, and so has an incentive to be less than transparent when performance is poor.
Similar to implemented consultants are structured solutions multi-managers who advise clients on the best ways to use products for achievement of investment objectives.
There’s a subtle difference between the true implemented consultant who is packaging his best advice, and a multi-manager who is advising on the best way to use his products. In most cases the difference can only be distinguished by the actions of the specific advisor.
The agency conflict over manager selection is perhaps slightly clearer with the multi-mananger as there is a more distinct understanding that the client is ultimately buying a product. Yet there might be an incentive for this type of advisor to force a fit between the clients’ needs and his particular product range.
Multi-managers and single-investment managers are typically considered to be purely implementers, although a recent trend has been for multi-managers to move towards the structured-solutions model by adding varying levels of consulting.
Generally, however, there is not too much potential for interest conflicts at this level (aside from potential concerns regarding portfolio churn, brokerage and trade allocation).
The disadvantage is that the client, when insufficiently sophisticated in investment matters, often ends up buying an investment product which is inappropriate for the needs of the fund.
There are clearly pros and cons to all approaches, with the potential for conflicts of interests in virtually all the relationships. So there does not appear to be any single system so perfect that it not only eliminates all potential conflicts but also ensures accountability of the advisor.
Accordingly, trustees should seek to understand where the potential exists for conflicts and how the advisor intends to manage them. They should also satisfy themselves on the integrity of the advisor because, at the end of the day, integrity is as important as competence.
Whatever the functions that are outsourced, the trustees have ultimate responsibility for fund performance. There’s no escaping the need for them to apply their minds.