Careers in Finance: Investment Consulting
Operating largely under the radar, investment consultants help money managers perform for their clients. Applying their industry-specific knowledge and experience they help millions of employees reach their retirement goals, help companies operate efficiently and reduce the risk for retirement plan sponsors.
What is Investment Consulting?
Investment consulting (a.k.a. investment management consulting or management consulting) is the business of providing advice to clients in the form of advisory and investment management services. Operating outside of their clients, they are third party advisors. But as any consultant will tell you, sometimes projects for a specific client can last years.
Who Uses Investment Consultants?
Pension funds are the largest users of outside investment consultants, providing advice on investment and strategic decisions. A 2011 survey by Pensions and Investments, 94% of pension funds use outside investment consultants.1 One example is the California Public Employees Retirement System (CalPERS), the nation’s largest public pension plan. With roughly $285 billion representing roughly 1.8 million members and their families, they paid out $33 million in fees to outside consultants in 2012.2 Also, charitable foundations, sovereign wealth funds and endowments entrust investment consultants to help get investment decisions right.
Financial advisors and private wealth managers like family offices may also outsource a portion of the investment decision making process to consultants. This ‘investment outsourcing’ sometimes includes on-demand, specialized investment solutions and research. Consultants can help advisors de-risk their client’s portfolios through diversification and other strategies such as adding liquid alternatives (liquid ‘alts’) to portfolios.
Corporations also utilize the services of investment consultants. Offerings include implementing an employee benefit package, aiding a corporate retirement plan sponsor, human resource management, executive compensation and M&A advisory services.3
Why Use Investment Consultants?
Combined, public pensions have entrusted approximately $324 billion to hedge funds and private equity funds to seek non-correlated returns.4 And these fund managers aren’t cheap-charging fees as high as ‘2 and 20’ (2% of assets under management and 20% of profits). When the fund’s performance doesn’t beat the markets, there’s significant pushback by pensions regarding the excessive fees paid to managers. Consequently, pensions, foundations and endowments use investment consultants to help with the fund manager selection process.
Some managers manage to ride the wave of a bull market in their asset class (stocks, bonds, commodities, etc.) without adding any alpha. Alpha is a measure of performance on a risk-adjusted basis. It compares the returns from an investment against a comparable index so it tells you how much, if any, outperformance is coming from the manager’s selections versus the movement of the market as a whole. Through detailed performance attribution models, a shrewd investment consultant can measure the true alpha of managers and determine whether they’re earning their fees.
Investment consultants help managers control risk, providing an independent voice to validate and vet ideas. It’s of paramount importance that money managers “get the investment right” as trillions of dollars of client funds and accumulated pension benefits are at stake. Financial organizations operate in an increasingly litigious manner, and the use of investment consultants can act as a risk management tool if an investment goes bad.
Investment consultants also keep clients abreast of the newest strategies in alternative investment. With the proliferation of such strategies, including smart beta, market neutral, risk-parity, etc. a pension manager can easily get behind in the latest trends. Dallas Police and Fire announced plans to add allocations to hedge funds with absolute return and structured credit strategies, two popular alternative investment strategies. It is likely the fund managers were found by consultants.5
Many pension funds are seriously underfunded, meaning they currently do not have enough assets to meet future obligations to beneficiaries. The amount of underfunding is commonly estimated at $1 trillion, but some put the estimates even higher, believing some pension funds have overstated return assumptions and understated future liabilities.6 Whatever the actual amount is, the stakes are high considering it will be taxpayers who may bail out the pensions if they become distressed enough. At the very least, benefits could be cut for workers, both active and retired. Karen Friedman of the Pension Rights Center worries “this is going to be a national crisis for hundreds of thousands, and eventually millions, of retirees and their families.6
Given that backdrop, investment consultants help assess the likelihood of a pension fund’s ability to meet future obligations and can recommend appropriate strategies. Sometimes this may be a simple tweak to their current asset allocation model. If significant resources, both in capital and time invested, are becoming burdensome, company sponsors consider a pension risk transfer to focus on their core business.
Pension risk transfers are when a pension fund shifts all, or part, of future projected benefit obligations to a third party, often an insurance company. In a pension buyout, the risk is directly transferred as insurance company takes over the liabilities, often funding them with their own annuities. Some investment consultants have enough clout that they may be able to positively affect pricing for their clients, a key value-add. Pension buyouts are becoming increasingly popular, with over $8 billion transferred through the first three quarters of 2015 alone.7 That compares to 8.5 billion for all of 2014 and up from just $3.8 billion in 2013.8
Criticisms of Investment Consultants
Critics point to a lack of transparency since investment consultants are not required to disclose the performance history of their recommendations. For those that do, there is growing concern regarding the track record of the investment consultant’s recommendations. A study by the University of Oxford revealed that, on average, consultants underperformed their benchmarks by 1% while a New York Times column goes as far as challenging the very necessity of investment consultants.9
Still, a Pensions & Investments magazine survey of pension fund respondents showed that nearly one quarter of respondents considered the recommendations from their consultants ‘crucial’ while another 40% listed them as ‘very important’.10 Andrew Kirton, Chief Investment Officer of one of the largest investment consultants, Mercer Investments, defends the practice of minimal disclosure. He believes such disclosure requirements would focus their resources on marketing efforts rather than helping clients.11
What is the Compensation for Investment Consultants?
As with many consultant firms, the hours are long but the compensation is commensurate. Glassdoor reports generous compensation for investment consultants from the major firms-Cambridge Associates reported average salary of $133,282, Towers Watson revealed a $127,595 average and Mercer Investments was reported as $83, 910.12 According to the Bureau of Labor Statistics, management consulting has a fast expected growth rate of 24% through 2018, versus a 10% growth rate for the average industry.13 The BLS adds that many employers seek individuals with an MBA, or a related discipline.14 For investment consultants, this would likely be an MBA with a concentration in finance.
How do I Become an Investment Consultant?
Most consulting firms require strong academic credentials-clients want advice from smart people. Many ambitious students begin the process while they are undergraduates by interning with their own schools endowment fund. This provides an understanding of how the endowment works and its requirements. You’ll likely encounter the work of investment consultants so it’s also a great way to network. Many use this experience as a stepping stone to other endowments, pension funds and foundations or directly to an investment consulting firm. New hires typically begin as research analysts, then move up to consultant upon merit.
Contact the major players in the investment consulting such as Mercer Investment Consulting, Towers Watson and Cambridge Associates. To give yourself the best chance for a career in finance with an investment consulting firm, you may also consider pursue the CFA Institutes’ Certified Investment Performance Measurement (CIPM). This certification deals extensively with performance attribution. PwC estimates there will be $30 trillion of sacrosanct pension funds in North America alone by 2020.15 While investment consulting has its detractors, we don’t expect their advice to be going anywhere soon. There’s simply too much at stake.