Institutional investment consultancy is big business. The Financial Conduct Authority (FCA) estimates the industry advises on over $25 trillion in assets globally. In the UK, pension consultancy is in the hands of a few firms who carry a lot of clout. Yet, the advice it gives to pension trustees is not regulated, for now at least.
There are just three companies who dominate the market. Aon, Mercer and Willis Towers Watson have around 80% of the UK advisory market by proportion of client assets. They also offer both consultancy and fiduciary management services. Perhaps unsurprisingly, this can lead to challenges. In some cases it has led to obvious questions over conflicts of interest and acting against clients’ interests with their investments. It also raises questions around the fees they are charging.
Meanwhile, auto-enrolment in the UK has significantly increased the number of people with direct contribution (DC) pension schemes and thus the number of employer/trustees requiring consultancy services. But while these trustees may clealrly lack the data, knowledge and expertise of the consultants, they are ultimately reponsible for the investements they oversee.
Transparency in fees and investments, and the ability to make informed decisions are vital in creating a sustainable eco-system which provides for its beneficiaries. With employer scheme pensions that means employees. These are the people, often furthest down the chain from where these decisions happen, who rely on good long-term returns for their retirement.
When it comes to regulating the market, there are of course many angles to consider. Looking across the pond at Aon’s behaviour in the U.S. highlights some of those concerns.
Investment Consultancy Is Big Business. Who covers the losses?
You may have read about that time Allianz SE pled guilty to fraud and agreed to pay out $5.8 billion. That fraud was related to the $7 billion crash of Allianz Global Investors US’s Structured Alpha Fund. What you might have missed was the Blue Cross and Blue Shield Association (BCBSA) pension fund losing $3 billion it had in the Structured Alpha fund. That was over 60% of its portfolio. A bad investment it blames Aon Hewitt (Aon’s investment consulting division) for.
But as we keep finding, with pensions everything is always a little more complex. So, in this case, Aon is countersuing. It is claiming that based on the fiduciary duty outlined in the Employee Retirement Income Security Act (ERISA), if they are found to have breached their fiduciary duty, BCBSA should bear more responsibility and compensate Aon for any damages incurred because of the breach. In other words, the pension trustees didn’t do enough of their own due diligence.
This wasn’t the first time Aon’s advice didn’t work out well for clients. Two other cases are perhaps even more egregious. Lowe’s Companies, Inc and First Group America, Inc both found themselves invested in Aon’s own investment fund. A fund that was untested and ultimately performed below its benchmark, leaving future retirees nursing significant losses.
However, again the suit came down to responsibility for the choices made. According to reports, the suit claims Aon Hewitt tried to use its consulting client base to bring in investors to the new funds, but the “overwhelming majority … did not fall for the sales pitch, and rejected Hewitt Funds for their plans through their own fiduciary screening process.” However, Lowe’s screening process did fall for the pitch.
While it would be easy to point the finger of blame at Aon, especially where conflicts of interest are so blatant, regulators in the UK must ask, who messed up here? The people giving the advice or the companies’ trustees who should have had their eye on the ball.
The Pension Priorities for Employers – Consultancy Fees or Performance
There is a reason employers might not be paying so much attention to these investments. We know pensions are large and complex. We have written about the difficulty of navigating choices of multiple investment strategies in pensions before. That is why consultancy is big business. But for many employers they are also not an immediate concern. And, if it weren’t for auto-enrolment regulations under the Pensions Act 2008, they may well choose not to engage at all. But engage they must.
Here’s the problem that still exists. Unlike an individual worried about their retirement, an employer is still more likely looking at its bottom line, not some hazy, far-off performance, when deciding what course of action to take. So, companies are making choices based on fees rather than performance. The decision is driven by current price, not future value.
The knock-on effects almost seem inevitable. Providers trying to remain competitive with lower fees will find ways to cut costs elsewhere. That could mean more, cheaper, passive funds being used and less attention to day-to-day active monitoring. This in turn could lead to potentially worse returns which means worse pension savings for employees. It also makes it harder for market disruptors when margins become ever tighter.
The messenger in this case might not be ideal, but Aon have argued for an increase in fees. At the same time, those engaged in litigation with the company may think the fees are excessive. However, the underlying message is the right one. At the end of the day, even a small increase of a few basis points could lead to greater returns and better managed funds for future retirees.
Who Regulates Fiduciary Management Firms?
The CMA’s Investment Consultancy and Fiduciary Management Market Investigation Order 2019 sets out 2 important steps to achieving some control over the industry.
Firstly, the investigation confirmed that many pension scheme trustees went with the fiduciary management service recommended by their investment consultant. Now, trustees who transfer over 20% of investment decisions of their assets must run a competitive tender when purchasing fiduciary management services. They must request at least 3 bids to compare.
Secondly, so that trustees have better tools for this comparison, fiduciary management firms have to provide more information on both fees and performance. This includes how much they charge existing clients, and should make it easier to judge potential future value.
However, while the investigation shared its concerns over regulation of the sector, nothing was mandated. These advisers still sit outside of FCA regulation.
But while the conflicts of interest in the largest firms will no doubt come under scrutiny if they are ever regulated, there will be another new framework soon which addresses some of the issues.
Better data could lead to better employee pension outcomes
The UK’s Department for Work and Pension’s Value for Money Assessments VFM framework is likely to come into force this year or next. It will require providers to publish assessments on performance, service quality and charges. These will then go into the public domain, allowing employers to know if their pension scheme is providing value.
Ultimately, this should be of great benefit to employers. Pensions are complicated for a reason. They require more than just a short-term view of current price, they require a long-term outlook based on value. Having better data to make these decisions could greatly improve the situation for all involved.
Advisers who can utilise the information will be in a far stronger position to consult with their clients. The client trustees will equally be able to verify and do their own due diligence with more accessible data, closing the circle. This could also make it easier for other consultants to find a place in the market. The wealth of information available more openly could mean that even with tighter margins, there is a place for other players too.
Pensions are Complicated Products, Data and Consultancy must provide value
An OFT report in 2013 concluded that:
“The buyer side of the DC workplace pensions market is one of the weakest that the OFT (Office of Fair Trading) has analysed in recent years. Part of the reason for this is that most employees do not engage with, or understand, their pensions. Pensions are complicated products, the benefits of which occur a long time in the future for many people.”
And therein lies the rub.
Yes, regulation could address the conflicts of interest properly, but it wouldn’t necessarily affect the consultancy advice itself. It is, perhaps, more vital that providers start reporting the information stipulated in the VFM Framework so that advisers and investors have a clearer understanding of what they are investing in, based on real long term value goals.
At the same time, employers and individuals need to take a more active role and interest in these complex schemes. And where a race to the bottom is a lose-lose situation, they must also question whether ever lower fees are doing us a disservice.
Paying a little more in the knowledge your future retirement savings are being put to best use shouldn’t be a hard sell. Maybe it just needs the right vendor?
Author: Mike Davies
