By Simon Jessop, Huw Jones and Carolyn Cohn
LONDON (Reuters) - Consultants who advise pension schemes how to invest may face a full-blown competition probe, after coming under fire from Britain's financial regulator, which said their industry was prone to conflicts of interest and charged opaque fees.
Little known outside the pensions and insurance industries, investment consultants play a hugely influential role advising where trillions of pounds worth of people's savings should be invested.
But the Financial Conduct Authority said the largely unregulated sector is too ready to accept hospitality from asset managers, and provides the schemes they advise with little information on whether they get value for money for the fees they pay.
The consultants, typically hired by companies to choose their asset managers, have grown in power in recent years. They offer advice to the institutions - mainly pension funds, insurance firms and charities - which in 2015 accounted for around 3 trillion pounds ($3.7 trillion) of the 7 trillion pounds overseen by the UK asset management industry.
The three largest consultancies in the industry in Britain are Aon, Willis Towers Watson and Mercer, which between them take in 60 percent of the sector's revenues.
In interim findings published after a year-long review into the asset management sector, the watchdog said there was a culture of investment consultants accepting gifts and invitations to sporting and cultural events from asset management companies. That could influence the "ratings" they then give to managers, it said. It did not identify individual firms.
As well as helping clients pick which asset classes and funds to invest in, many consultants now also offer to invest the money themselves.
This move into so-called 'fiduciary management' can mean consultants are in direct competition with other managers they are hired to independently assess, a conflict of interest the regulator has threatened to refer to the anti-trust regulator.
"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," the FCA said.
As there is no benchmarking of fiduciary management, it is not always easy to compare one fiduciary manager’s performance with another, and pension funds often feel more comfortable with an investment consultant they know, said Ros Altmann, an independent pensions expert and former pensions minister.
"But it seems a clear conflict of interest," she added.
More than half of defined benefit pension funds using fiduciary managers chose the fiduciary arm of their existing consultant, according to a survey cited by the FCA, while 75 percent of new fiduciary mandates in 2014 were awarded without a fully competitive tender, with investment consultants getting the bulk of them.
Consultancy firms acknowledged that the potential existed for conflicts of interest, but said they acted to prevent them.
"All providers and decision-makers in the market have potential conflicts," said Tim Giles, senior partner and head of UK investment consulting practice at Aon Hewitt, adding that the firm took steps to manage potential conflicts.
"We have a fairly strict entertainment policy for our research staff. In most cases we would pay our fair share of entertainment. The researchers wouldn't do things like rugby matches or concerts."
Willis Towers Watson said it had "long been a vocal supporter of increased regulatory oversight of the investment consultant industry".
"We fully support transparency, measurement and the reporting of meaningful performance figures for fiduciary managers," the firm said in an emailed statement, saying it disclosed performance figures for its own fiduciary management business.
A spokesman for Mercer said the company had not yet fully considered the report. "However, we do remain supportive of the FCA's aim to ensure that the asset management sector works well and delivers value for money for customers."
REGULATION
Calling the performance and fees of fiduciary managers "among the most opaque parts" of the industry, the FCA said investors "cannot assess whether the advice they receive is in their best interests".
The FCA has recommended that Britain's finance ministry consider giving it oversight over investment consultants, whose activities are now outside the watchdog's remit. It also launched a consultation on Friday on whether the sector should be referred to Britain's Competition and Markets Authority.
Weak competition, too-high fees and poor advice were all flagged as areas for asset managers to improve, but the role of consultants in hampering the ability of many pension schemes to plug their often deep funding deficits got special mention.
The regulator assessed 12 consultants influencing 1.6 trillion pounds in assets.
Those offering to manage funds themselves collectively ran 58 billion pounds in funds, or 4 percent of assets under advice, but this accounted for a much larger 41 percent of their revenues, the FCA report said.
Pension funds and other institutional investors tended to stick with the same consultant for years, with 91 percent of investors not switching in the last five years, the FCA said.
Devoting 30 of the 208 pages that make up its interim report into the asset management industry to the role of investment consultants, the regulator said consultants, on average, failed to pick fund managers who could outperform.
While acknowledging that the due diligence on managers offered by consultants may reduce risk for their clients, it said the ratings they place on external fund managers were not a good predictor of performance.
The ratings can also act as a barrier to entry, expansion and innovation in the asset management sector, it said, and do not place enough emphasis on the fees charged by the manager.
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