Quantifying the Value of an Advisor
Investment consultants play a central and growing role in institutional advice, but industry consolidation and rising client expectations have intensified the industry’s competitive pressures. Consultants report that the greatest threat to their firms is an inability to distinguish themselves from their competitors.
This article outlines how consultants can further differentiate their value proposition by focusing on controllable outcomes in order to advance society by giving institutional investors the best chance of achieving their mission, be it charity, education, or retirement. Consultants can enhance and distinguish their value by placing even more emphasis on their fiduciary expertise, their experience with investment policy statements, and other topics such as retirement plan design.
Consultants to defined benefit, defined contribution, and nonprofit clients can add value to each client engagement and many are already doing so, but the nature of the services and the potential benefits will vary significantly by client type and circumstances. We believe that, when executing this framework, consultants can add on average, about 2% to 3.5% in value.
The Role of the Advisor
Institutional investors range from small-business owners seeking to provide employees with qualified retirement plans to the largest public state pension plans. For the purposes of this paper, we focus on how three particular subsets of institutional investors engage with the consulting community: defined contribution plans (DC), defined benefit plans (DB), and nonprofits. In the case of DC and DB retirement plans, the assets will be used to secure the retirements of individuals and families. In the case of nonprofits, the assets will be used to fund the ongoing operations and investments of educational or charitable organizations. The consultant is an essential partner for the many institutions that do not have the expertise, willingness, or access to execute on their goals. Even those that have these capabilities often find it beneficial to engage with consultants. By providing dedicated resources and expertise, consultants can help their institutional clients achieve their goals and fulfill their fiduciary responsibility in an environment of growing operational complexity and regulatory scrutiny.
Growing influence, significant headwinds
Institutional assets in the U.S. have increased to over $20.7 trillion (Cerulli, 2017b). As these assets have grown, so, too, has the intermediated nature of the industry. Approximately 65% of surveyed managers’ net flows in 2016 involved a consultant (Cerulli, 2017a). While investors’ preference for low-cost investments is often in the headlines, institutions continue to push for lower fees on the service side as well. This has led to a variety of responses from consultants and their firms. Some firms have expanded their service offer via mergers and acquisitions to better capitalize on economies of scale and serve institutional investors looking to reduce the number of their relationships. Others have focused more on niche specialization. All of them, though, have placed greater emphasis on customization and personalized service.
A Shift in Mindset
Vanguard believes that one potential key to success in institutional consulting is to emphasize your value proposition as one focused on elements within a consultant’s control. These elements may include increased attention to non-investment issues such as regulatory developments and retirement plan design. By creating and articulating a value proposition based on areas that are in your control, setting and meeting client expectations becomes an exercise in executing on your differentiated value proposition—rather than hoping the markets or your active managers perform as you said they would. This may not be easy, but that’s precisely why it can be so valuable. Institutional consultants who focus on the areas discussed in this paper can add significant value to their clients and their clients’ end beneficiaries or participants. We have approached this research in a modular format in which we discuss and quantify the value added for four best practices in institutional consulting. These four modules are not meant to be an exhaustive list of the areas where consultants can add value, but we believe it’s a strong starting point. Modules 1 and 2 cover the fiduciary considerations and the investment policy statement process, which are applicable for various institutional clients. Module 3 covers plan design and monitoring, which is specific to DC plans. Finally, module 4 covers investment strategy, which is relevant for both DB and nonprofit clients. For each of these modules, we lay out evidence to establish a baseline for the average experience. We then compare that baseline to an alternate experience in which the consultant applies and executes on these best practices. In each case, we tried our best to err on the side of conservatism and we intentionally use “about” to account for the possibility that some consultants are already adding the value discussed, and that for others, adding each module’s numbers together may double-count the value-add. As a result of this comparison, we believe implementing the Vanguard Institutional Advisor’s Alpha framework can add on average about 2% in value for the typical DB client, about 2% for nonprofit clients, and about 3.5% for the typical DC client. As with any approximation, the actual amount of value added may vary significantly, depending on clients’ circumstances. As with the traditional definition of investment alpha, Institutional Advisor’s Alpha should not be thought of as a discrete, annualized guarantee. It’s uncertain and is often delivered in episodic bursts. It can even be negative at times. Ultimately, it doesn’t show up on a statement, hence the difficulty and importance in articulating it.
Many consultants are already applying these best practices and adding this value; others have the opportunity to move closer to these outcomes for their clients. In sharing the Vanguard Institutional Advisor’s Alpha approach, we hope to provide a guide for consultants to demonstrate their value and in doing so, help shape the success of their practice.