Opportunity in Complexity for Investment Advisers

Consultants and financial advisers face strong opportunity in developing sophisticated investment strategies for their institutional clients, according to new research from Cerulli Associates.

Unforeseen risks, uncertain future equity returns and diversification challenges have institutional investors searching for new portfolio solutions, according to the latest issue of The Cerulli Edge – Institutional Edition. The report suggests more successful consultants and advisers are already embracing opportunities to help many types of institutional investors address complex challenges in evolving markets, including corporate retirement plans.

Cindy Zarker, a director at Cerulli, says many asset managers and investment consultants are finding new ways to help their institutional clients with custom solutions that go beyond the management of a single investment strategy.

The report shows different institutional client segments exhibit many investment strategy commonalities, but each also has unique needs. Most institutions have increased their use of alternative investments in recent years to boost returns and dampen portfolio volatility, for example, but defined benefit (DB) and defined contribution (DC) retirement plans often have more liquidity constraints governing flows of assets, making it harder to efficiently incorporate alternatives. Advisers and consultants have a key role to play in helping retirement plans get over these hurdles, Cerulli says. 

Additionally, Cerulli notes that strong equity markets and a small rebound in interest rates propelled corporate DB plans as a group to their highest funded level in five years at year-end 2013. In this environment, many DB plans can be expected to implement a liability-driven investment (LDI) approach to de-risk their portfolios. Advisers and investment consultants are in a great position to help these plans replace riskier assets with more robust liability hedging.

Cerulli’s report also anticipates that more significant rise in rates can be expected in the relatively near future. As questions continue on if or when interest rates will rise, plan sponsors must balance de-risking goals with their need to secure continuing portfolio returns. Citing a recent BlackRock analysis, Cerulli researchers suggest that even when 100% funded, DB plan sponsors can benefit from a return-seeking component in their portfolio to sidestep the potential need for cash contributions—yet another opportunity for advisers and consultants.

Cerulli says effective client solutions combine advice and implementation elements. Cerulli places LDI, corporate DB plan resolution, outsourced chief investment officer (OCIO), and multiple asset-class solutions under this “umbrella of opportunity.”

When evaluating asset allocation, institutional investors continue to shift away from a style-box approach to a risk-based emphasis, Cerulli says, adding that risk-based portfolio construction sets the stage for greater use of unconstrained bond, absolute return, multi-strategy, and other investment approaches that do not fit squarely into traditional asset-class buckets.

Cerulli finds successful asset managers are organizing custom solutions services around multi-asset-class platforms in part to fend off rising competition from investment consultants. As the report explains, money managers both compete with and collaborate with investment consultants in serving the institutional marketplace. The research suggests it is in asset managers’ and investment consultants best interest to align their focus on serving institutional clients’ interest in customized portfolio building.

Fee consciousness among institutional investors has also risen; they do not want to overpay for beta, Cerulli warns. For this reason, many investment consultants recommend that their clients incorporate passive strategies in their portfolios, especially for large-cap equity, which is generally considered a more efficient market. To optimize portfolio expenses, 42% of surveyed consultants endorse investing passively in large-cap equities.

Whatever the specific solutions investment consultants provide for retirement plan clients, asset-allocation skill and multi-asset capabilities are critical, Cerulli says.

Information on how to obtain Cerulli reports is available here