The UK financial watchdog said it will review the influence of investment consultants and the potential damage they cause as part of a wider investigation of the asset management market.
The biggest concern is that consultants, who traditionally advised pension schemes on their investment decisions, are increasingly pitching their own asset management services to clients.
The chief executive of a large UK pension fund said: “There can be no doubt [investment consulting] is a conflicted business model. How can consultants possibly give unbiased advice at the same time they are offering their own investment services? The system is perverse, and most definitely needs a review.”
Last year it emerged that three-quarters of the contracts awarded to consultants for their investment services, known as fiduciary management, were given without a competitive tender, according to research from KPMG, the financial services provider.
One investment executive, speaking on condition of anonymity, said: “There are absolutely inherent conflicts of interest within the growth of fiduciary management. Trusted advisers end up pushing their own products on clients.
“[Consultants] will claim there is always an open tender. The reality is somewhat different.”
The executive, who estimated fiduciary management fees are triple those charged for providing investment advice, urged the regulator to ensure tender processes are more transparent and to force consultants to publish their fiduciary management performance figures.
Andrew Clare, who holds the chair in asset management at London’s Cass Business School and is a trustee on the boards of two pension schemes, also questioned the reliability of the “Chinese walls” that are meant to divide consultants’ advice arms from their fiduciary arms.
“The conflicts definitely need to be sorted out. The investment consulting industry is getting complex and it has muddied the waters,” he said. Mr Clare suggested consultants should be forced to spin off their fiduciary management businesses into separate companies.
There is further concern that the three largest investment consultancies, Mercer, Aon Hewitt and Towers Watson, have become too powerful in determining how pension funds invest. The quality of the advice they provide has also come into question.
Dominic Johnson, chief executive of Somerset Capital, the UK asset manager, urged the regulator to promote more competition among consultants, given “how concentrated the market is”.
Mercer, Aon Hewitt and Towers Watson are estimated to advise around half of UK pension funds. The six largest consultancies advise 70 per cent of the market.
The chief investment officer of one of the UK’s largest public pension funds said: “[Consultants] have too much influence. Hedge funds and currency funds have all found their way into pension funds’ portfolios at great expense and often with poor returns.
“Many consultants feel obliged to recommend change to justify their fee, when, in fact, no change would be better.”
Last year the Law Commission, an independent body that reviews law reform in England and Wales, highlighted these problems and urged the government to “actively monitor” how the investment consultant industry operated. “A lack of regulation in this area does appear anomalous,” it said.
Tim Giles, a partner at Aon Hewitt, said: “We welcome the FCA review as we feel it will provide a great opportunity to debunk the myths that surround the role of the investment consultant. The consulting market operates competitively, with many players and no barriers to entry.”
A spokesperson for Mercer added: “We believe the current regulatory environment enables pension funds to receive competitive advice from a range of providers. However, we remain open to alternative views and will work with regulators to serve the best interests of pension schemes.”
Ed Francis, head of investment at Towers Watson’s European business, said: “It is widely accepted that total costs in the pension fund food chain are disproportionately high, despite a highly competitive marketplace. We hope the [FCA] review will address this.”