Consultants facing pressure as clients press for guidance

Investment consultants have their work cut out for them as they advise and guide asset owner clients through an increasingly difficult investment climate — which in some cases also has dragged down their assets under advisement.

According to P&I's latest survey results, total institutional assets under advisement for investment consultants slipped 0.6% to $46.85 trillion as of June 30, compared to $47.14 trillion the previous year. Over the same period, U.S. institutional tax-exempt AUA rose slightly — 2.7% to $27.1 trillion.

Nimisha Srivastava, the Charlotte, N.C.-based North America head of investments at Willis Towers Watson PLC, said her clients are generally concerned about the U.S. economy's ability to withstand higher interest rates and continue to grow. They also are worried about the likelihood of a slowdown, or recession, which would have longer-term implications for economic growth and has the potential to impact both asset prices and volatility negatively. These factors, in turn, could result in asset owners not reaching their return or strategic objectives, she noted.

Clients have focused more recently on "where they will get their required returns from … what levers they can pull in this environment of tightening global financial conditions and negative skew of downside risks," she said.

Ms. Srivastava said the firm is a "strong proponent" of diversification.

"We continue to believe asset owners need to be evaluating additional types of strategies they can add to their portfolios to make them more resilient in times of uncertainty," she said. "We have seen particular focus on real assets and hedge fund strategies this year. Given market developments, we (also) are currently strongly advocating that asset owners add or increase their alternative credit allocations."

Alternative credit, with its high carry and low-duration characteristics, is a "strong play" in the fixed-income space, she said. "We believe it has the potential to deliver strong risk-adjusted returns from here," she added.

Ms. Srivastava also said: "Real assets exposure has benefited client portfolios by not only adding a diversified revenue stream but also inflationary protection as well. Private credit offers this as well, particularity given the floating rate nature of certain lending strategies."

Willis Towers Watson had worldwide institutional AUA of $4.7 trillion as of June 30, up 30.6% from June 30, 2021, making it the third-largest consultant in P&I's database. Ms. Srivastava attributed the increase in AUA to "a combination of growth and new client expansion" as well as client portfolio diversification.

Rising inflation and climbing interest rates also are the top macro issues for Segal Marco Advisors' asset owner clients, said Sue Crotty, New York-based senior vice president and chief investment officer.

"These factors impact the entire portfolios of our clients," she said. "With the exception of certain real asset classes like real estate and infrastructure, almost all other assets are down double digits (this year)."

Year-to-date through Nov. 14, the Russell 3000 index was down 16.7%, while the Bloomberg U.S. Aggregate Bond index slumped 14.3%.

While stocks and bonds used to be negatively correlated in prior years, that relationship has evaporated this year in a scenario Ms. Crotty described as "unusual" and a "double whammy."

However, Ms. Crotty said she is advising her clients to stay cautious and conservative and try to ride it out.

"Remember two years ago when some investors were enamored with cryptocurrencies like bitcoin as the next wave of investing as a non-correlated asset class?" she pointed out. "And you see what's happened with crypto since."

Segal Marco Advisors reported worldwide institutional assets of $381.8 billion as of June 30, down 5.5% from the previous year. Ms. Crotty attributed the decline primarily to falling markets.

While Meketa Investment Group Inc. regularly reviews asset allocation policy with clients, "what is new this year is the impact of rising inflation and interest rates on forward-looking return expectations," said Stephen P. McCourt, San Diego-based managing principal and co-CEO at Meketa.

Mr. McCourt said in an email that he advises clients to adopt well-balanced, strategic asset allocation policies "intended to weather the market volatility and dynamics we have seen in 2022."

Meketa's institutional assets under advisement totaled $2.8 trillion as of June 30, up 4% from a year ago.

Thomas Toth, a Broomfield, Colo.-based managing director of Wilshire Advisors LLC, said while he had been advising clients to "shy away" from core fixed-income investments given low yields and asymmetric risks, he is now recommending that they re-evaluate that position in light of the rising interest-rate environment and higher expected returns for fixed income.

"We are more constructive on fixed income now," he said. "Fixed income has generally provided ballast and liquidity in a portfolio, and now we are having discussions with some of our clients, particularly institutional plan sponsors, about re-examining their fixed-income exposure."

Wilshire reported worldwide institutional assets under advisement of $1.05 trillion as of June 30, down 3.2% from a year prior.

Along with Mr. Toth, Segal Marco's Ms. Crotty is bullish on fixed income.

"Real returns from bonds are now very attractive," she said. "Fixed-income yields are now higher than they have been in decades."

Indeed, as of Nov. 14, investment-grade bonds were yielding about 4.78% to maturity, while high-yield bonds were yielding about 8.84%.

Once inflation falls, locking in these yields might be a good investment, especially for savers and retirees, she added.

Jay Love, Atlanta-based partner and U.S. investment leader at Mercer Investments LLC, agreed. "With these higher yields we are seeing, it makes some sense to move more into bonds, particularly those with longer liability durations," he said.

Mercer, the largest consultant in P&I's database, saw its worldwide institutional assets under advisement fall 5.2% to $16.45 trillion as of June 30, which Mr. Love largely attributed to market drops.

Higher interest rates have made forward-looking returns for bonds much better than they were only a year ago, acknowledged Greg Allen, San Francisco-based CEO and chief research officer at Callan LLC. "While our clients are just starting to absorb this into their long-term planning process, the initial reaction has been a recognition that they can now potentially meet their long-term return targets while taking less risk," he said.

But he said, "It's too early to tell whether this will result in a trend towards increasing fixed-income allocations in long-term strategic targets."

Callan, the second-largest consulting firm in P&I's ranking, saw its assets under advisement jump to $4.79 trillion as of June 30, up 48.76% from a year ago, which Mr. Allen attributed in an email to "gaining a small number of very large plans as clients."

He cautioned, however, that "investment consultants who work with very large plans on both a retainer basis as well as a project basis tend to have these year-over-year AUA fluctuations."

The firm declined to identify its new clients. However, P&I reported last October that the Federal Retirement Thrift Investment Board, Washington, which administers the $743 billion Thrift Savings Plan, hired Callan, along with four other firms, to assist the board in several areas, including investment policy evaluation and design, portfolio governance and portfolio manager evaluation, investment option review and evaluation, investment manager search, and more.

Segal Marco's Ms. Crotty thinks the traditional 60/40 asset allocation could even come back.

"The 60/40 portfolio has not really existed in years given how much money has been flowing into alternative assets," she said. "But now I see an increasingly challenging environment for asset flows into alternatives in the coming years given that clients are already overweight to targets. As such, we might see a rotation back to traditional equities and fixed-income securities."

Wilshire's Mr. Toth said that as many of his clients, including both public and private pension funds, have increased their allocations to non-traditional asset classes like private markets, he worries that these positions might now represent an overweight in some portfolios.

"Although we think private assets are a valuable part of an investment portfolio, we are cognizant of the risk of being overallocated relative to private asset targets given the 'denominator effect,' and are helping clients manage around the risk," he said.

That risk can be managed, Mr. Toth explained, by "updating commitment pacing schedules for private equity, credit and real asset portfolios to align with lower total fund market values." However, he added, "We are not recommending dramatic reductions in commitments to avoid a 'stop-start' approach to making commitments and want to take advantage of opportunities offered by the market volatility."

With the Fed expected to cease its program of rate hikes sometime next year (as long as inflation numbers come down meaningfully), Mr. Toth also said that there may be a light at the end of the tunnel out of the current crisis.

"Historically, markets begin to rally when the underlying economic conditions are still relatively poor and this is something we want our clients to be aware of," he said. "On this basis, we suggest that they continue to actively rebalance portfolios and look for opportunities to judiciously add risk in preparation for market upturns."

Mr. Toth noted that this could be done by tilting more toward global equity, for example, or by moving into small-cap equity or making additional allocations to below investment-grade credit.

Demand for OCIO services has increased due in part to market weakness and volatility as well as the ever-increasing complexity of investible securities, according to Mercer's Mr. Love, noting, however, that he wouldn't classify the rise in demand as "huge."

"While we haven't seen a huge spike in demand, we've had more discussions with clients over how to maneuver in this climate," he said.

In P&I's consulting survey, Mercer reported $345.75 billion in managed assets as of June 30, down 12% from the previous year.

Callan's Mr. Allen said demand for OCIO services has been "pretty steady" for the last few years. "The most notable change would be an increase in the number of replacement opportunities, where a client made the decision five to seven years ago to adopt this model and are now going back out to the market to consider changing their provider," he said. "Another change we've noticed is that there seems to be more opportunities this year where the process is being run by a third-party search firm rather than directly by the client. This reflects the complexity involved in making these decisions."

Mr. Allen also observed that "many times we are being asked to bid on the relationship on both a discretionary and non-discretionary basis. It seems that in these cases clients are using the RFP process to evaluate the relative merits of the two governance models."

Callan reported $5.53 billion in managed assets as of June 30, up 2% from the year-earlier period.