What's the point of being No. 1 in a rotten business?
By Rich Blake
Institutional Investor Magazine
What's the point of being No. 1 in a rotten business? Ask William M. Mercer Investment Consulting, the leading pension adviser in the U.S. and the U.K.
Stephen Viederman made his name as a shareholder activist. When he stepped down last year as president of the $100 million Jessie Smith Noyes Foundation, he needed a firm to chart the future for the trailblazing organization, which was the first nonprofit to file a shareholder resolution. His choice: William M. Mercer Investment Consulting.
"Originally, they were brought on to do a one-time study, but we were so impressed by their resources and professionalism that we ended up giving them a two-year contract," says Victor De Luca, Viederman's successor as the foundation's president. "Mercer does an excellent job."
Indeed. When it comes to investment consulting, no firm is more powerful or prestigious than William M. Mercer. Whether they are behemoths or boutiques, asset managers know they must pass muster with Mercer gatekeepers to reach many of the deep-pocketed pension funds, foundations and endowments whose business they covet. The firm controls access to more than $1.5 trillion in global assets, consulting full-time to more than 900 clients from Seoul to San Diego. Mercer boasts a brand name widely respected for its excellence; in the two biggest markets for pension consulting, the U.S. and the U.K., it claims the No. 1 market share.
Yet for all this hard-earned prestige, don't expect to hear champagne corks popping at the New York headquarters of William M. Mercer Investment Consulting. The high-profile U.S. operation appears to be in trouble.
Begin with profits. Outside the U.S., where there are relatively few players and only modest price competition, Mercer reports respectable operating profit margins of 10 percent in pension consulting. In its home market, though, as rivals relentlessly undercut each other on fees and drive up the cost of talent, Mercer barely breaks even.
The firm confronts an alarming talent drain. Three heads of the U.S. investment consulting business have come and gone in less than two years; in that same time, half of its 30 top consultants have decamped. One result: A growing number of Mercer's pension funds have switched their lead consultants several times within a year or two. That's a disruptive and unsettling pattern in a business defined by the personal relationship between consultant and client. And clients are beginning to get antsy. Several, including the New York State Teachers' Retirement System and the Knoxville City Employees Pension Fund, have left Mercer. Recently, the $400 million Virginia College Savings Plan, a state-run prepaid college tuition program that has worked with three Mercer consultants in the past year, decided to cut the firm loose. "This turnover has been a bad situation for us," says Diana Cantor, the executive director for the Richmond, Virginia-based plan, which expects to put its consulting business up for competitive bid this summer.
"There's a perception in the industry that Mercer is imploding," says Steve Holmes, president of boutique consulting firm Summit Strategies Group, a regional rival based in St. Louis. "The firm seems to be twisting in the wind."
Why? Many current and former staffers feel that Mercer, for all its sway in the world of money management, remains an outcast in its own home. To them, Mercer is the neglected offspring of its corporate parent, New York-based human resources consultant William M. Mercer, Inc., which is in turn a subsidiary of insurer Marsh & McLennan Cos.
By the numbers, the consulting business certainly doesn't amount to much: Although Marsh & McLennan doesn't break out the group's financial results, Mercer's margins clearly lag behind the 10 percent operating margins for the U.S. investment consulting industry and the 14.6 percent margins for Mercer's own overall consulting operations. Although Mercer runs investment consulting groups in 14 countries, those 40 offices essentially operate on their own. In the U.S. Mercer's investment consulting business reports to the larger U.S. consulting group, which sells benefits, communications and health care services. But even when the worldwide operations of Mercer's investment consulting units were tallied in Marsh Mac's 2000 annual report, they reported revenues of only $80 million, contributing just 4 percent of Mercer's total worldwide consulting revenues of $2.1 billion and less than 1 percent of Marsh Mac's global revenues of $10.2 billion.
"In the industry we were treated with the highest regard," says one ex-Mercer consultant. "But within our own organization, the investment consulting practice got very few resources - and very little respect."
Mercer veterans complain of a lack or resources. When executives of the U.S. pension consulting group proposed buying out competitors or starting up a fund-of-funds business, their bosses at Mercer's U.S. consulting group turned them down. When the pension consultants asked for extra money for new hires, the answer from their corporate superiors was almost always no.
Mercer certainly doesn't seem to compete on pay. Senior consultants at Mercer top out at about $300,000, according to former staffers; their counterparts at Callan Associates or Frank Russell Co. can make between $500,000 and $750,000 a year, with an elite handful at Callan earning more than $1 million. At Callan and other privately held firms, staffers may also receive equity stakes in the business.
To be sure, the other firms do have history going for them. Mercer backed into the business - it started out as a benefits consultant and moved into pension consulting through acquisitions in the mid-1980s - but investment consulting has always been a core competency at Callan and many other Mercer rivals.
"At a firm like William M. Mercer, investment consulting is almost irrelevant," says Michael Rosen, a principal at Angeles Investment Advisors, a small consulting firm. "They won't be able to attract or keep the best and the brightest."
Nonsense, says Barry McInerney, 37, who took the top job at Mercer Investment Consulting three months ago and is quick to play down any woes in the U.S. arm. "We have a strong bench and continue to attract new talent," says McInerney, a former actuary who previously served as the head of Mercer's Canada and Latin America pension consulting groups. "Yes, we've had some turnover, but it's cyclical, and we think it's a passing trend. In a way, we are just starting out, and we see a lot of potential for growth."
Tim Gardener, 49, the London-based global practice leader for all of Mercer's investment consulting operations, sounds a more cautionary note. "We've had a great deal of turnover in the U.S. I suppose if it doesn't let up, then we would be in trouble," he says. While the heads of pension consulting groups report to the larger consulting operations in their home country, Gardener keeps an eye on Mercer's global pension business; as part of Mercer's dual reporting structure, investment consulting practice leaders such as McInerney all answer to Gardener as well as to the overall consulting operation bosses for each country.
"Is the U.S. practice as stable as it could be, personnel-wise?" Gardener continues. "No, it's not. Is it the end of the world? No. Am I optimistic that we can right the ship? Absolutely."
To that end, McInerney hopes to recruit more large multinational accounts, some of which are consolidating their cross-border pension plans and can be more profitable to serve. Mercer's international presence should help further that cause.
Mercer is not alone in feeling a squeeze. Investment consulting has always been a labor-intensive, cost-inefficient sideline to the management of institutional funds. Certainly, it serves a clear need: Pension funds, especially public plans, bear a fiduciary obligation to responsibly manage a plan's assets. Hiring a consultant for guidance about money manager selection and evaluation provides cover if the investment choices go sour.
But pension funds have kept a tight rein on consulting payments, which have typically been paid as annual retainers or hourly fees. For all their prestige and influence, consultants have never managed to crack the lucrative asset-based fee arrangements that money managers enjoy. At the same time, consultants must compete with money managers for their professional staffs.
Exacerbating that pressure, consultants have lost prospective customers as defined benefit plans, which almost always use consultants, have been eclipsed by 401(k)s, which generally don't. According to the Employee Benefit Research Institute, the number of defined benefit plans has fallen from 150,000 in 1980 to about 60,000 in 1997. During that period defined contribution plans almost doubled in number, to 660,542. Not surprisingly then, operating profit margins for investment consultants fell from about 15 percent in the mid-1980s to roughly 10 percent today.
Some of that erosion reflects lowball fees thrown out by none other than William Mercer. In the mid- and late 1990s, as the firm pushed to seize market share from its rivals, it slashed its fees from $200,000 for a basic annual retainer to prices as low as $50,000. Competitors cut their fees too, and industry margins fell across the board. Simultaneously, Mercer aggressively recruited new staff, doubling to 200 its investment consulting personnel, and allowed its overhead to get out of control.
Marsh Mac, which expects from its divisions and subsidiaries growth rates and operating margins of 15 to 20 percent, thought about selling or shutting down the investment consulting business back in 1998. It decided to soldier on, partly because William M. Mercer, Inc., the larger consulting operation dominated by human resources, retirement and health care consulting, finds value in marketing itself as a full-service firm.
But whereas investment consulting represents a respected and substantial part of the overall business at Russell and Wilshire Associates, the investment consultants at Mercer say they have often felt like second-class citizens.
That feeling may help explain the recent staff exodus. Many consultants lose talent to better-paying money management jobs, and Mercer is no exception. But several respected staffers have abandoned Mercer for its competitors. The most notable departure was that of John Dickson, the well-regarded head of the Southeast practice, who recently joined Capital Resource Advisors in Chicago.
Meanwhile, Mercer Investment Consulting has also faced simmering resentment from one of its fair-haired siblings, Putnam Investments, which Marsh Mac bought in 1970. Former Mercer consultants report that Putnam executives have chafed at the fact that Mercer consultants - appropriately - have bent over backward to avoid favoring Putnam in their money manager searches.
"Consultants at Mercer used to have a bias against us. When in doubt, they'd pick the other firm," says John Brown, head of institutional business at Putnam. "But the past year has been a turning point for us. In categories where we do well, in active EAFE management especially, we get hired. Mercer is still viciously independent, but when we should be hired, we are."
Mercer consultants value that independence, but McInerney has his work cut out for him in renewing a sense of pride among the Mercer troops. Says Gardener, "We can't compete with money management in terms of compensation, but we should strive to be the employer of choice in our own industry."
In strengthening Mercer's investment consulting business, Gardener says, "McInerney's biggest job will be to make Mercer an attractive place to work."
Easier said than done.
Pension consultants have been plying their trade for the better part of 35 years, but the industry did not come into its own in the U.S. until 1974, when president Gerald Ford signed ERISA into law. Managers of pension funds understood that they suddenly faced new obligations to ensure that their plan assets were prudently invested. In theory, at least, consultants could further that cause.
In the 1970s a handful of firms dominated the small industry. The ranks included AG Becker (which became SEI Corp.); Dreher, Rogers & Associates (later RogersCasey) and O'Brien Associates (now Wilshire Associates).
In these early years pension consultants focused on performance measurement and building proprietary databases to evaluate money managers. By the early 1980s they had expanded their offerings to include more strategic advice on investment policy, asset weightings and style selection.
Consultants act as gatekeepers, advising pension fund trustees on ways to manage their funds. In addition to conducting an asset allocation study, consultants may conduct one or more money manager searches as well as monitor performance.
Mercer traces its own roots back to 1945, when a Vancouver entrepreneur, William Manson Mercer, launched one of the first consulting firms in North America, carving out a niche as a general strategic adviser to large corporations. In 1959 Mercer sold out to Marsh Mac, which had a substantial presence in benefits consulting, in addition to its insurance brokerage business.
In 1974, in the wake of ERISA, Marsh Mac merged all of its consulting operations under the Mercer banner, and a year later this entity became William M. Mercer, Inc.
Through a series of acquisitions in the late 1970s and early 1980s - among them such well-known actuarial consulting firms as Duncan C. Fraser & Co. and MPA in the U.K., John Eriksen & Partners in New Zealand and Campbell & Cook in Australia - Mercer became a global presence in benefits and retirement consulting.
The 1984 acquisition of Meidinger Associates, a Louisville, Kentucky-based consulting firm, brought Mercer into investment consulting. Primarily an actuarial and benefits consultant, by 1984 Meidinger had also developed a small but highly regarded investment consulting practice that served about 45 pension plans and was led by David Eager.
Three years after the Meidinger acquisition, Mercer moved further into investment consulting when it bought Chicago-based A.S. Hansen. Mercer was still a distant threat to the three firms that then dominated investment consulting: Frank Russell; Rogers, Casey & Associates and SEI Capital Resources.
By the early 1990s Mercer Investment Consulting, with less than $15 million in annual revenues and little profit, was essentially a collection of about a dozen fiefdoms, geographically based units that served their local clients and had little contact with one another. With roughly 150 clients on its roster, Mercer Investment Consulting had begun to earn a national reputation for smart, solid performance, but inside William M. Mercer, Inc., the investment consultants had virtually no cachet.
"In the 1990s investment consulting was almost an irritant within the Mercer organization," recalls one former staffer. "It always needed money and was never profitable."
Between 1990 and 1993 the division slogged along without a clear leader. A five-person practice committee, of which Dallas consultant Carol Proffer was the most senior member, effectively ran the business. In 1994 two of the group's strongest producers, Proffer and Lawrence Gibson, became co-heads of the investment consulting business.
Proffer had made her name signing a string of major accounts, including the Colorado Public Employees' Retirement Association and the New York State Common Retirement Fund. As head of the mid-Atlantic region, Gibson was well liked and admired within the firm. The pair reported to Timothy Lynch, the former Meidinger chief who had risen through the ranks to head all of Mercer's consulting in the U.S. Lynch, who was preoccupied with melding the larger retirement and health care consulting practices of Mercer and Hansen, gave Gibson and Proffer free rein.
As the two consultants surveyed the landscape in 1994, they saw a firm that was No. 9 in the industry, with just $107 billion in clients' assets and revenues of $15 million. At the time, the No. 1 firm, Frank Russell, handled clients with $500 billion in assets; SEI, at No. 2, had $400 billion.
Ambitious, energetic and convinced that Mercer's reputation could be far better exploited, Gibson and Proffer put together a five-year plan aimed at catapulting the firm to the top of the industry.
Their agenda, which Lynch and his higher-ups endorsed: Grow big, and grow fast. Gibson and Proffer decided to hire more staff and centralize money manager research and selection. But even at this critical moment, Mercer investment consultants felt shunted to the sidelines by their corporate parent. When Gibson requested extra resources from Marsh Mac to help fund the expansion, he was turned down. Most critically, though, Gibson and Proffer decided to cut prices to grab market share.
Not surprisingly, price-cutting did indeed help Mercer's industry ranking. By 1996 its revenues totaled $30 million, more than twice the 1994 level.
In 1996 Proffer left, taking a job at Crossroads Group, a Dallas-based private equity fund-of-funds, which she soon left for Wayne, Pennsylvania-based Pilgrim Baxter & Associates. But for the most part, turnover at Mercer remained modest. Feeling confident that the firm was on the right track, Gibson in late 1998 embarked upon his own pet project: creating Mercer's version of the well-known Callan Investments Institute, which he dubbed the Mercer Global Investment Forum. Mercer's offering was a lucrative, two-day conference, held four times a year, in which a select group of 100 money managers paying $50,000 apiece could chat up plan sponsors whose business they hoped to solicit. An instant success, the forum is probably now the most profitable line of business at Mercer Investment Consulting.
For both Callan and Mercer, though, success has come at some intangible cost to their reputations. Critics, mostly independent consultants who don't throw their own industry schmooze-fests, argue that the forums pose an inescapable conflict of interest. How can a consultant offer truly objective advice about selecting money managers, they ask, when some of those same money managers are paying juicy fees to attend their conferences?
"Over the past two years, we've seen an increasing number of large plan sponsors show concerns over their consultant's alternative sources of income," says Jennifer Cooper, whose Cooper Consultants specializes in helping pension funds select and manage their consulting relationships. "The issue is whether these consultants are serving more than one master."
Gibson's forum proved to be a success, but his other big move in 1998, pushing through the multi million-dollar acquisition of Eager & Associates, a regional investment consultant, turned out to be a major debacle. The firm, founded by Meidinger consulting pioneer Eager, lost hundreds of thousands of dollars under Mercer's aegis, largely because several important rainmakers quit soon after the sale.
"It was a black hole," says one source. Eager, who last year left Mercer to join Driehaus Capital Management as East Coast head of sales and marketing, admits that "the growth of the franchise was not in line with what either of us had originally envisioned." Through 1998 and 1999 Mercer Investment Consulting barely broke even.
Like the indulgent parent of a wayward adolescent, William M. Mercer, Inc. had tolerated the paltry margins of investment consulting. But by the autumn of 1999, Lynch, the head of the larger consulting group, had decided it was time for a change. In September he summoned Gibson to his Manhattan office and told him that he was being replaced as practice leader by Asghar Alam, a former actuary who had spent no time at all in investment consulting. Gibson's new role was left unclear.
Coming as it did just three days before a national client meeting, Lynch's move seemed especially harsh to Mercer's investment consultants. Replacing Gibson with an actuary who had no experience in investment consulting seemed extreme - and another sign that investment consulting had become a pariah within the firm.
Gibson won't elaborate, but he concedes that his demotion was a factor in his decision to leave Mercer in March 2000 to become a principal with Thompson, Siegel & Walmsley, a Richmond, Virginia-based value equity specialist.
Alam cast an unsentimental look at the business and concluded that the group's costs were out of line. He shut several offices, and he severed ties with some of the firm's unprofitable clients. He also jettisoned Mercer's portfolio performance measurement group. Once a core competency in investment consulting, the group had become something of a commodity.
By the end of last year, Alam's cost-cutting boosted margins to something less than 5 percent. But the new chief could not stem the tide of staff departures. Within four months of Gibson's exit, Mercer Investment Consulting had lost a half dozen stars. In stark contrast, rival Callan has lost only two out of 30 veteran consultants over the past five years. Most of Callan's top consultants have been there at least a decade.
The U.S. industry may well be heading for a shakeout. Says independent consultant Cooper, "A few big players will probably decide to get out." Though Marsh Mac executives decided not to sell off Mercer Investment Consulting two years ago, they could easily change their minds.
McInerney insists that no sale is in the offing. As he consolidates his hold on the business, staffers and rivals alike will keep a close eye on a prize Mercer client. That's the $121 billion New York State Common Retirement Fund. After working with four Mercer consultants in four years, the fund put its consulting contract up for bid last month. "Any time we evaluate a contract, turnover and personnel quality are among the factors we consider," says a spokesman for the fund.
That's prudent and appropriate, as any reputable financial adviser would agree - but it may not be what America's No. 1 pension consultant wants to hear.
Mercer Investment Consulting may be reeling in the U.S., but beyond its home turf, business looks pretty good.
"If you view Mercer from a global perspective, you might recognize why we're less concerned about the situation in the U.S. than you might guess," says Tim Gardener, the firm's London-based global consulting practice leader, who tracks Mercer's worldwide consulting practices.
Of Mercer's $1.5 trillion in global assets under advisory, $800 billion is held by non-U.S. institutions. About $400 billion comes from the U.K., where Mercer is one of only four firms dominating the $1.1 trillion pension market. Among Mercer's 350 U.K. clients: the $25 billion Consignia Pension Plan (formerly the U.K. Post Office Pension Plan) and the $30 billion Universities Superannuation Scheme.
Although many global pension consultants focus on just a few international markets, Mercer covers a wide swath of territory. From 40 offices, including a dozen in Europe and four in Asia, Mercer serves 900 full-retainer consulting clients, 500 of them based in Europe, Asia or Latin America.
"Among the consultants we deal with, on a global basis no one comes close to Mercer," says Stephen Potter, director of institutional sales at Northern Trust Global Investments.
More than half of the firm's roughly $80 million in global investment consulting revenues in 2000 came from outside the U.S. In the U.S. and U.K., as well as in Canada and Australia, Mercer ranks No.1 in market share (as measured by the total number of clients). Last month Australia's Commonwealth Bank selected Mercer as its investment consultant to oversee some $15 billion in master pension trusts. As part of the contract, Mercer will provide advice on the selection and evaluation of fund managers for the new trusts that the bank will set up as it consolidates a dozen trusts into one or two megafunds.
This summer Japan's Government Investment Pension Fund, which manages state pensions, will deploy Mercer consultants to help overhaul its investments. The GIPF is asking for competitive bids to manage more than $200 billion in funds - a substantial sum by anyone's measure. Mercer gatekeepers will help determine who gets to star in the show.
For many years now, Mercer's consulting business has been much more lucrative overseas than it is in the U.S. Why? The biggest component of investment consulting overhead, employee salaries, tends to be lower in the U.K. and Canada than it is in the U.S., while the fees clients are willing to pay tend to be higher. With less competition abroad, marketing expenses tend to be lower. "We think we add the same amount of value in the U.S., so why is it we can't demonstrate it?" asks Gardener. "It's a conundrum, and if I knew the answer, we'd be making money in the U.S."
What's the point of being No. 1 in a rotten business?