FEATURE: Advice on one side, funds on the other

When US consultant and investment manager, The Townsend Group, announced last month it had hired Nick Cooper, the former head of ING Real Estate Investment Management’s multi-manager business as a principal in London, it provoked powerful reaction from certain quarters of the private equity real estate industry. Most notably, fund of funds managers in Europe saw the move to employ Cooper as a direct threat.

For months now, there have been rumblings among fund of funds specialists about the investment consultants encroaching on their territory. 

The complaints specifically relate to consultants expanding their services from being traditional advisory firms to offering investment manager services. These steps into investment management come in the form of bolting on de facto multi-manager businesses, offering discretionary fund selection services, and in some cases sponsoring in-house real estate fund of funds products. Some market observers view this as akin to the consultants not only driving their tanks across the funds of funds managers’ lawns, but also parking on them.

The resulting debate is one that may ultimately benefit investors. Competition, after all, tends to enhance customer service. The competition is also bringing important issues to the surface for investor consideration, issues such as alignment of interest and the management of conflicts of interest. 

It is also not a new debate. Real estate’s asset class cousin, private equity, has already seen the move of some pure investment consultants into money management, with predictable charges of conflict of interest coming from consultants who remain in the pure investment advice business, as well as from fund of funds managers who (usually privately) question how the “crossover” consultant can remain unbiased. 

And yet the various business models have all grown alongside each other. Will real estate’s experience be similar?
In recent weeks, PERE has spoken with a number of fund of funds managers and consultants both in Europe and in the US about the issue. Unsurprisingly, most fund of funds were reluctant to speak on-the-record, perhaps not wanting to bite the hand that sometimes feeds them. The diversity of views make for important reading and are all worthy of serious consideration.

Taking the issue to task

When considering which mix of investment service providers to hire, investors must confront a number of issues that arise depending on the business model of the firm:

Managing conflicts: Investors need advisors to guide them into the most appropriate and attractive investments, based on the merits of the investment opportunities alone. Some in the market ask, is it possible for a consultant to act as an advisor to an institutional investor and help select the best and most appropriate real estate managers available, while also operating an in-house product? Might there be the temptation to usher client money towards an in-house fund of funds rather than to a third-party fund that happens to better fit the risk/return profile of that particular client? In addition, how does a consultant allocate an attractive but small fund commitment opportunity between accounts? Does it go to its retained/hourly-paying client or its own in-house fund? Not surprisingly, fund of funds managers warn investors to look into how these potential conflicts are managed where a consultant also has an in-house fund of funds.

Competitive sensitivities: Investors pay experts to scour the market for data that will help guide investment advice and decisions. Some fund of funds managers say they are troubled that some investment consultants, while meeting with them to further fund selection advice on behalf of their clients, might also be using that information for their firm’s own discretionary offering. Investors should be aware of this tension, which in some cases is making funds of funds reluctant to take a meeting with certain consultants.

Capacity and know-how: Whoever is providing discretionary investment services, investors need to vet the provider’s on-the-ground presence and insight into real estate funds, strategies and geographies. Fund selection requires the cultivation of relationships, “boots on the ground”, frequent GP interviews, prodigious due diligence and continual performance reviews. Does your provider really have the requisite number of real estate specialists to do this job? Discretionary selection from a limited number of GP candidates may yield inferior results. 

If there ever was a time for investors to focus on alignment of interests and potential conflicts of interest, it is now, as many in the market are salving their wounds. 

Investors are becoming more
aware of conflicts and that will
breed opportunity for us to expand
our non-discretionary business.

Jamie Shen, Callan Associates 

As Jamie Shen, head of alternatives consulting at San Francisco-based Callan Associates, notes:  “Sometimes it takes disruption in the market for some of the issues to bubble to the surface. As people are examining their portfolios, they are looking more closely at how the advice came to them to be in certain funds. They are asking whether that advice was driven by it being the best option for the client’s programme or whether it was driven by the consultant getting better terms for its fund of funds business.” 

Better economics


Consultants often move into money management because it offers higher margins over pure consultancy. Though impossible to generalise about how investment consultants charge for advisory work, clients will generally pay consultants an annual retainer, perhaps an hourly fee, with some additional costs for manager searches or special projects. Clients have the right to end the arrangement at the end of each year. In contrast, in a fund of funds, investors commit to paying management fees for the life of a fund – typically seven years – based upon assets under management, with an incentivised carry component. 
For some though, straddling the line between acting as a consultant and working as an investment manager is not an option. Douglas Crawshaw, senior investment consultant at London and New York-based Towers Watson, says not having its own fund product was all about “perceived conflict”. When assessing GPs on behalf of clients, he adds: “I want to be able to go and see a manager and ask them whatever questions I feel appropriate in order to assess that manager.” If his firm ran a competing product, he would not feel at liberty to do so. 

Callan’s Shen views the current concerns about conflicts of interests as a reason to push Callan’s credentials as a pure consultant. “Investors are becoming more aware of conflicts and that will breed opportunity for us to expand our non-discretionary business,” she says. At the time of press, Callan had just hired former Russell Investments head of Asia Pacific property Sally Haskins to do just that.

Navigating muddied waters

Yet consultants who have expanded into money management defend their ability to navigate the perceived conflict of interests. Russell Investments says it is sticking by its decision made a few years ago to move away from a pure advisory practice to include an investment management model, although last year the Takoma, Washington-based firm decided to “re-energise” its consulting practice.

Carol Broad, Russell’s director of private real estate, who has been with the firm for 20 years, argues it is absolutely possible to run both a consultancy business and money management products, but the structure has got to be right. With 15 real estate professionals in its investment division, three in London and two in Sydney, Broad says organisations need to be “appropriately structured” to serve the best interests of their consulting clients and their investment management clients and properly manage potential conflicts.

Russell has both a consulting division and an investment division, which remain separate entities, she says. The investment division real estate research team works on real estate asset-class research and direct fund research, which is accessed by both Russell consultants and Russell product portfolio managers within the investment division. It is not allowed to review other firms’ fund of funds products. Instead, a separate analyst team in the investment division carries out fund of funds research on the full spectrum of fund sponsors, providing this research directly to the consulting division for use in advising its clients.
Says Broad: “If I am creating a fund of funds it wouldn’t be appropriate for me to meet my competitors and look at their fund strategies, fee structures and track record. That would be really peering into confidential competitor information.”

When a consulting client wants a fund of funds product, Russell stresses that the client will make this decision independently. In some cases, the client may also employ another external consultant to help it decide whether Russell’s own fund of funds should be recommended for a commitment, adds Broad. “We are very sensitive about going to consulting clients and saying: ‘Here, go into a Russell fund of funds product – that is the only thing you need to consider’.”

Townsend crosses over

The Townsend Group is another long established firm that now offers consulting and investment management to clients. With a staff of 75, the Cleveland, Ohio-based firm has the largest real estate consultancy practice out of any of the firms in the US. It advises clients on about 500 funds and is famed for its huge database and performance assessment capabilities.

Townsend’s size makes it a large target for criticism from competitors. One fund of funds manager described the lines between Townsend’s consulting, discretionary consulting and full discretionary fund of funds approach as “fuzzy”.

Townsend tends to form vehicles that can be applied to a single client, such as a segregated account, where the firm will tailor the strategy and choose the fund managers. It might create a particular “white label” fund of funds – where Townsend makes investment decisions but its name doesn’t appear on the product – for wealth channels, such as private wealth banks, giving the high-net-worth community, for example, access to institutional-style funds. Townsend has established around 18 such products, including with Penn Square Real Estate and Bank of Ireland. 

If I am creating a fund of funds it
wouldn’t be appropriate for me to
meet my competitors and look at
their fund strategies, fee structures
and track record. That would be
really peering into confidential
competitor information.

Russell Investments' Carol Broad

Kevin Lynch, Townsend’s co-founder, says since 1983 the firm’s main focus has been to work with large pension schemes, often with $1 billion or more of allocations to real estate. Townsend provides strategic plans for the pension’s entire portfolios globally. He differentiates the firm from generalist consultants – those for whom real estate is a small component of their consultancy services – in Europe such as Mercer and Towers Watson, and also distances itself from firms that operate both a property fund of funds and direct real estate vehicles. 

“The primary product we have is providing strategic advice. We design the strategy and have the discretion to hire and fire managers. We don’t sell products, we don’t buy properties, we don’t lease them, we do none of those things,” says Lynch.  
 Lynch stresses that the products or services Townsend offers on a discretionary basis are multi-manager mandates just for individual clients, including the University of Illinois or retailer JC Penney. The firm has been operating multi-management portfolios since 1996. 

“Our multi-manager portfolio is similar to a fund of funds, but the capital comes from one investor for which the strategy is tailored,” says Lynch. 

“There is not a Townsend fund of funds you can buy into like Aviva Investors, Aberdeen Property Investors or ING Real Estate Investment Management that we offer to our clients,” he adds. “Our clients generally access the market directly.  We identify best in class, independent partners to execute globally in line with our respective clients’ objectives and our view of the markets.  We get preferred access and improved transparency from direct property investment managers because we don’t compete with them and don’t have a firm product our clients could potentially choose in lieu of them.” 

He accepts that no model is without conflict. That said, he points out clients rarely ask Townsend to evaluate a fund of funds on their behalf. “There are a number of alternatives to our model ranging from fund of funds to consultants.  We believe we bring the investment perspective and standard of care inherent to a model with roots in consulting, as well as, the investment expertise, deal access and structuring knowledge necessary to an investor. ”  

Nevertheless, some limited partners remain skeptical of consultants that operate in-house products. An advisor and non-executive director of two large UK corporate investment and pensions schemes points to remuneration as the main reason why consultants are entering into money management. 

“There may be a five-year basis points income from an in-house product as opposed to a one-off fee or a retainer every year,” says one pension official. “It’s a logical thing for consultants to do. But do I think it is right? I think they have to decide whether they are in the advice business or the money management business.”

The growth of all models of real estate investment services indicates that at least some investors are quite comfortable with advice and management existing under the same roof.