A Brief Primer on the Realities of Placement Agents and Investment Consultants
I thought it might be helpful to my readers to explain the role of placement agents and consultants in the hiring of money managers. After reading “Report Concerning Placement Agent Review,” I think the authors of the report would have benefitted from a better understanding of the realities of each of these advisory businesses.
Placement agents are retained and paid by money managers as third-party marketers. Although their fee is only a small percentage of the assets raised, the overall fee can quickly add up to a seven-figure payday. However, in the absence of the placement agent, the money manager would probably have to pay that seven-figure amount to a group of internal marketers. While most placement agents will do some due diligence on their money management client, their primary role is to provide access to potential investors. An investor should never rely on the placement agent’s due diligence.
Some placement agents, particularly those housed in large banks, may also offer compliance services to money managers so that the money manager doesn’t run afoul of securities laws involving the solicitation of private offerings. Many placement agents also coordinate the scheduling and logistics of taking the money manager on multi-city tours to visit potential investors.
While you may not like the sound of it, a placement agent gets paid for obtaining access to potential clients. That’s their job, and it is valuable to money managers; otherwise they wouldn’t engage placement agents. Pension plans and endowments are buried in deep piles of investment proposals and offering memoranda. If the money manager doesn’t have a marketer with the requisite experience or contacts, it is going to be extremely difficult to obtain even an introductory meeting. So the placement agent’s job is to get someone at a pension or endowment to take a meeting with a money manager and hopefully get them interested enough to do due diligence and make a commitment.
A good placement agent can save an investor a great deal of time by helping to point out opportunities that warrant the investor’s attention. Admittedly, some placement agents are just pests who bombard the investor with all sorts of potential investments. On occasion in my tenure with the pension plan, a placement agent turned out to be extremely useful in convincing the money manager to give me critical due diligence information. After all, the placement agent doesn’t get paid unless the investor makes a commitment. Thus the agent had a big incentive to convince his client, the money manager, to satisfy all my due diligence needs.
There’s nothing unusual about managers using multiple placement agents or placement agents hiring sub-agents. Some agents have better contacts at public funds and others are more experienced with endowments. Money managers are more likely to use placement agents when they market overseas even if they have a deep marketing team. A local placement agent is going to have a better contact list and knowledge of the legal necessities of marketing.
As I see it, there are two potential problems with placement agents. First, there’s the placement agent who is more than an introducer, and who gains influence over the investor’s decision-making process. As CIO for North Carolina, I always told placement agents that I preferred that they not attend meetings. However, if they insisted on showing up, I didn’t want them to speak at all. I wanted the money manager and not the placement agent to answer my questions. Nonetheless, I’ve seen placement agents get too involved. Ironically, it’s not the politically connected sorts of placement agents who cross this line. They don’t know enough about investments to interject.
Second, there’s the placement agent who is conveniently injected into the hiring process in order to get paid. In other words, the investor was inclined to meet with the money manager, and the investor had a hand in putting the placement agent in front of the money manager. This kind of activity was at the heart of improper practices in California and New York and led to Treasurer Cowell’s examination of the practices under her predecessor.
There’s a huge irony in the crackdown on placement agents by North Carolina and other states. While those placement agents with political or personal connections with investment decision-making are suspected of undue influence, the placement agents with the biggest influence get to fly under the radar. The big placement agents, particularly those associated with big banks, can show that they have no direct political or personal connection. However, because their firms offer all sorts of other financial products and services, they can gain access and influence that is far beyond the capabilities of your average local politician. Moreover, the new regulations imposed by the SEC and the various states are a minor cost for the big boys.
Investment Consultants are hired by investors to supplement the internal capabilities of their staffs. The idea is to hire someone who can screen investment opportunities, conduct due diligence, and make recommendations. At various points in the Treasurer’s report, there are references to “independent” or “objective” consultants; the inference being that these folks provide an unbiased set of services. In thirty plus years, I’ve never met an investment consultant that satisfies either of those terms. There is no business more prone to conflict of interest, client pressure, and biased advice than investment consulting. Much of the problem stems from consulting’s business model, which provides scant profit margins while evaluating managers making big fees.
While some consultants strive to achieve the report’s ideal, most of them fall short.
The goal of the consultant isn’t to provide impartial advice, it’s to keep the relationship with the investor. Thus, the advice is often tailored to what the investor wants to hear. If the investor is inclined to make an investment with a particular manager, the consultant’s report will be shaded. The consultant isn’t going to want to write a report that will embarrass the investor or wind up in the investor’s files as fodder for an auditor or public records request.
Because the profit margins are slim, consultants often engage in other businesses. Some consultants provide advisory services to money managers in order to help them better position their product. I trust you see the potential conflict in this line of work. Other consultants run fund of funds businesses. In other words, they’re not only recommending investments for consulting clients, they are also investing in managers through their fund of funds.
Late in my tenure with the state, we had a consultant who also ran a fund of funds. We were making a second investment with the manager and requested a $100 million allocation. The manager tried to cut us back because our consultant had also requested an allocation. In other words, the consultant was benefiting from our due diligence and relationship. I don’t know if the consultant got an allocation, but after a phone call the pension plan received its full allocation.
Investment consultants purport to provide customized research tailored to specific clients. I know of only one or two consultants who did this, and they are overworked people. Customization is an anathema to consulting. Unless you can recommend a manager or use investment studies for multiple clients, the business model just doesn’t work. An investment consultant can ill-afford to do tailored work for a client. However with a computer and PowerPoint, it’s not hard to generate impressive looking reports that justify whatever the fiduciary or staff has decided to do.
Neither the placement agent nor the consulting businesses are pristine endeavors, and no amount of internal policies will change that fact. In the case of placement agents, the economic proposition is clear: it is fees for access. In the case of investment consultants, the economic proposition is harder to discern. However, most of the consultant’s fee is earned for providing the pension plan with political cover.
If you really want to understand how influence works in a public pension please read, “Private Equity: Democratic Style.” (November 21, 2012). It is the story of how Steve Rattner (Quadrangle Group, and ex-auto czar) and Ron Burkle (Yucaipa Companies) managed to get to the front of the investment queue even though there wasn’t a placement agent, consultant, or prior relationship in sight. It takes trust and not voluminous policy manuals to deal with these situations.