Investment gatekeepers have a value problem

By James Saft

China’s great divergence

(Reuters) – The investment gatekeepers who help control $25 trillion of institutional money have trouble figuring out who is and who isn’t good at money management.

Investment consultants, who play a key role advising pension funds, charities and endowments, actually choose managers who end up lagging those whom they pass over, according to a new study.

“We find no evidence that consultants’ recommendations add value to plan sponsors,” write Tim Jenkinson and Howard Jones of the University of Oxford and Jose Martinez of the University of Connecticut, whose paper last week won the Commonfund Prize, an annual award for research into foundation and endowment management. (here)

Investment consultants help institutional fund trustees, who are usually not professional money managers, on a variety of issues, from choosing managers to asset allocation to modeling assets and liabilities. It is a huge industry, advising $25 trillion, and a highly concentrated one. The top 10 consultants, including Mercer, Towers Watson and Russell Investments, have estimated global market share of 82 percent.

The study focused on actively managed U.S. equity funds, looking at institutional funds of about $3 trillion and surveys of consultant recommendations over 13 years. The upshot: funds recommended by consultants return, on average, 1.12 percentage points less per year on an equally weighted basis than those not recommended.

On the face of it, that is pretty damning.

It certainly is not what trustees think they are paying for. In a 2011 survey in Pensions & Investments when plan sponsors were asked where they thought consultants were adding the most value, the single largest response, from 27 percent, was “money manager search/selection.”

To be sure, there are a host of “yes, but’s” here. U.S. equity is one of the largest and, presumably, most efficient markets. It is possible that consultants are better able to add value in emerging markets or high-yield bonds, for example. It is also notable that consultants seem to favor larger funds, perhaps because they can take on large allocations for huge pension funds or perhaps because they have client service or investment process offerings not available among smaller funds. Larger funds have a documented tendency to lag smaller ones in performance.


The study did look at why consultants recommend given funds and found that they were not simply chasing the best performance. While performance plays a role in selection it is actually outweighed by ‘soft’ factors, according to the study, such as service and investment process. It might possibly be that those investment process issues mean that chosen funds are less likely to suffer large meltdowns and are thus to be preferred. That’s possible, but wasn’t reflected in the 13 years of data.

Those other soft factors definitely have a value, as any client of a private bank will tell you.

One thing is certain: getting chosen by investment consultants is a huge business issue for fund managers.

Based on the data they examined, the authors calculate that attracting (or losing) recommendations from one-third of the investment consultants will drive, on average, an increase (or decrease) of 10 percent in the size of the investment product in a year. That 10 percent flow is equal to about $800 million, which if we assume annual fees and charges of 1 percent, would mean annual revenue of $8 million.

It is useful to consider why these consultants exist, and why plan sponsors use them. Partly it is a useful buying in of expertise in planning and risk management. They also clearly can act as a liability shield for trustees fearful of being held accountable by angry stakeholders if their choices prove disastrous.

But many naive plan sponsors may actually have bought into the return-chasing mind-set that pervades investment. They may believe that consultants, generally an impressive lot, actually can identify the magic dust which separates a Warren Buffett from an also-ran. This group needs educating, but will find only limited help on offer from the consultants charged with advising them.

Data disclosure is not what it should be.

“An obvious policy response by regulators, or a market response by plan sponsors, is to require full disclosure of consultants’ past recommendations so that such decisions are better informed and, as a consequence, their assets more efficiently allocated,” the authors write.

Just as it is in fund management, sunlight is needed in the investment consultant business.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may bean owner indirectly as an investor in a fund. You can email himat and find more columns at

(Editing by James Dalgleish)