Widely used by retirement plan sponsors and pension fund trustees, investment consultants advise on institutional assets worth trillions of dollars. But their influence is not matched by their performance. New research finds no evidence that they add value to plan sponsors — or provide higher returns for pension scheme investors.
Survey data from 2011 suggests investment consultants are hired by more than 90 per cent of retirement plan sponsors and that they advise on institutional assets of more than $13 trillion in the US. The costs to plan sponsors are considerable: ‘transition management’ fees are incurred when they move between funds. Are they getting value for money?
A new research study, based on a 13-year period, analyses the formation, impact and accuracy of investment consultants’ recommendations. Focusing on US active equities and investment consultants with more than a 90 per cent market share, it compares survey data from Greenwich Associates, which reflects recommendations of US equity products, with that from eVestment on returns from US equity funds under management between 1999–2011.
It concludes that the influence of consultants is hugely disproportionate to the value they add — and that the products they recommend do not outperform other products by a margin sufficient to cover their costs.
The researchers found that, going from the fund with the fewest consultant recommendations to the fund with the most, the assets under management increased by $2.4bn, controlling for other factors — but that the recommended funds were no more likely to generate market-beating returns.
While consultants used a (perhaps surprising) variety of ‘soft’ factors in fund selection — including, for example, ‘consistent investment philosophy’ — their recommended products failed to do better than other products. On an equal-weighted basis, in fact, US equity funds recommended by consultants actually under-performed other funds by a statistically significant 1.1 per cent a year.
On a value-weighted basis, the results are mixed, but there is no evidence that recommended funds significantly outperform. The underperformance on an equal-weighted basis can be explained, say the researchers, by the consultants’ tendency to recommend large funds, which often perform worse than small funds owing to ‘diseconomies of scale’.
A more important question is why plan sponsors continue to rely on investment advisers and follow their recommendations. One explanation is that they feel they need a ‘hand to hold’ while making their decisions and ‘navigating’ the markets; another is that they want to use consultants as a scapegoat or shield if things go wrong – to ‘fail conventionally’, as the economist John Maynard Keynes put it.
The main reason, however, is probably that plan sponsors appoint investment advisers ‘blind’. While fund managers testify to the rigour with which investment consultants scrutinise their performance, investment consultants themselves are shy of disclosing the sort of information that would allow outsiders to measure the accuracy of their recommendations. While some show their ‘value added’ by comparing the performance of a portfolio of their recommended funds with that of an appropriate benchmark, they do not generally compare this performance with that of funds they do not recommend.
Put simply, plan sponsors lack the information to carry out ‘due diligence’ on investment consultants.
The study points to a need for plan sponsors and pension fund trustees to make more informed decisions. The accuracy of the recommendations of a particular consultant might be better than the average, but plan sponsors currently do not have the information to tell.
The researchers suggest that investment consultants should be required (by plan sponsors or regulators) to provide the same level of disclosure as fund managers provide on their performance, or research analysts on their stock recommendations. Greater transparency would make it easier to see which consultants were destroying value — and in which asset classes.
There are implications, too, for employers. Plan sponsors and investment trustees should, it could be argued, be encouraged to make their own judgments about fund selection. Why go to the trouble of appointing competent plan sponsors if they’re going to refrain from applying that competence in favour of selecting from consultants’ shortlists?
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