Yield of Dreams

If Institutional Consultants Can’t Pick Managers, Who Can?

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Many advisors justify their fees on their ability to pick winning asset managers (among other things). But if even pension fund consultants—who’s sole job it is to rigorously vet managers for use by the largest asset pools in the world—can't pick winners, what makes advisors think they can?

Earlier in my career, I covered the world of pension fund investments and the consulting firms that tell them what to do. In both the institutional and retail circles, consultants are known for their sophisticated investing strategies and their rigorous due diligence process for finding investment managers. Just ask anyone who has gone through the RFP process.

Yet a new paper from the University of Oxford Said Business School found that consultant-recommended U.S. equity funds underperformed those of non-recommended funds by 1.1 percent per year from 1999 to 2011. From the report:

We find no evidence that consultants’ recommendations add value to plan sponsors. On an equal-weighted basis, the performance of recommended funds is significantly worse than that of non-recommended funds, while on a value-weighted basis the performance is mixed, and the recommended and non-recommended products do not perform significantly differently from each other. The underperformance of recommended products on an equal-weighted basis can be explained by the tendency of consultants to recommend large products which perform worse. When we adjust for the different sizes of recommended and non-recommended products, we find that recommended products still fail consistently to outperform non-recommended products. The same result holds when we adjust for possible backfill bias.

The institutional consultant business is not a small one. According to the authors, consultants advise on over $13 trillion tax-exempt U.S. institutional assets. Eighty-two percent of U.S. public pension plans, and half of corporate plans, use a consultant.

This is the first study of its kind that I’ve seen providing hard data on the performance of these consultants. The advisor industry has long tried to track and mimic the investment portfolios of institutional investors, especially the endowments such as Yale and Harvard's, whose portfolios seemed to weather even the worst downturns.  

But if even the consultants running these large pools of assets cannot outperform, who can? How can advisors, who rely on their own due diligence of managers, possibly outperform the guys perceived as pros?

This is not to say that advisors don't have value. (And by no means am I trying to make enemies.) But, I do believe that advisors will have to step up to the plate, offer more services to clients, and find creative ways to justify their fees. I'm open to ideas...

 

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Casting a gimlet-eye on asset management issues.

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