Pension funds, endowment plans and other large institutional investors who engage investment consultants for market advice failed to see a better return on their investment when compared to the rest of their peers, according to new academic research cited by the Financial Times on Sunday, begging the question what the true value of consultants’ recommendations really is.
In a paper titled Picking Winners? Investment Consultants' Recommendations of Fund Managers from Oxford University’s Saïd Business School, researchers found that U.S. equity funds recommended by consultants actually underperformed non-recommended funds by 1.1 percent a year between 1999 and 2011.
Analysing the recommendations offered by 29 consultancies (with a share of 90 percent of the U.S. consulting market) during the period, the researchers also concluded that there was “no evidence” to suggest that consultants’ recommendations added any value to their clients, while at least $2.5 billion a year was spent worldwide on this so-called advice.
“The enormous power wielded by consultants is not matched by their performance,” said Jose Martinez, one of the authors of the study, to FT.
“It is high time that pension funds or regulators required consultants to disclose their past recommendations. Unless investment consultants are ashamed of their performance, they should come out of the shadows,” added his co-author Howard Jones.
According to the Oxford team, more than $13 trillion of U.S. institutional money was advised on by consultants from 2011. Worldwide, consultants advised on nearly $25 trillion of assets.
Using thirteen years of survey data, the researchers examined three questions relating to consultants’ recommendations of fund products. First, what drove consultants’ recommendations; second, whether capital flows were affected by consultants’ recommendations; and third, whether these recommendations could predict a fund’s performance.
The Oxford team found that while consultants would base part of their recommendations of fund products on past performances, they were also far more highly influenced by two sets of non-performance factors; namely Soft Investment Factors and Service Factors. In particular, Soft Investment Factors, which consist of incalculable elements such as a consistent investment philosophy, stood out as a high factor in consultants’ recommendations.
Next the researchers found that consultants’ recommendations were highly influential. In the U.S., a fund recommended by many consultants could typically expect to see additional inflows of $2.4 billion, “confirming survey data which reports that manager selection is one of the most highly valued services offered by consultants”, the paper said.
The researchers speculated that institutional investors continued to rely on recommendations either because they want a “hand-holding service”, a “shield” to defend their decisions, or are “simply unaware how accurate or inaccurate” consultants’ calls are.
“Since consultants do not disclose their individual recommendations, pension funds are allocating assets on advice the quality of which is impossible to judge,” said Mr Jones, who contrasted the situation with consultants’ “ruthless” scrutiny of fund managers.
Andrew Kirton, global chief investment officer at Mercer, a large consultancy, responded to the Financial Times that it released performance data to its clients on a quarterly basis, with the latest figures showing value added across all categories of 1.3 per cent a year since inception, and 1.1 per cent for US equities. Towers Watson and Aon Hewitt however declined to comment.
Download The Full Paper: Picking Winners? Investment Consultants' Recommendations of Fund Managers Here