Blood-letting: evaluating the role of consultants

The advent of investment consultants into fiduciary management raised some concerns, not least over conflicts of interest.

The proliferation of descriptive titles for these activities also raised concerns, as in addition to the possibility of finer distinction, this practice also serves to obscure. It reduces the fiduciary management classification to a fuzzy, ill-defined set.

One of the key points in the sales pitches for fiduciary management was that this delegation of powers would enable faster decisionmaking and the exploitation of rapidly passing opportunities in markets. No mention here of ‘marry in haste, repent at leisure’, which does have academic support. No mention either that such transient “opportunities” are speculations rather than investment; but, perhaps more importantly, no evidence has been offered that this short-term speculative behaviour can be achieved and aggregated to deliver superior long-term returns.

The recently published study by Jenkinson, Jones, and Martinez (JJM): Picking winners? Investment consultants’ recommendations of fund managers, casts serious doubt on the ability of investment consultants to select managers. Of course, the fiduciary problem is somewhat different – here the selection is of securities rather than managed portfolios, but the linkages between these are strong.

This JJM study is not unique – in 2001, John Woods and Mike Smith published a short paper: Investment Consultants’ Fund Manager Recommendations: Is There Any Value in Them?  This is far from an overwhelming body of evidence, but it appears that investment consultants are loath to provide data on their recommendations, and much more.

These findings do not appear to have surprised or shocked many. In a recent industry survey, in response to the question: “A study of US investment consultants has concluded that their manager recommendations add no value. Do you think this is true in the UK?” – 47% thought it true and 26% did not know. However, one finding from this latest study offers scope for further analysis.

It appears that pension schemes do rather slavishly follow the recommendations of their investment consultants, which means that we may be able to infer the quality of that advice from the performance of pension funds. Given the relative performance of pension funds’ overall investments, this does not appear to offer high hope of redemption.

The soft touch

The JJM paper examines the determinants of manager selection and finds that “consultants’ recommendations are driven partly by the past performance of fund managers, but more so by non-performance factors”. The analysis of the use of soft and service factors in manager selection by investment consultants is both interesting and a source of concern.

Soft factors include such aspects as clear decision-making, capable portfolio management and consistent investment philosophy, while service factors include capabilities of relationship professionals, usefulness of reports prepared by the fund manager, and effective presentations to consultants.

Quite how this latter point is relevant to investment performance is something of a mystery, though its value to consultants is clear. The cynic might well view the use of soft factors by investment consultants as little more than the introduction of a little “magic” into a process which otherwise might be reduced to algorithmic analysis of performance data.