Pension funds and other large investors are throwing away billions of dollars a year on worthless advice from investment consultants, according to academic research

September 22, 2013 4:16 am

Billions of dollars wasted on investment advice

By Steve Johnson

Pension funds and other large investors are throwing away billions of dollars a year on worthless advice from investment consultants, according to academic research. The funds recommended by consultants do no better than any other, and by some measures they underperform the wider market significantly, the research* found. On an equal-weighted basis, US equity funds recommended by consultants underperformed other funds by 1.1 per cent a year between 1999 and 2011, according to analysis of 29 consultancies accounting for more than 90 per cent of the market by a team from Oxford university’s Saïd Business School. “The enormous power wielded by consultants is not matched by their performance,” said Jose Martinez, one of the authors of the study. “In US equities, one of the largest asset classes, investment consultants as an industry appear to add no value in fund selection,” added co-author Howard Jones.According to the Oxford team, more than $13tn of US institutional money was advised on by consultants from 2011, with 82 per cent of public pension plan sponsors and half of corporate sponsors paying for advice. Worldwide, consultants advised on $25tn of assets.

If only one basis point of this was allocated for manager selection, this would amount to $2.5bn a year. An estimated $2tn of assets a year are also subject to “transition management”, often driven by consultants’ recommendations to hire and fire managers, incurring significant, and seemingly pointless, transaction costs.

In the US, the academics found consultants’ recommendations were highly influential. A fund recommended by many consultants could typically expect to see additional inflows of $2.4bn, “confirming survey data which reports that manager selection is one of the most highly valued services offered by consultants”, the paper said.

The Oxford team found these flows, and the fact that consultants tended to recommend larger funds in the first place, explained the underperformance of 1.1 per cent a year, as unwieldy funds suffer from diseconomies of scale.

However, they found “no evidence that the recommendations … enabled investors to outperform their benchmarks or generate alpha [market-beating returns]”.

The paper speculated 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.

“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.”

Andrew Kirton, global chief investment officer at Mercer, a large consultancy, said 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 declined to comment.

* “Picking winners? Investment consultants’ recommendations of fund managers”, by Tim Jenkinson, Howard Jones and Jose Vicente Martinez.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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