When the Financial Conduct Authority (FCA) reported on the state of the UK’s top investment consultants, it didn’t say it with flowers.
Its interim report last autumn found that consultants were not able to identify outperforming managers and pointed out potential conflicts of interest.
Further, it said that competition was not working effectively, leading to higher costs, less transparency and poor fiduciary management services
Just to add insult to injury, it then made a provisional decision to refer the sector to the Competition and Markets Authority (CMA) for a market investigation.
As an investment consultant myself, I bear the scars of the report, if only in the shape of comments in my Twitter stream.
The main goal of the study was to answer a simple question: do investors obtain good value when purchasing asset management services from investment consultants?
What do the numbers say?
So the big talking point is – do the numbers back up the FCA?
An academic research study, recently published in the top ranked Journal of Finance, comes in handy when trying to work this out.
The paper is written by Tim Jenkinson, professor at the University of Oxford, and colleagues
They not only confirm the FCA conclusions, but also extend them to the global community by analysing the actions of consultants with a combined share of 90% of the worldwide consulting market on US funds.
The paper poses and answers two main questions:
Do consultants significantly influence the decisions of pension plan sponsors regarding which fund managers to include in pension assets?
Yes, consultants have substantial influence in driving flows in and out of funds. For example, a fund which is recommended by all of the consultants in the sample receives a staggering $2.4 billion in additional assets compared to a fund that does not receive any recommendations!
Do these recommendations predict outperformance of the funds selected and ultimately add value to the final portfolio return?
No, there is no statistically significant evidence that funds recommended by consultants provide alpha compared with those funds not recommended by the same consultants.
Jenkins et al don't mince their words either, concluding that: 'We find no evidence that these recommendations add value, suggesting that the search for winners, encouraged and guided by investment consultants, is fruitless.'
Money for nothing
In fact, on a net basis, an equal weighted portfolio of all the funds ‘recommended’ by the consultants produced an annual excess return over the benchmark of 0.51%.
Those without the badge of recommendation did rather better – achieving 1.67% a year above the benchmark.
Which is embarrassing.
Although investors do religiously follow the advice given by consultants, it seems that the ‘average’ advice they get (and there’s no doubt some consultants do perform and add value better than others,) comes with a high price tag and no value added to portfolio performance.
So, we are left intrigued that plan sponsors and investors continue to use consultants with little questioning of their decision making process and ultimate results.
Even more puzzling are the high fees that this group is able to charge as evidenced by the FCA report.
The FCA is right to voice the need for stronger accountability on the part of consultants and managers to act in the best interest of investors.
But investors need to do their bit as well in holding the consultants to account and doing their own homework to select outstanding fund managers (Try Citywire’s Fund Manager Ratings maybe? – Editor)
Jenkinson himself says as much noting that ‘Investors should require full disclosure of consultants’ past recommendations so that such decisions are better informed and, as a consequence, assets are more efficiently allocated’
As the old adage says: ‘It takes two to tango’ …
Dr Elisabetta Basilico CFA is a quant investment expert and consultant who specialises in what she terms ‘turning academic insights into investment strategies.’ She helped several private and institutional clients achieve stable returns and financial prosperity. Follow her at academicinsightsoninvesting.com