How Effective Are Investment Consultants for Allocators?
Art by Tilda Rose
Investment consultants are a boon to many allocators. They help plan, design, and allocate assets, and they recommend asset managers that smaller investors might not have the resources or staff to look into themselves.
How effective they are when it comes to delivering investment returns is another question. Over the years, critics have argued that some consultants do little to add value to a fund, despite charging high fees for their services. Many investment teams have little choice in the matter, given that consultants typically report directly to the trustees.
But adding fuel to this debate, one joint research study from the University of Oxford and the University of Connecticut, updated this year, found that investment consultants tend to overstate how well they outperform. In truth, the analysts said, the products recommended by consultants performed no better on average than other investment products.
Recommendations from three of the UK’s leading consultants were reviewed over a 10-year period in the report, “Virtual Reality? Investment Consultants’ Claims About Their Own Performance,” originally published in 2018.
While the consultants in the report were based in Britain, they have an enormous global reach. Though the report did not disclose which consultants it studied, it did say that they had about 51% of the global market share in 2019, and about 60% of the market in the UK the same year, according to the report.
“Our analysis suggests not only that consultants’ claimed performance is wide of the mark, but also that their disclosures are difficult to compare, making them poor guides even to their relative performance,” the report read.
When it comes to what consultants claimed on their websites and what the researchers observed, the gap was startling. The difference between what consultants said they gained and what the universities’ analysts found was 1.93%. That gap widened even further when management fees were accounted for.
On average, analysts found that the products recommended by consultants actually underperformed when compared to similar investment products, according to the study. Researchers found that investments recommended by the gatekeepers returned 0.20% lower per annum on average than the returns in similar asset categories, such as US large cap value equity.
But consultants themselves marketed that they returned about 1.73% per year in excess gains. That’s a weighted average from consultants whose stated excess returns ranged from 1.64% to 2.51%.
No evidence was found that investment products chosen by consultants outperformed as much as they said they did, the researchers said. There are several reasons their claims might be too high.
For one, consultants compare their recommended investments to passive benchmarks, which institutional products already outpace by 50 basis points (bps) (gross of manager fees) on average, rather than to similar assets. A better measure for consultant performance, the analysts said, would be to compare their showings to benchmarks on top of the 50 bps.
Secondly, consultants include simulated and backfilled returns in their analysis, which helps the firms generate better track records. Third, because the firms include products with five-year returns, their analyses include managers with proven track records, inflating the performance results. Fourth, disclosures from consultants often exclude products and investment categories seemingly arbitrarily.
“Given the tendency for investors to chase past performance and to trust even non-verifiable disclosures, asset owners may therefore be following consultants’ manager recommendations, and allocating assets, on false pretenses,” the study said.
Representatives at several consulting firms—Aon, Mercer, and Willis Towers Watson—were asked to comment on the findings of this study. A spokesperson from Willis Towers Watson declined to comment on the report. The others gave no response.
For allocators, the lack of transparency among consulting firms and other financial services firms could make it very difficult to choose between them.
Related Stories:
Choosing Consultants: What Should You Measure?