Do Institutional Consultants Add Value Picking Money Managers?

I grew up in the finance industry working in the institutional consulting world. Most consultants provide a wide range of services but what they’re all really selling is their due diligence capabilities for choosing money managers to invest on behalf of these large pools of capital. They often use buzzwords like ‘alpha’ and ‘access’ to get their clients’ attention, but very few allocators of institutional money ever really spend much time judging the results of these manager-of-managers.

Consultants are probably one of the least scrutinized groups in the investment field, which has always been bizarre to me because they oversee tens of trillions of dollars for large pensions, endowment and foundations.

The latest issue of the Journal of Finance has a new research paper on these institutional investment consultants as a group. The results aren’t too pretty in terms of their ability to pick above average money managers (emphasis mine):

Investment consultants advise institutional investors on their choice of fund manager. Focusing on U.S. actively managed equity funds, we analyze the factors that drive consultants’ recommendations, what impact these recommendations have on flows, and how well the recommended funds perform. We find that investment consultants’ recommendations of funds are driven largely by soft factors, rather than the funds’ past performance, and that their recommendations have a significant effect on fund flows. However, we find no evidence that these recommendations add value, suggesting that the search for winners, encouraged and guided by investment consultants, is fruitless.

Here’s the data to back up these claims:

consultants

One of the problems is that these consulting firms are so concentrated at the top, with the top 10 firms controlling over 80% of all institutional assets. This data is a little stale, but it shows just how large some of these consulting firms are:

The five largest investment consultants in 2011 were Hewitt EnnisKnupp ($4.4 trillion under advisement), Mercer ($4.0 trillion), Cambridge Associates ($2.5 trillion), Russell Investments ($2.4 trillion), and Towers Watson ($2.1 trillion). Not surprisingly, institutional asset managers view being highly rated by these major investment consultants as crucial to their success.

When you’re that large you almost have to invest in the largest money managers which ends up being a de-facto performance chase. It can also be difficult to offer personalized service at that size because you’re more worried about scale than anything.

The other problem is that those who are trying to pick consultants to pick money managers on their behalf don’t really have the expertise required to judge either the money managers or the consultants who are recommending the money managers. So the blame gets passed around and everyone is none the wiser when the results end up being subpar.

Here are a few simple takeaways from this research:

  • Picking money managers is hard.
  • Picking other people to pick money managers for you is also hard.
  • Many of the organizations overseeing these consultants probably aren’t even aware how poor their performance has been.
  • Picking money managers should not be the main focus for 95% of all institutional clients.
  • Consultants could add value to these relationships if they focused more of their time on client engagement, board education, asset allocation, investment policy and the unique goals of the nonprofits they are working with.

Source:
Picking Winners? Investment Consultants’ Recommendations of Fund Managers

Further Reading:
Consulting & The Smart Money Herd Mentality

 

This content, which contains security-related opinions and/or information, is provided for informational purposes only and should not be relied upon in any manner as professional advice, or an endorsement of any practices, products or services. There can be no guarantees or assurances that the views expressed here will be applicable for any particular facts or circumstances, and should not be relied upon in any manner. You should consult your own advisers as to legal, business, tax, and other related matters concerning any investment.

The commentary in this “post” (including any related blog, podcasts, videos, and social media) reflects the personal opinions, viewpoints, and analyses of the Ritholtz Wealth Management employees providing such comments, and should not be regarded the views of Ritholtz Wealth Management LLC. or its respective affiliates or as a description of advisory services provided by Ritholtz Wealth Management or performance returns of any Ritholtz Wealth Management Investments client.

References to any securities or digital assets, or performance data, are for illustrative purposes only and do not constitute an investment recommendation or offer to provide investment advisory services. Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any investment decision. Past performance is not indicative of future results. The content speaks only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others.

The Compound Media, Inc., an affiliate of Ritholtz Wealth Management, receives payment from various entities for advertisements in affiliated podcasts, blogs and emails. Inclusion of such advertisements does not constitute or imply endorsement, sponsorship or recommendation thereof, or any affiliation therewith, by the Content Creator or by Ritholtz Wealth Management or any of its employees. Investments in securities involve the risk of loss. For additional advertisement disclaimers see here: https://www.ritholtzwealth.com/advertising-disclaimers

Please see disclosures here.