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 universitys 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.
