William M. Mercer Investment Consulting Inc.'s recent move to publicize the performance of its active investment manager recommendations, along with Frank Russell Co.'s existing similar effort, deserves praise. The effort begins to get at the heart of the issue for the pension fund clients of consultants: whether active managers can add value and whether a consultant has the skill to identify those superior managers.
But manager performance tells only part of the story in evaluating the skill of a consultant. And it's a small part. Looking at only money manager recommendations ignores the consultant's role in setting investment policy - in other words, asset allocation - which academic studies show is by far the more important component of fund sponsor performance.
The two consultants' efforts could serve as a step toward providing a quantifiable measure to enable fund sponsor clients to better screen consultants for potential hiring and, ultimately, to put consultants on performance-based fees. But despite the moves by Mercer and Russell, such developments still are far off.
The Investment Management Consultants Association, Denver, ought to take the lead in encouraging performance reporting by consultants, not only of the track record of the investment adviser recommendations but also recommendations on policy asset allocation, target allocation ranges and style tilts. IMCA should develop standards along the lines similar to the portfolio performance presentation standards of the Association for Investment Management and Research. The standards should include performance benchmarks and composites to guard against consultants cherry-picking by reporting results only for better-performing clients.
The association has kicked around ideas involving some performance measurement for consultants, according to Ronald J. Surz, president of PPCA Inc. and a director of IMCA, but nothing has come of them. One reason is the complexity of developing such measurement.
But consultants might be reluctant to adopt such standards for themselves because such data might define them as providing investment advice. They then might have to register as investment advisers with Securities and Exchange Commission, especially if they started to accept performance-based fees. Many consultants now aren't registered, suggesting they don't give investment advice and don't accept fiduciary responsibility, although some of IMCA's members are SEC registered, as are Mercer and Russell.
Using the clout of their assets under management, fund sponsors ought to encourage consultants to provide a track record of their recommendations on asset allocations and money managers. At least one pension fund already is doing so to some extent. Missouri State Employees' Retirement System pays a performance-based fee to its consultant, Summit Strategies Inc., which also is SEC registered.
Fund sponsors should demand more accounting of consultants' skill, no less than they already demand of investment managers, especially because the work of the consultant in asset allocation is considerably more important.