Investment consultants and asset owners disagree with an award-winning paper that questions the value consultants offer their clients.
The paper — “Picking Winners? Investment Consultants' Recommendations of Fund Managers” — asserts that consultants' recommendations of money manager strategies are not driven by investment performance, and instead are based largely on “soft factors,” such as “clear decision-making, capable portfolio management and consistent investment philosophy.”
The authors were unable to find evidence that recommendations based on those factors added any particular performance-based value, suggesting the search for winners is “fruitless.”
“They (consultants) may be adding value through the other decisions they help plan sponsors with, they just fail to do it in this particular decision: which asset manager to hire for a particular mandate,” in this case, active U.S. equities, said Jose Martinez, assistant professor of finance, University of Connecticut School of Business and co-author of the paper, which won the annual $10,000 Commonfund Prize this year.
But investment consultants and asset owners interviewed for this story cry foul.
Michael A. Rosen, a principal and chief investment officer at investment consultant Angeles Investment Advisors LLC, Santa Monica, Calif., said the questions clients should be asking are: “Over time, has the fund performed better than its benchmark? Has it done so with less risk? Has the manager achieved their objectives?”
“If so, then the consultants provide considerable value,” Mr. Rosen said.
He also said consultant recommendations being driven largely by soft factors rather than performance, is by design and is “a good thing.”
“Past performance is a poor indication of future results because performance can be affected by many complex factors, some of which are random or difficult to control or anticipate,” he said after reading the paper.
When asked to comment on the paper, Michael G. Trotsky, executive director and CIO of the $61 billion Massachusetts Pension Reserves Investment Management board, Boston, echoed the sentiment that consultants shouldn't choose investment strategies based on past performance.
“Past alpha generation has absolutely zero predictive ability for future performance,” said Mr. Trotsky.
Mr. Rosen explained that, while factors that affect past performance aren't consistent, a manager's strategy, discipline and process are.
“By evaluating these so-called "soft factors,' there's a much deeper understanding of what drives portfolio returns and of what environments are more conducive to outperformance,” he added.
In addition to not having any special powers to pick winners, the paper also notes that consultants lack transparency and tend to favor larger managers, which the authors say tend to perform worse.
Mr. Rosen said that the criticism that consultants tend to favor larger funds across the board didn't ring true to him, but said that the size of allocations often guide manager recommendations.
“If you're investing $300 million in a niche strategy, you're not likely to hire a manager that only has $200 million or $500 million under management,” he said. “There are advantages and disadvantages of scale, and one disadvantage is capacity constraints.”