Study: Consultant Recommended Funds Gain Assets, Not Alpha

US active equity funds on consultants’ shortlists performed no better than average, but consultants’ recommendations focused on more than past returns.

(September 20, 2013) — Investment consultants' recommendations can significantly alter fund flows, but do not necessarily add value to plan sponsors' portfolios, according to a study.

Finance researchers Tim Jenkinson, Howard Jones, and Jose Vicente Martinez, all of Oxford University's Saïd Business School, examined the performance of US active public equity managers relative to their recommendations by institutional investment consultants.

The main data set used in the study derived from Greenwich Associates consultant surveys for the 1999 through 2011 period. The authors based their findings on the stated public equity product recommendations from an average of 29 investment consultancies annually. In 2011, respondents' firms had a cumulative 91% share of the US consulting market, according to the paper.

The researchers found that recommendations tended to be based in part on past fund performance, but foremost on “soft” factors, such as the capability of the portfolio manager and consistency of a fund’s investment philosophy.

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Fund flow data for the 1999 through 2011 time frame indicated that consultants’ recommendations had a substantial effect on the volume of assets entering and exiting.

The authors further found that recommended funds were significantly larger on average ($4 billion under management) than non-recommended ones, which averaged $0.8 billion.

“This finding provides evidence that consultants’ recommendations have a large influence on investor allocation decisions and confirms survey data which reports that manager selection is one of the most highly valued services offered by consultants,” Jenkinson, Jones, and Martinez wrote.

However, recommendations did not have a similarly positive link with returns. Active US public equity products that had the backing of consultants showed “insignificant outperformance” relative to benchmarks, the study found. On an equally-weighted basis, “we find that average returns of recommended products are actually around 1% lower than those of other products,” the authors wrote. This result stayed consistent when they used one, three, and four factor pricing models, and were in every case statistically significant.

All returns calculated were gross of fees.

“Our analysis focuses on one asset class, US active equity, which may be more efficient than other asset classes, and it is possible that elsewhere the recommendations of investment consultants are more prescient,” the authors acknowledged. “However, US active equity is a major asset class for plan sponsors, and our analysis of flows indicates that consultants’ recommendations in this asset class are highly influential.”

Read the full paper here.

(September 20, 2013) — One of the largest public pensions in Detroit has failed in its attempt to bring fraud charges against several bulge-bracket banks.

On September 18, an arbitration panel from the Financial Industry Regulatory Authority, an independent regulator of US securities firms, dismissed claims brought by Detroit’s Police and Fire Retirement System, Reuters reported.

The system had brought claims against Citigroup, Morgan Stanley, and several other smaller institutions in 2010. It claimed the banks had defrauded and breached both contracts and their fiduciary duty when recommending the system invest in various collateralized debt obligation funds.

The system was seeking $39.9 million in damages from the institutions cited in its claims. The panel denied all of the system’s claims.

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The ruling is the latest in which US public pensions have failed to win compensation from financial institutions embroiled in the financial crisis, and the selling of asset-backed securities.

In August, a New York judge dismissed a pension fund-led case brought against Moody’s, which claimed the rating agency misrepresented the creditworthiness of securities, and thereby harmed investments.

Some investors have had more luck, however. Dutch giant ABP has won back tens of millions of euros in legal settlements with banks over asset-backed securities claims as defendants—including Deutsche Bank and JP Morgan—settled before trial.

The state of Detroit filed for bankruptcy this summer, leaving creditors, including the Police and Fire Retirement System facing a battle for any free cash. The system, along with the general public fund, attempted to sue Governor Rick Snyder to block him from authorizing the bankruptcy that would potentially cut pensions to members.