Do Investment Consultants Add Value?


Large institutional investors such as foundations, endowments, and pension plans spend billions of dollars on investment consultants on whom they rely to pick active managers. Recently, three researchers (two from Oxford University and one from the University of Connecticut) delved into the question of whether this money is well-spent. Their answer will appear in a forthcoming article1 in the Journal of Finance titled Picking Winners? Investment Consultants' Recommendations of Fund Managers. This study originally came to our attention through this New York Times article where one of the authors is quoted as saying, “It's a waste of money listening to consultants. It's a service that is useless.” The abstract of their study spells it out in a more formal manner:

“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 very 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.”

From the perspective of fund managers, investment consultants act as gatekeepers who decide whether their fund will make the grade to be utilized by institutional investors. The authors note the abundance of “pay-to-play” scandals involving U.S. public pension plans. They also cite an SEC study from 2005 that highlighted potential conflicts of interest facing investment consultants, and their failure to disclose them. Despite these problems, it is still possible that investment consultants provide a net benefit to their clients (which are often the taxpayers of a state or municipality), and that is the question explored by the authors.

Their primary source of data was a survey of investment consultants’ recommendations of U.S. long-only (i.e. excluding hedge funds) actively managed equity products conducted by Greenwich Associates. They examined 20,950 recommendations from 29 firms representing 91% of the $13 trillion U.S. pension consulting market made over a thirteen year period from 1999 to 2011. They measured the one-year returns of each fund for the year after it was recommended. If a fund was recommended in multiple years, then each of those years was included in the returns. While the net return of an equally-weighted portfolio of recommended funds was 6.31%, the portfolio of non-recommended funds got a 7.43% return, and the 1.12% difference was found to be statistically significant at a 95% confidence level. The table below summarizes the results:

The difference persisted even after returns were shown net of benchmarks or adjusted for exposure to risk via a three-factor or four-factor model. On a value-weighted basis, the adjusted returns for the recommended funds were higher, but the results were not statistically significant.

To summarize, we find this study to be completely consistent with past studies of the performance of institutional investors such as the ones discussed in this article. We hope that it will influence decision-making, especially for public pension plans in which all of us have a stake.

1Jenkinson, Tim and Jones, Howard and Martinez, Jose Vicente, “Picking Winners? Investment Consultants' Recommendations of Fund Managers” (September 26, 2014). Available at SSRN: