Can schemes still justify active management?
The average active fund manager cannot outperform their benchmark net of fees, and according to the Competition and Markets Authority, the average investment consultant cannot reliably identify those managers who do. Can an average trustee board reasonably keep the faith in active management?
The latest findings from the competition watchdog’s ongoing investigation into investment consultancy are damning on asset manager product recommendations.
There is no evidence to date that products that are ‘buy-rated’ by consultants outperform either their respective benchmarks or unrated products “to a statistically significant extent” on average net of manager fees, the report stated.
What they need to do is put out there some of the evidence as to whether they’re any good at their job
The CMA acknowledged that manager recommendation only forms part of the service provided by investment consultants, but nonetheless pointed out that it “is an area which potentially adds value and can reasonably be measured, and where claims are commonly made”.
Still no evidence of outperformance
Expanding on the analysis undertaken by the Financial Conduct Authority for its asset management market study, the CMA carried out its own work looking at recommendations made by consultancies Aon, Capita, Hymans Robertson, Redington, Russell Investments, Willis Towers Watson, KPMG and LCP.
Despite making a number of adjustments to the methodology used by the FCA, the overall results proved similar. Not one consultancy in the sample had buy ratings that outperformed on average on a net-of-fees basis.
Across the sample, consultant buy recommendations delivered average active returns relative to the benchmark, or outperformance, of 0.23 per cent per quarter, a figure the CMA called statistically significant.
However, after fees were deducted, this outperformance ceased to be statistically significant. Relative to unrated products, outperformance was not statistically significant even before fees.
Buy and sell recommendations from different consultancies rarely overlapped one another, meaning the best-performing funds could not have been consistently picked by most consultants.
Industry still split on alpha
The results stood in contrast to the claims of outperformance made in marketing materials seen by the CMA, which commonly said recommendations outperformed by between 1 and 2 per cent annually.
“I think the industry needs to be clearer with its clients about what it is selling them and the promises it is making," said Patrick McCoy, head of investment consulting at consultancy Xafinity Punter Southall.
“A lot of providers in the industry have been very optimistic, in selling stuff to clients, about what they can expect.”
He attributed part of the problem to consultants continuing to place their faith in active managers operating in liquid, efficient markets.
“In the long run that is very difficult to achieve, because these funds are generally quite expensive... anyone selling that story to their clients is probably going to disappoint them in the long run,” said McCoy.
He recommended that schemes only pursue active management in asset classes where credible passive options do not exist and focus on allocation.
“The biggest thing that drives outcomes is strategic asset allocation and risk management,” agreed Dan Mikulskis, managing director of defined benefit pensions at Redington, but added that manager selection was still an important “second order” function.
“Good performing managers can contribute to investment outcomes,” he maintained.
Consultants must argue their case
If investment consultants should moderate their claims of outperformance, there will always be a role for consultants providing manager recommendations, said Andy Cheseldine, client director at trustee company Capital Cranfield.
“Someone has got to do the check on whether someone is a complete fly-by-night investment manager,” he said.
There are financial reasons for not being more humble about recommendations. “What they’re claiming is added value, and therefore you can charge more money for it,” said Cheseldine.
As for improvements to the system, Cheseldine said improved transparency was essential, and that despite misgivings about the lack of consideration for risk control in the CMA report, it was now up to consultants to prove their worth.
“What they need to do is put out there some of the evidence as to whether they’re any good at their job. I think some of them will be and some of them will have been at some stage... some of them won’t have the track record,” he said.
However, McCoy doubted that this would achieve a significant improvement. A more robust remedy would see the conflicts inherent in vertically integrated consultancies dissolved, by splitting up advisory and fiduciary management businesses.
“Some of the fiduciary managers in the big three, they think it would be better if they were isolated businesses,” he claimed.