Evaluating performance

Evangelism is in short supply in
the pensions industry. So it is
refreshing to find odd voices
that are full of belief. Two such belong
to Kevin Sime and Roger Brown of
Blacket Research in Edinburgh.
Blacket is an independent business
seeking ways to evaluate the advice
given by investment consultants and
the decisions implemented by their
clients, the boards of occupational
pension funds.
“We think we’re fighting a good
cause,” says Sime. He believes that
evaluation fulfils a gap identified by
the Myners Review of institutional
investing in the UK. Myners wrote:
“The review finds it surprising, given
the effort devoted to analysing the
performance of fund managers, that
investment consultants have undertaken
so little statistical work to demonstrate
their ability to add value
through manager selection.”
Blacket is seeking to achieve this
aim with a number of offerings. Its
manager selection evaluation service
scrutinises two separate decisions:
the shortlist drawn up by an investment
consultancy for a particular
mandate and the actual pick from
that shortlist by the fund’s board.
This service covers only those asset
classes for which plentiful public, verifiable
data exist, and so not private
equity or hedge funds.
Its manager selection evaluation
compares the risk and return characteristics
of all the short-listed managers
against a relevant universe of
other managers; the same characteristics
of solely the successful manager
are compared against the unsuccessful
short-listed candidates.
The former provides one kind of
judgment on the investment consultancy’s
recommendations while the
latter provides one kind of judgment
on the board’s choice. The judgments
can be made over various periods.
Brown wants to expand the service
by gathering together all the shortlists
recommended by consultancies
and comparing them with all the
equivalent permutations from a universe
of same-asset-class managers.
He says that universes for the likes of
global equities would be created by
congregating all the GIPS-compliant
managers with a suitable institutional
investment product.
The philosophy is that consultancies
have the capability to select any
suitable GIPS-compliant manager
and therefore it is fair to judge their
choices within this pool.
Brown says he was shocked by preliminary
research which showed that
some consultancies were delivering
recommendations in the bottom
decile. He qualifies the revelation
with notice that the research is incomplete.
And herein lies one of several
problems facing this small research
company. The workings of pension
funds are opaque and unless consultants
and boards of trustees release
data on shortlists, Blacket will not
succeed in creating a full universe.
Brown admits that as its kind of service
could hurt the model of the larger
consultancies and the relationships
they enjoy with fund clients, there is
no evident alignment of motive with
Then there is the tricky issue of attribution.
At one extreme, odd cases fly
around of consultants’ recommended
shortlists that appear to the client as
no more than a list of asset managers
with no further explanation. It is
such generic lists that Blacket wants
to capture in its universe. At the
other extreme lie contributions, welcome
or otherwise, by pension fund
executives and trustee boards at the
shortlist stage. The issue is troublesome
for the likes of Blacket because
it is neither pure nor fair to attribute
such ‘joint efforts’ solely to the consultancy.
Attempting an overarching, general
analysis appears doomed. Even
in a consultant-led market like the
UK, there is no standard for a shortlist.
If even each consultancy stuck to
a fixed number of recommendations
– four, five or six – then at least some
uniformity of evaluation would be
possible. But there is no such custom
and furthermore, as Brown himself
acknowledges, boards and pension
managers are prepared to add or subtract
from shortlists.
Whatever the evolution of Blacket’s
business model, it is not true
that investment consultancies have
ignored the findings of the Myners
Review. They are most supportive of
the recommendations that pension
funds should be prepared to pay sufficient
fees for each service to attract a
broad range of kinds of potential provider;
and that fees devoted to asset
allocation should properly reflect the
contribution it can make to investment
performance [see next article
on managing_money].
On the matter of accountability,
some consultancies began efforts
before the Myners Review appeared.
First perhaps were Watson Wyatt’s
model portfolios, which give results
for a matrix of 13 major asset classes,
regions and classifications, including
property and currency management.
The model portfolios comprise
returns from a number of underlying
managers so they are in effect a
manager-of-managers format. The
latest figures available, to the end of
2004, give a five-year track record in
which only emerging market equities
has underperformed its relative
benchmark, although this is only
after fees and transition costs have
been subtracted. Watson Wyatt has
factored these in as part of a convincing
replication of the frictions costs
which would have occurred had the
notional accounts transferred real
money between underlying managers
as they fell in and out of favour.
Worthy of note is an outperformance
of 2.7% in US equities of the benchmark
S&P 500, with an information
ratio of 0.7; and global government
bonds with an outperformance of 1%
with an information ratio of 1.2.
Sime of Blacket acknowledges that
these portfolios are a step in the right
direction in terms of accountability
but argues that they are generic
and not specific advice. This criticism
seems out of place given that
Blacket wishes to assemble a whole
host of manager recommendations,
stripped of any relativity to particular
schemes, in order to benchmark them
against every equivalent permutation
in a very large universe.
Indeed, it may be only journalists
who wish to know the aggregate
shortlist scores of consultants. Given
the barriers their usefulness may be as
limited as snapshot figures of the deficits
of a universe of pension schemes.
None of the constituents will care
much about each other’s situation.
Hewitt in the UK has developed a
form of performance measurement
which neatly aligns its worth as a
consultant with the health of client
schemes’ ratio of assets to liabilities.
This is not for all. But for those
who want it, there are three options,
according to head of UK investment
consulting Andrew Tunningley.
The first ties half the annual fee to
an improvement of the ratio of assets
to liabilities. The second is a more
modest proportion while the third is
“highly geared”, he says.
Given the volatility of UK pension
funding levels in recent months, it
seems Hewitt is making a bold statement
with all three options. Tunningley
points out that alignment with
the clients’ interest is surely a good
thing. “Everyone seems to accept
performance-related fees for asset
managers,” he points out. Moreover,
by tying the fee to the ultimate
benchmark of liabilities, Hewitt has
to make sound holistic recommendations
on markets and the interaction
of liabilities and assets.
Perhaps liability-related fees will
make evangelists of all investment

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