Good advice is valuable in the investment business. But can it actually be measured? Suggestions stemming from the Myners Report that advice given by investment consultants should be formally measured have provoked some cooperative but questioning responses from the industry.
While it is easy to show in numerical terms – at least with hindsight – how successful an investment fund is, advice is trickier to assess, consultants say.
Paul Myners, chairman of UK investment group Gartmore, has pointed out that advice given by investment consultants is hardly evaluated at all. In his report for the government into institutional investment, he says: “There is surprisingly little assessment or measurement of the impact and effectiveness of investment consulting advice, either on asset allocation or manager selection. This is a problem in its own right, but also goes some way towards explaining the current industry structure.”
An important factor driving the structure of the investment consulting industry, says Myners, is that pension funds commit a low level of resources to asset allocation.
“It is difficult to persuade trustees that they should spend more and make use of a wider range of investment consulting advice if they have no means of assessing its effectiveness,” he says.
Consultants do not deny that there is a place for objective evaluation of the service they provide. “I don’t think anyone in the investment consultancy business can have any objection to having their performance measured,” says Michael Robarts, associate at Bacon & Woodrow. “If an adviser is shy of that then he really shouldn’t be in the business.”
Others agree. Andrew Green, head of investment strategy at William M Mercer, says: “It is important that trustees should be able to evaluate the performance of any of their advisers or the delegated organisations they use, as indeed they should be able to measure themselves.”
But what form this evaluation should take is an issue for debate. The complexity lies in how you define performance, says Green. The service offered by fund managers is relatively measurable, at least retrospectively. Maximising returns within a particular investment brief is the basic game, and relative success is easy to see.
On the other hand, the service offered by consultants is a few steps removed from the end result achieved by their clients.
For a start, consultants simply offer advice to their clients rather than making the decision themselves. Trustees may find themselves with a range of options set out by their consultant, and ultimately the investment returns they win will depend on which option the trustees decide to go with.
Also, says Green, consultants’ advice is often formed around risk reduction rather than simply chasing the highest investment returns. “Every pension fund adviser is trying to devise a structure which meets the liabilities, therefore a big part of it is about risk control,” says Robarts. “It’s not as easy to measure risk control as opposed to absolute performance either prospectively or retrospectively,” he says.
The fundamental decision between equity-related and bond-related investments is likely to have more of an impact on the fund’s returns than which manager it selects, says Green. “How do you measure the service if you’ve assisted a client in controlling risk, if you haven’t increased returns?”
It is also vital that clients and consultants are clear about what it was they were trying to achieve at the start when they set about assessing results later on. A lower risk strategy, for example, needs to be judged in the context of other low risk strategies.
The WM Company already has a product up and running which can give pension funds information on the effectiveness of investment recommendations made by consultants.
Within each investment category, such as UK equity, consultants are asked to say which fund managers they are recommending. The performance of the group of typically between three and 13 managers recommended by the consultant is then measured over the following quarter and assessed relative to the index.
The reverse is also assessed, with consultants stating who they are recommending as a sell. “We give the consultants the chance to review their decision at the end of the quarter,” says Peter Warrington, executive director of the WM Company. But in practice, he says, consultants do not change their recommendations very often, perhaps removing only one manager every two years out of a list of 10.
“Over a period of time, the idea is that had you followed the recommendations of a certain consultant, you would be 2% better off,” he says.
The system deals with some concerns from investment consultants that they should not be judged by the investment performance of their clients, since it is the trustees who make the actual decisions, and they simply make recommendations.
WM’s system measures the recommendations from the consultants, thereby shutting out the impact of the trustee decisions, says Warrington.
WM also measures asset allocation advice given by consultants. Although the equity bond split recommended is a risk control decision, anything below this is an investment decision and should be measured on that score, he says.
“Any consultant that advises you as a result of a study that you should have a certain percentage of your fund in US equities (rather than equities as a whole) is making an investment decision,” says Warrington.
The only way to measure this type of decision is to compare them against each other. “In that respect, we say peer group is still required,” he says.
Warrington agrees with Myners that there is a need for asset allocation recommendations to be measured. “The subjective judgement that goes into making benchmarks isn’t subjected to the rigorous analysis of comparison with competitors,” he says.
If a pension fund is forgoing returns for the sake of risk reduction, the trustees need to be aware of the level of returns they are giving up, he says. The lost returns are in effect an insurance premium that protects them, but the cost of this return is often not being pointed out to the trustees, he says.
“You have to make sure all these asset allocation decisions are measured, and the consultants have to be accountable,” he says.
Tony Pryce, manager of investment at the National Association of Pension Funds, says the association set up a working party to look into judging the service provided by investment consultants. This coincided with the Myners Report.
“What became clear very early on is that it is easier said than done,” he says. “Investment consultants provide a wide range of services – some can be measured, but with others this is not so easy.”
As a result of the research, the NAPF has produced a publication – “The Trustee/ Asset Consultant Relationship: a guide to good practice” – to help trustees understand how to assess the service they get from consultants .
It is possible to measure whether a consultant’s investment advice has caused a fund to lose or gain more or less than other funds, he says. But much of the service can only be judged subjectively. The consultant may be making suggestions or educating trustees, for example.
“Here it’s about personality and style,” says Pryce. “It’s the way they present the information, how they explain it and whether they have created a feel-good factor. That’s a decision for the trustees to make.”
Robarts agrees that what makes a consultant right for a client comes down to trust. Pension funds and other clients are able to make judgements about their consultants. They can — and do – vote with their feet, he says. “It may be that the chemistry just isn’t right or the way the advice was given.”
But, in general, pension fund trustees should assess their consultant in a more systematic way. Bacon & Woodrow suggests clients ask themselves a series of questions about advisers and their influence and impact.
Robarts says: “We think the best approach is for clients to list the decisions they have taken where an adviser was influential. They should then evaluate the impact of each decision and go on to consider how helpful the advice was in reaching it. This implies a mix of qualitative and quantitative judgements by the client.”
Myners makes the point that the investment consultancy industry is dominated by the big four players – Watson Wyatt, William Mercer, Bacon & Woodrow and Hymans Robertson. These firms hold at least 70% of the market in investment consulting, his report says.
And there are low levels of customer switching. The report says the review was told that actual switching between providers by pension funds is infrequent, with many funds retaining the same firm for 20 years or more.
But the fact remains that there are alternatives, should clients be dissatisfied with their consultant. “It’s certainly not the case that we’re the only show in town,” says Robarts.
Like the major consultancies, Watson Wyatt agrees with Myners that the quality of investment consultants’ advice should be measured. But it does not believe there should be a prescribed way in which that assessment is made.
“For trustees to measure the success of consulting advice, consultants need to conduct many more assessments of the value (incorporating risk reduction) of their advice. We do not regard it as constructive to prescribe the form of these performance proof statements. Each should reflect the context of the advice or deliverable,” says Watson Wyatt in its official response to the report.
Where consultants are operating in ‘implemented consulting’ areas, objective measurement can be carried out, it says. But it is harder to measure performance if the service given is advice, because in many cases the subsequent performance of the fund does not exactly reflect the advice given.
“In such situations, consultants need to be measured on the quality of their inputs in more general than specific terms,” the firm says.