Do expert investment consultants advising institutions recommend outperforming funds? In their September 2013 paper entitled “Picking Winners? Investment Consultants’ Recommendations of Fund Managers”, Tim Jenkinson, Howard Jones, and Jose Vicente Martinez analyze survey data to determine what factors drive consultant fund recommendations, what impact their recommendations have on fund flows and how well their recommendations perform. While individual investment consultants do not publicly disclose their recommendations, survey responses allow assessment of aggregate recommendations (a list of top-rated funds) from consultants accounting for over 90% of the U.S. consulting market. To assess recommended fund performance, the authors compare recommended funds to style-matched alternatives based on returns and three-factor (market, size, book-to-market) and four-factor (plus momentum) alphas. They measure performance net of trading frictions but gross of fees of both fund managers and the investment consultants themselves. Using responses from an average 29 investment consultants to annual survey questions on their recommendations of long-only active U.S. equity funds, along with size/performance data for the funds they rate and similar funds, during 1999 through 2011 (13 years), they find that:
- Soft factors (clear decision making, capable portfolio manager and consistent investment philosophy), more than the fund past performance, drive investment consultant recommendations.
- Recommendations significantly affect fund flows.
- Over the entire sample period, an equally weighted portfolio of all funds recommended by investment consultants produces an average annual return before management fees of 7.1% and an average annual four-factor alpha of 1.1%.
- However, on a value-weighted basis, recommended funds do not significantly outperform similar non-recommended funds. On an equal-weighted basis, similar non-recommended funds outperform recommended funds by an average 1% per year.
- Similarly, non-recommended funds produce annual three-factor and four-factor alphas that average 0.86% higher than recommended fund alphas.
- The relatively large size of recommended funds explains their underperformance relative to non-recommended funds.
In summary, evidence does not support belief that expert investment consultants add value in the selection of institutional equity funds, even before their fees.
Cautions regarding findings include:
- The study assumes that survey responses accurately reflect investment consultant fund recommendations.
- A sample period of 13 years is not long for assessment of annual performance.
- As noted in the paper, results are gross of fund manager and investment consultant fees. Both recommended and non-recommended funds impose management fees. Investment consultant fees would debit performance only of recommended funds.
