When hiring consultants, asset owners aren’t necessarily in search of improved investment performance.
Instead, they’re looking for strong performance reporting, fiduciary compliance help, and softer skills like a consultant’s ability to educate the allocator’s staff and board.
Stephen Nesbitt, CEO at Cliffwater Research, said there’s always been questions out there about the value of a consultant. In other words, “Are some consultants better than other consultants?” he said.
In an attempt to partially answer that question, Nesbitt and his team recently published a study that did not include consultants that act as outsourced chief investment officers. Among consultants hired strictly as advisors the report claimed that none of the firms it analyzed had any effect on investment performance. For many allocators, it doesn’t really matter whether one consultant is associated with higher returns than another — even if some consultants believe otherwise.
Historically, allocators have tapped consultants for many reasons, including the vetting of external managers and the establishment of benchmarks. More recently, they've hired consultants as OCIOs to manage all or part of their portfolios — and where measuring investment performance would be more critical.
Many of the major investment consulting firms offer OCIO options and non-discretionary services, which involves offering advice without investing on a fund’s behalf. Mercer is one example. “Outperformance is frequently a primary objective when seeking investment guidance and particularly when establishing an OCIO relationship,” said a spokesperson for the firm.
According to Nesbitt, it’s not really possible for non-discretionary consultants to attribute a fund’s performance to their work though. After all, it’s just advice.
But that hasn’t stopped some from trying. Callan’s chief executive officer Greg Allen said that certain peer consultants have created composites of their non-discretionary clients’ performance, then compared that to benchmarks.
“My issue with all of that is there are no rules,” Allen said. “[I]t gets so messy that I think there’s a lot of room for gaming the system.”
There are plenty of other reasons to hire a consultant anyway. And consultants who aren’t acting as OCIOs likely aid performance in indirect, hard-to-measure ways by freeing up the investment team to focus on the investments.
But one allocator, who asked for anonymity, said most public funds would never say they hire one consultant over another to generate better performance. “It's more like, which will give us better reporting or due diligence support.”
Sam Masoudi, the CIO for the Wyoming Retirement System, agreed.
“Some of the value of consultants is being defensive and protective,” Masoudi said. “They can help boards fulfill their fiduciary duties.”
Allen said that consultants can help preserve the history of an institution in terms of its structure and strategy. Boards and investment staff members turn over quite regularly, and according to Allen, it’s not uncommon for a long-serving consultant to have studied the fund’s “archaeology” in depth. He said that consultants help by “keeping clients from doing crazy things because they understand the structure.”
Nesbitt added that some board trustees don’t have investment backgrounds. Consultants can help to teach these board members about investment issues and assure them that the fund is moving in the right direction.
Consultants do a sizable amount of work on performance reporting, according to Masoudi.
“In general, they’re just critical as third-party analysts who calculate and evaluate performance and provide feedback to the board,” Masoudi said. Another key characteristic? Calculating the performance in a timely way with a very small error rate.
“Performance calculations are so nuanced,” Masoudi said. “It can be very complicated.”
Manager databases that consultants support also play an important role in how they work with public funds. A consulting firm’s research team meets with investment managers and tracks everything from portfolio holdings to employee attrition over time. This all goes into a database, which clients can access, either directly or through the consulting firm itself.
Consultants may also partner with outside providers like eVestment to augment their offerings. While it still may not be one-stop shopping, it’s often more comprehensive than a small public fund’s staff can manage on its own.
Masoudi said that his team does much of its manager sourcing internally. When the team comes up with a potential investment, the staff may then turn to the consultant for more data on the managers on the shortlist.
“Consultants are helpful with doing some analysis on a peer set we may invest in,” he said.
According to Masoudi, when the Wyoming Retirement System hires a new consultant, it looks to see whether that organization works with state public pension plans that are similar to the $7.8 billion fund he and his team manage.
“We’ll face issues that are unique relative to endowments and foundations, and private plans,” he said. “It's important that they understand the stakeholders and the politics we deal with.”
Masoudi’s team also considers a consultant’s client load. In an RFP process the fund went through a few years ago, the plan assessed a consulting firm that was covering 20 different funds. “We didn’t know if we’d get the service we were looking for,” Masoudi said.
“With consulting firms today, particularly general consultants, if they can’t differentiate on performance, it basically comes down to client service,” Nesbitt said. “It’s about who has the resources to deliver to wherever they’re pitching the business.”