At the end of every quarter, in thousands of offices across America, an elaborate charade takes places. Members of the investment committee of pension plans, trusts and 401(k) plans meet with highly paid consultants. They review the performance of the fund managers who are managing assets in their plan. They drop poorly performing funds and select replacements with stellar recent track records. In making these choices, they often rely on the recommendation of their consultants, who dazzle them with charts and graphs supporting their selections. This ritual is repeated endlessly. I am sure the participants believe they are doing something of value.
But are they? Not according to a report authored by three professors at the University of Oxford’s Saïd Business School entitled “Picking Winners? Investment Consultants’ Recommendations of Fund Managers.”
The authors note that, by some estimates, 82 percent of public plan sponsors and 50 percent of corporate sponsors use investment consultants. These consultants advise on more than $13 trillion of tax-exempt assets. Surely, they must be the best and the brightest, adding immeasurable value that more than makes up for their hefty fees.
The study reached a contrary conclusion. It reviewed 13 years of data reflecting recommendations of U.S. stock funds from 1998-2011. It aggregated the recommendations of all the consultants surveyed because data on individual recommendations is not available. It used data on the actual performance of the products rated by consultants, their relevant benchmarks and the capital allocated to each fund.
Its conclusion is stunning: “We find no evidence that consultants’ recommendations add value to plan sponsors.” In fact, on an equal-weighted basis “the performance of recommended funds is significantly worse than that of non-recommended funds.”
The authors find it puzzling that plan sponsors “follow consultants’ recommendations when they are apparently not rewarded for doing so.”
The ramifications of this study are profound. If the best and brightest investment consultants are unable to pick fund “winners,” how likely is it that your local broker or adviser will do any better?
Participants in 401(k) plans that are being advised by consultants should ask the plan sponsor to demonstrate how these consultants are adding value. One study concluded that the mutual funds selected by plan sponsors for inclusion in 401(k) plans (often based on the recommendations of their consultants) were “worse than comparable indexes but superior to the returns of comparable, randomly selected funds.”
Here’s the bottom line:
The investment options in retirement plans can — and should — be materially improved if consultants to the plans charged with this responsibility were fired. In their place, plan sponsors should include only a limited number of globally diversified, risk-adjusted portfolios, consisting solely of low-management-fee index funds, passively managed funds or exchange-traded funds.
Let’s stop the charade and eliminate the gravy train at the same time.
This commentary appeared October 08 on Dan’s blog at HuffingtonPost.com
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