We all know that trustees should assess the performance and value for money provided by their investment consultants – the real question is how to achieve this, says CEM Benchmarking's Tej Dosanjh.
It is simple to measure asset managers where performance is directly related to cost, but trickier with advice; you have to more fully understand the background, market context and role of the advisor.
It is more problematic to measure consultant performance than that of fund managers, but that does not mean we should not try
In the UK, investment advisors became prominent during the early 2000s, when the Pensions Regulator recommended pension funds use investment management to better govern members’ money.
Coupled with the emerging crisis of underfunded defined benefit plans this was a perfect opportunity for existing advisory firms, acting as scheme actuaries in the UK market, to broaden their service lines and offer investment advice.
Key players moved swiftly and are now well established – but what should they be adding to the schemes they work with?
Identify key adviser skills
Defining the investment strategy and recommending the strategic asset allocation is the most critical deliverable.
This should help the fund understand its journey-plan to reach full funding. It can be measured in the context of the advice provided, and quarterly board meetings should focus on it.
Selecting asset classes with the right balance of return-seeking and liability-matching qualities is the next layer of advice.
The building blocks of the portfolio would typically be implemented by external managers. This gives rise to another function of consultants: the all-important manager selection advice.
Given the potentially lucrative size of mandates awarded, advice in this area should be measured. Trustees may find substantial quantities of underpinning data to help them with this.
Consultants hide behind advice label
Most critically, there is the monitoring role. Advisors typically produce pages of graphs, tables, narrative and context, all of which describes the fund’s performance but not the advice given.
Measuring investment advice is implicit but should be explicit. The word advice is unfortunately often used as a ‘get-out’ clause – the investment advisor will offer solutions, but ultimately it is down to the trustees to make the decisions and take ownership.
Most investment advice is based on data modelling of the probability of asset class performance over a period of time. The investment time horizon is fundamental to the strategic recommendations.
Returns and strategy should be assessed over the long term to look past market volatility, and as with a zero-sum game there will be winners and losers.
Schemes may be able to judge whether their advisor makes the right predictions more often than others by backtesting data over the life of the client relationship, allowing them to see if there is a correlation with fund performance. However, this is tricky.
Other factors come into play such as pension fund governance, the quality of internal skill and the ability of selected managers to implement strategies. It is not as straightforward as it seems.
Answering key questions
CEM has collected fund cost data for 25 years, and from our global database we have found that the average cost for fund governance, operations and support is 4.6 basis points. Of this, consulting and performance measurement account for 1bp.
It is perfectly reasonable to ask what the return on this is; it is more problematic to measure consultant performance than that of fund managers, but that does not mean we should not try.
Trustees should start by asking some serious questions of their advisors. With many boards better skilled in investment management than they were previously, they might first ask whether they still need an advisor?
Next they should ask how their advisor compares with others in the peer group and whether their support is needed through all aspects of the investment process.
Certainly, schemes should be aware of any conflicts of interest between the scheme actuary, investment advisor and fiduciary manager. A more radical proposal still might be to rotate advisors, as is prescribed for clients of the so-called big four accounting and audit firms.
Tej Dosanjh is a director at CEM Benchmarking
