Asset consultants are a key part of the investment chain, providing small funds with services that include decision making processes and strategic asset allocation, and for larger funds traditionally playing a key role in manager and strategy selection. But a study by Gordon Clark and Ashby Monk, which is part of a broader look by the academics in to the changing relationships between asset owners and managers, shows that the relationship between consultants and asset owners is “characterised by ambiguity”.

The authors suggest that more clarity, particularly for the services used by large funds will benefit both parties.

The paper, The contested role of investment consultants: ambiguity, contract, and innovation in financial institutions, sits in the context of the big industry changes of insourcing and re-intermediation of the relationship between managers and owners.

The paper sketches out, or explains what consultants do, with Gordon Clark, professor and director of the Smith School of Enterprise and the Environment, University of Oxford, saying there is a lot of misunderstanding of what they do.

“A lot of people don’t understand what consultants do – academics, critics of the funds management industry, governments all lack understanding,” he says.

“Consultants get bad press, we don’t particularly criticise and we think some criticism is wrong-headed and that some empirical papers are also a far stretch in conceptualising the relationship and effect or lack of it.”

The authors look at the different use of consultants by small, medium and large asset owners, using size as a proxy for resources.

With small funds consultants largely undertake an administrative role of investment decision making, and the process is just as important as the outcome, because there is alack of resources or capability for the fund to do it themselves.

“For small funds the relationship with the consultant is about the process of decision making and choices but is weighted towards the processes not the choices of investment options themselves,” Clark says.

“Asset owners which recognise their reliance on consultants for this process may look to fiduciary management as an obvious way out. Consortium or pooling is a very good idea, but effective platforms for pooling are hard to find – mostly due to governance issues.”

Large asset owners, on the other hand, have historically outsourced investments to a manager and have relied on the consultants as part of that process. The relationship between large funds and consultants is more equitable, and the fund is less reliant on the consultant for process and more for the opportunity set. It’s a more level playing field for knowledge.

But with insourcing, the choice of investment strategy and supplier – a role that the consultant assisted with – has becomes internalised.

“In the paper we say as insourcing is increasing it raises the questions as to the role of the asset consultant and who should they report to?” he asks.

“Internal teams do need to be monitored and accountable, but consultants shouldn’t do that. We are watching the process of building teams and organisations, some people are skilled at doing that. A time will come when others, who may have skills in running those teams will do it. The board needs to be more adept at managing this – more sophisticated.”

The authors say it’s not appropriate for a consultant to be a critic or adviser to the board on what the internal team is doing because it second guesses the team and could possibly generate an us and them culture.”

With the advent of internal investment management, the consultant is no longer serving the board of a pension fund, but the internal team

“With that in mind the consultant has to bring something special, either a high level of expertise in a particular sector of the market or insight that is not available or too expensive for the internal team to do itself,” Clark says.

“The most sophisticated asset consultants have a tendency to fill that new brief, but a lot of consultants are at a loss, what’s our value add? There is a premium on the major consultants to deepen their skill base and become more expert. Where their roles of managing the process and making a choice of manager is no longer required, then roles will need more explicit contacts, and it will outline what is the specific value add.”

Clark says large asset consulting firms have tended to be decentralised, but as large funds are requesting more specific skills from consultants they will need to pool ideas internally across the globe.

“Internationalisation of investments is here to stay and consultants could play a key role in using their expertise, but they will need to move away from their practice of servicing client by client and region by region.”

 

 

US public pension funds, on average, have around 9.4 per cent allocated to private equity but for many public funds monitoring the firms that manage these investments – including the transparency of underlying investments, fees, performance and benchmarking – as well justifying these investments to boards and stakeholders, takes up more than 10 per cent of their time.

Broadly speaking, one of the problems is gauging whether private equity firms are doing what they say they are doing and how to use comparable metrics to assess private equity investments with the other investments in a portfolio. Now, with the help of some new academic analysis from Chicago Booth and Harvard, investors can gain a greater insight into what private equity firms say and think they do.

Steve Kaplan, the Neubauer Family Distinguished Service Professor of Entrepreneurship and Finance at the University of Chicago Booth School of Business, along with his colleagues from Harvard, Paul Gompers and Vladimir Mukharlyamov, examine “what private equity firms say they do”.

The authors survey 79 private equity investors with combined assets of more than $750 billion about their practices in firm valuation, capital structure, governance, and value creation.

The research finds some differences between the practices of the private equity firms and the LPs which invest in the funds.

One of the findings is that private equity investors believe that absolute, not relative performance is most important to their LP investors.

“The focus on absolute performance is notable given the intense focus on relative performance or alphas for public market investments,” the paper says. “There are two possible explanations for this. First, LPs, particularly pension funds, may focus on absolute returns because their liabilities are absolute. Alternatively, the chief investment officers of the LPs choose a private equity allocation based on relative performance, but the professionals who make the investment decisions care about absolute performance or performance relative to other PE firms. We believe that the advent of greater dissemination of risk-based performance benchmarks like PMEs is likely to affect the view of limited partners and potentially trickle back down to the private equity general partners.”

Public market equivalents (PMEs) try to deconstruct alpha indirectly by comparing it with the return of a related public market benchmark. They try to evaluate the value of a private equity investment by assessing its opportunity cost against investing in other available vehicles or investments.

The authors also find that private equity investors anticipate adding value to portfolio companies, with a greater focus on increasing growth than on reducing costs.

They also explore the difference between firms and how the actions that private equity managers say they take group into specific firm strategies which are related to firm founder characteristics.

The paper looks at exploratory analyses to consider how financial, governance and operational engineering practices vary within PE firms.

“The analyses suggest that different firms take very different strategies. For example, some focus much more heavily on operational engineering while others rely heavily on replacing incumbent management. These investment strategies are strongly influenced by the career histories of the private equity firm founders. It will be interesting (and, with these data, possible) to see which of these strategies, if any, exhibit superior performance in the future.:”

 

 

Steve Kaplan will address delegates at the Fiduciary Investors Symposium at the University of Chicago Booth School of Business

He is the Neubauer Family Distinguished Service Professor of Entrepreneurship and Finance at the University of Chicago Booth School of Business, and co-founded the entrepreneurship program at Booth.

Although most factor research focuses on the equity market, the concept and benefits of factor investing apply equally well to the corporate bond market. A smart way of investing is combining the factors into a multi-factor credit portfolio in order to diversify across factors. A multi-factor portfolio retains the high Sharpe ratio of the individual factors, but with smaller drawdowns and lower tracking error versus the market. Moreover, in a multi-asset portfolio, corporate bond factors also add value, beyond the equity factors. Read more about this white paper.

Ethics and finance will top and tail the program at the Fiduciary Investors Symposium to be held at Chicago Booth School of Business, from October 18-20, highlighting the fact that as asset owners get larger and employ more staff they need to be clear on their own internal ethics and responsibilities.

One of the world’s leading thinkers and authors on ethics Peter Singer, Ira W. DeCamp Professor of Bioethics at the University Center for Human Values at Princeton University, will set the scene for the conference discussing the ethical responsibilities involved in investment decisions. He will focus on the implications for climate change and global poverty in particular, helping to frame what it means to be a fiduciary investor.

The Fiduciary Investors Symposium brings together global investors to examine the management of fiduciary assets in both investment strategy and implementation, including the latest thinking relating to asset allocation, risk management, beta management and alpha generation.

A big part of the event is examining the responsibilities of managing fiduciary capital and has become recognised as an event that challenges the influence and responsibility of fiduciary management.

The conference will examine integrity and ethics in the investment industry drawing on the experience of Ronald D Peyton, chairman and chief executive of Callan Associates and chair of the CFA Institute Asset Manager Code of Professional Conduct Advisory Committee. Peyton will speak alongside AustralianSuper chief investment officer, Mark Delaney, about the ethics in the context of investment manager relationships and the fact that as asset owners get larger and employ more staff they need to be clear on their own internal ethics and responsibilities.

The A$90 billion AustralianSuper has endorsed the CFA’s Asset Manager Code of Professional Conduct, and Delaney is a member of the committee.

The code outlines the ethical and professional responsibilities of firms that manage assets on behalf of clients and its attempt to get unity of basic standards worldwide.

It enforces the code for all its external managers as a part of a wider set of standards it has created and Delaney says it aligns with the commitment to protect and maximise its members’ retirement outcomes.

AustralianSuper is one of a growing number of asset owners around the globe which holds its managers to account on values and ethics.

The $60 billion Massachusetts Pension Reserves Investment Management Board which has nearly 300 investment manager relationships, holds those managers to account, quizzing them on values and ethics as part of the due diligence process.

The idea is the CFA code of manager conduct sits alongside the more quantitative GIPS reporting standards that are used almost universally now by managers.

CFA Asset Manager Code of Conduct:

  1. Act in a professional and ethical manner at all times.
  2. Act for the benefit of clients.
  3. Act with independence and objectivity.
  4. Act with skill, competence, and diligence.
  5. Communicate with clients in a timely and accurate manner.
  6. Uphold the applicable rules governing capital markets.

 

If you are an asset owner and are interested in being part of the event, contact amanda.white@top1000funds.com or visit www.fiduciaryinvestors.com

One of the key ways that institutional investors can promote a long-term orientation in the companies they invest, is by rejecting a company’s compensation plan if it puts too much emphasis on short-term results, says Bob Pozen, visiting senior lecturer at the MIT Sloan School of Management.
Writing in the Financial Analysts Journal, he says if institutional investors want companies to take a long-term approach to corporate growth, they should push for three-year performance period for determining cash bonuses.
He says long before any proxy vote fight is in the offering, institutional investors should push for their vision of sustainable long-term growth through engagement with the companies they own. And one of the most important ways to facilitate changing corporate behaviour to be more long-term in orientation is to shift companies away from basing their cash bonuses on only the prior year’s performance.
Another way is for investors to engage in the process of nominating directors with a long-term approach to corporate growth.
“Big owners should act like big owners,” he says. “In that role, institutions should carefully study any proposal’s impact on a company over many years, depending on the type of company and its history of delivering long-term results.”
In the article, Pozen who is the former chairman of MFS Investment Management and is also a senior lecturer at the Harvard Business School as well as a senior fellow at the Brookings Institution, looks at the role of institutional investors in curbing corporate short-termism. He argues that institutional investors are not active in taking an outspoken position for or against activist hedge funds.
“If institutional investors are serious about supporting long-term value creation, they can pursue this goal through various forms of investor engagement with the company. Then, if a hedge fund launches a proxy fight, they should vigorously participate to make sure the outcome promotes corporate growth over the next several years rather than the next few months.”

To access the full article click here

Two Robeco researchers have become the first to analyze the effect that factor premiums can have on corporate bond investing. The work by Patrick Houweling and Jeroen van Zundert aims to show that the factors used successfully in equity market investing can also work in the corporate bond market. Read more about this research study.