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I always thought that when I finally hung it up on journalism I would go into business providing financial advice to criminals. The more I wrote about them, the more I could see the need. (Memo to celebrities trying to get kids into college: No, do not try to deduct illegal bribes on your tax return. The IRS won’t like it.)
But I’m starting to see a lucrative alternative that runs less risk of getting an awkward visit from the FBI: Pension plan “consultant.”
I first encountered these characters back in 2012, when I wrote a profile for Smart Money magazine about the young Salt Lake City-based investment genius Allan Mecham. He had been beating the stock market by a wide margin year after year. But he couldn’t get approved or recommended by pension plan consultants. Instead, he said, they kept turning him down for their clients—before asking if they could invest in his fund themselves.
You couldn’t make it up.
There’s a fortune to be made latching on to the $37 trillion fund industry as a “consultant.” And it appears that you don’t need to have any skill. If new research is accurate, it might even be a hindrance.
Investment managers hired by pension funds, endowments, foundations, and sovereign-wealth funds are actually likely to perform worse than their competitors by nearly a full percentage point a year over the next three years, according to a new study conducted by Amit Goyal of the University of Lausanne, Sunil Wahal of Arizona State University and M. Deniz Yavuz of Purdue University. The underperformance was 0.85 percentage points a year, and the study found a reasonable degree of statistical significance.
“At the minimum,” they add dryly, “these results suggest plan sponsors have no discernible selection ability.”
Some of this may be due to the old school tie, alumni affects and so on. Using data from Relationship Science, a database that measures professional relationships, they found that investment managers with connections to plan managers or consultants are between 15% and 30% more likely to be hired by the fund than managers without connections.
You might think there was some logic to that. After all, the people running these funds, or their consultants, might use their connections and personal knowledge to hire money managers they believe to be really good, right?
Dream on. The connected money managers ended up doing worse over the next three years than their non-connected, non-hired competitors by an average of 1.12% a year. “Plan sponsor connections to investment managers generate worse return outcomes,” the researchers conclude.
It’s not completely irrational. Although pension plan sponsors and consultants are likely to hire investment managers they know, they do typically hire investment managers who have recently beaten their benchmarks. But they’re not picking managers who have a proven ability to keep beating their benchmarks. They’re either hiring those who’ve just had a lucky streak, or they’re seizing on that brief window of opportunity to throw some work to their pals.
The work that went into this research is impressive. The researchers studied around 7,000 investment hiring decisions made by more than 2,000 plan sponsors between 2002 and 2017, involving $1.6 trillion in funds and 775 unique investment managers. In each case they compared the subsequent performance of the hired funds to competitors who offered comparable investment products in the same geographic region, style and year.
The more endowments have diversified into “alternative” and exotic asset classes, the more they have left themselves at the mercy of these consultants and subpar investment managers. No wonder data now show that endowments overall have been underperforming a basic passive portfolio for at least a decade.
