The Price of Short-Term Advice: Performance Attribution of Investment Advisors using LGPS Data

November 17, 2014 | Posted in The Hidden Cost of Poor Advice | By

Conflicts of Interest Cost LGPS £6.2 Billion Over 10 Years.

In the first ever report of its kind CLERUS analysed Local Government Pension Schemes (LGPS) performance data to quantify the economic benefits of the various investment advisory alternatives used by Schemes. This is the first time it has been possible to provide transparency in this important area, across a well-defined pool of capital with similar long-term objectives. The analysis demonstrates how simple performance measurement and attribution can provide valuable insights which can lead to straightforward improvements to investment governance and performance.

Report Summary:

  • True cost of investment consulting advice to LGPS users is at least 0.5% or £740m per annum This represents a factor of around 50 times the headline fees over the past 10 years
  • Separating providers of actuarial services and investment advice added 0.1% to annual returns
  • Independent advisors have not been able to offset the cost of consultants’ conflicts of interest
  • No significant difference in performance across main consultants measured on annual return or manager selection over past 10 years (all detract value)

This analysis reveals systematic value detraction across portfolios from what are well-flagged conflicts of interest inherent in investment consultants’ business models that are not being effectively managed. This is an unintended consequence of current regulation which helps sustain these high costs to pension funds, because the ‘requirement to take advice’ has taken precedence over the optimisation of performance via a sensible and long-term investment strategy.

CLERUS’ research demonstrates that hiring a consultant to advise or manage investments is not a substitute for good investment governance or for the practical and applied investment expertise required to deliver desired outcomes. Investment recommendations are obviously made with an objective to improve results, but the key to justifying short-term investment activity must come with the requirement to demonstrate positive value, when compared to a more stable and long-term investment approach.

The recommendation of this report is that regulations are modified to promote clarity and transparency as better regulatory principles. This would allow trustees and investment boards to make informed decisions and focus on what they are best at. In addition, we suggest that trustees find ways to improve measurement of consultants’ impact on decision-making and take urgent steps to offset the cost of the conflict of interest – either by adding investment professionals who are able to challenge advice effectively (to reduce short-termism) – or by starting to unbundle the investment advisory services they receive.

Henrik Pedersen, Managing Partner & Co-Founder of CLERUS said:

“Up to now, due to the lack of transparency in this area, it has been difficult for Schemes to assess the full cost of investment consulting advice on fund performance.”

“Without this important information there has been little financial incentive for Schemes to challenge what has been perceived as a relatively small cost of consultants, the use of whom has been forced upon them by the regulatory framework.”

“However, this analysis suggests that prioritising performance assessment based on headline cost can be misleading because the investment decision-making that follows investment advisors’ recommendations is the single biggest factor in determining investment outcomes”

“Significant time and effort has been spent trying to identify winning investment managers and strategies, however this process has instead led to systematic value detraction. This report implies that there is massive scope to improve the performance of investment decision-making without the need to change portfolios or taking on any more investment risk.”

“The one-stop shop advisory model where consultants both recommend, benchmark, monitor and manage relations with investment managers may seem a sound and convenient proposition, but it transpires to have been bad governance due to the inherent lack of transparency and inability to assess properly the value added. It also disassociates decision-makers from key parts of the investment process.”

To read the full report “The Price of Short-Term Advice: Performance Attribution of Investment Advisors using LGPS Data” click here

CLERUS was founded to offer independent senior investment management, governance and decision-making expertise to Pension Funds or other asset owners looking to evaluate the efficiency of their current investment management process.

CLERUS co-founders Henrik Pedersen, MBA and Richard Rothwell, FSIP, ASIP are both seasoned financial experts with many years of applied institutional investment experience, which they recognise could be of value to those pension-fund investment-decision makers, who might lack the applied investment experience to question the investment advice they receive.

CLERUS investment governance and performance review process been has developed and successfully deployed to evaluate and improve the performance of investment decisions within leading investment firms and over many years.

Mis-selling of Alternatives by Investment Consultants? A Review of Methods Used to Promote Alternatives and Dress-up Performance

October 6, 2014 | Posted in The Hidden Cost of Poor Advice | By

Promotion and Benchmarking of Alternatives by Consultants Questioned: £5bn Underperformance in LGPS revealed.

CLERUS today released a new report which reveals that investment consultant’s promotion of alternative investments to LGPS does not stand up to proper scrutiny. It also raises important professional and ethical questions around the integrity of the performance benchmarks used to assess, and remunerate, alternative managers. Finally, it also highlights the risk to performance where decision-makers lack the expertise to properly challenge the ‘expert’ advice given to them.

Report Summary:

  • Performance assumptions used to promote alternatives to Local Authorities (LGPS) do not stand up to proper scrutiny and are inconsistent with realised past performance
  • Lack of integrity of alternative benchmarks has ‘hidden’ 0.5% per annum, or £ 5 billion in poor performance over 10 years, excluding excess incentive fees paid on below target performance
  • More than £20 billion worth of alternatives and absolute return products benchmarked, and remunerated, inappropriately using cash-like benchmarks in LGPS alone

LGPS regulations require administering authorities to take ‘proper advice’ when making investment decisions. However ‘proper’ is not well defined and does not oblige LGPS to scrutinise the quality of advice prior to making investment decisions. The report highlights the need for improved governance in this area and illustrates why this should include scrutiny of the risk and return assumptions used in various asset-liability simulations to promote alternative investments.

UK consultants’ recommendations also appear to be going against the tide of industry leaders. Examples include California Public Employees’ Retirement System (“CalPERS”) and their decision to divest from hedge funds stating excessive cost and complexity, and the decision in 2013 by the £73bn Danish Labour Market Pension Fund (ATP) to close down its own $1.9bn ‘alpha’ program citing that it had become time-consuming and expensive.

In the event that the original LGPS reform proposals were carried through, Local Authorities would still end up paying £301 million of annual fees, and 58% of total fees, to an 11.5% allocation to alternatives. However, as the data has shown, these alternative investments have historically provided lower return than bonds or equities, and were achievable by simple de-risking.

The dressing-up of investment performance by setting alternative performance benchmarks too low leaves financial intermediaries as winners, while plan sponsors and tax payers lose out.

1) Local Authorities are more likely to be able to report ‘above benchmark performance’
2) Investment advisors can finally report that their ‘buy-rated’ managers beat benchmark
3) Investment managers earn higher fees (including potential performance fees) for longer as their performance looks better than it is and cannot be assessed correctly

Henrik Pedersen, Managing Partner & Co-Founder of CLERUS said:

“The attraction of alternatives is predicated on the ability of consultants to identify the small percentage of managers who might be able meet the unrealistic risk and return assumptions into the future. However, actual performance data published over the last decade in both traditional and the much more complex alternative assets, suggests that this is an unlikely proposition.”

“A typical transition from equities to alternative managers requires the selection of between three and five additional managers, and subsequent monitoring. This is good business for investment consultants, however, as the data have shown, it is has not been so good for LGPS or taxpayers.”

“The report asks a simple question: Why are these products being promoted as providing equity-like returns, but benchmarked and remunerated against cash-like benchmarks?”

“The potential monetary impact and scale on plan sponsors and taxpayers from the lack of integrity of performance benchmarks used to assess and remunerate managers and advisors raises important professional and ethical questions.”

“We recommend that local authorities, and trustee boards, invest to acquire the expertise to challenge the advice they receive from their consultant, before taking any investment decisions. The pay-back of a small investment in improved governance and transparency will be fast and any costs will be far outweighed by the benefits of better investment returns.”

To read the full report “Mis-selling of Alternatives by Investment Consultants? A Review of Methods used to Promote Alternatives and Dress-up Performance” click here

CLERUS was founded to offer independent senior investment management, governance and decision-making expertise to Pension Funds or other asset owners looking to evaluate the efficiency of their current investment management process.

CLERUS co-founders Henrik Pedersen, MBA and Richard Rothwell, FSIP, ASIP are both seasoned financial experts with many years of applied institutional investment experience, which they recognise could be of value to those pension-fund investment-decision makers, who might lack the applied investment experience to question the investment advice they receive.

CLERUS investment governance and performance review process been has developed and successfully deployed to evaluate and improve the performance of investment decisions within leading investment firms and over many years.

Uncovering the Investment Performance Drivers of Local Government Pension Schemes

June 23, 2014 | Posted in The Hidden Cost of Poor Advice | By

Increase in LGPS pension contributions directly linked to poor investment recommendations.

CLERUS today released a report revealing that more than 60% of Local Government Pension Schemes (LGPS) performance variation is directly linked to investment recommendations, which are not being measured and assessed by more than 90% of Schemes. These are:

1. The performance of manager selection relative to the Scheme specific benchmark
2. The percentage allocation to assets classified as “alternative”

To read the full report click here

For the majority of Schemes, investment decisions have become little more than the implementation of recommendations made by their investment advisors. However, neither recommendations nor their impact (on investment performance and contribution levels) are being measured or assessed by most Schemes.

“Our research show that the increase in employer contributions is, to a large extent, due to the crystallisation of the £17.3 billion ‘hidden cost of poor advice’ that has not been measured or reported in the past”, said Henrik Pedersen, Managing Partner & Co-Founder of CLERUS

The report also evaluated the current LGPS reform proposal that it could be beneficial if schemes were ‘forced’ to adapt a high percentage of passive management for traditional assets, while still being allowed to invest in alternative investments. CLERUS finds that this is unlikely to yield the desired results because the overall investment governance issues will remain unresolved.

Henrik Pedersen added “It is the improvement of investment outcomes rather than potential ‘cost-savings’ alone that really matter for the taxpayer. In our view this will be best achieved by the proactive enforcement of Myners across all Schemes, by the Government”

Report Summary:

  • CLERUS two-factor explanatory model reveals that more than 60% of performance variation between LGPS is directly linked to the outcome of manager selection and alternative asset allocation
  • Up to 50% of LGPS performance outcomes can be explained by the performance of manager selection activities (average impact of -1.1% over the last 5 years)
  • Up to 35% of LGPS performance outcomes can be explained by their alternatives allocation. For each 10% allocation to this asset class, investment performance was reduced by 0.5% per annum over the last 5 years
  • CLERUS’ analysis suggests that the current LGPS proposal of ‘forcing’ Schemes to adapt a higher percentage of passive management, while still being allowed to invest actively into alternative investments, is unlikely to deliver the intended results

Conclusion:

  • Direct link between the performance drivers identified in this report and the failure to measure and assess the effectiveness of investment decisions and advice
  • The results will make it difficult for Schemes to claim good stewardship of funds without full performance measurement in accordance with Myners
  • Expected ‘cost savings’ achieved by increasing the percentage of passive management will most likely be offset by additional risk-taking in ‘active’ alternative investments
  • Making transparent performance assessment and reporting a regulatory requirement is the cheapest and most effective way to improve investment performance in LGPS

CLERUS was founded to offer independent senior investment management, governance and decision-making expertise to Pension Funds or other asset owners looking to evaluate the efficiency of their current investment management process.

CLERUS co-founders Henrik Pedersen, MBA and Richard Rothwell, FSIP, ASIP are both seasoned financial experts with many years of applied institutional investment experience, which they recognise could be of value to those pension-fund investment-decision makers, who might lack the applied investment experience to question the investment advice they receive.

CLERUS investment governance and performance review process has been developed and successfully deployed to evaluate and improve the performance of investment decisions within leading investment firms and over many years.

The Hidden Cost of Poor Advice: A review of Investment Decision-Making and Governance in Local Government Pension Schemes (“LGPS”) – Part 1

May 13, 2014 | Posted in The Hidden Cost of Poor Advice | By

£17 billion ‘hidden’ cost of poor investment decision-making and advice to Local Government Pension Funds.

CLERUS has just released the first in a series of research reports on governance and investment decision-making in UK Pensions Funds. The first report focuses on Local Government Pension Schemes (“LGPS”).

To Read the full report click here: The Hidden Cost of Poor Advice – A Review of Investment Decision-Making and Governance in LGPS – Part 1

The Independent research conducted by CLERUS reveals the majority of local government pension schemes do not comply with key Myners Principles on good governance and the data indicates that this basic lack of compliance and transparency can explain an annual shortfall versus LGPS benchmarks and targets of more than £2 billion per annum or £17 billion in net present value over 10 years. In addition the report shows that Schemes with good governance against the Myners Principles on Performance Measurement perform at least 0.5% per annum better over 5 and 10 years than those with poor governance.

“Improving investment governance via the formal measurement of the performance of investment decisions and advice has the potential to yield significant results for institutional investors” said Henrik Pedersen, Managing Partner & Co-Founder of CLERUS

Report Summary:

  • Significant Governance and Investment Decision-Making deficit in LGPS totalling £2.1 billion per annum or net present value of £17.5 billion over 10 years
  • More than 90% of LGPS does not substantially comply with Myners’ Principle of Performance measurement of investment advisors and own investment decision-making
  • Schemes with good governance against the Myners Principles on Performance Measurement perform at least 0.5% per annum better over 5 and 10 years than those with poor governance
  • LGPS data shows that Schemes using Investment Consultants on average perform more than 0.4% per annum worse than those who don’t

Conclusion:

  • Current situation where local pension schemes and advisors are left to ‘mark their own homework’ with respect to investment performance and decision-making is not working
  • Proper implementation of Myners Principles has the potential to unlock significant performance improvements of at least 0.5% per annum for the average scheme
  • Current Proposals to ‘force’ Local Government Pension Plans into passive management addresses the symptoms rather than being a cure for poor governance
  • It is the quality of governance and decision-making that drives performance differences and the Schemes with good governance have on average outperformed the Schemes with poor governance

The report highlights the urgent need to implement the good governance recommendations outlined in the Myners Report, including the formal performance measurement of trustees’ investment decision-making and of the recommendations made by their investment advisors.


CLERUS was founded to offer independent senior investment management, governance and decision-making expertise to Pension Funds or other asset owners looking to evaluate the efficiency of their current investment management process.

CLERUS co-founders Henrik Pedersen, MBA and Richard Rothwell, FSIP, ASIP are both seasoned financial experts with many years of applied institutional investment experience, which they recognise could be of value to those pension-fund investment-decision makers, who might lack the applied investment experience to question the investment advice they receive.

CLERUS governance review process has been developed and successfully deployed to evaluate and improve the performance of investment decisions within leading investment firms and over many years.

Oxford Paper recommends that pension funds review the performance of their investment consultants

January 13, 2014 | Posted in The Hidden Cost of Poor Advice | By

Oxford Paper recommends that pension funds put their investment consultants under the same scrutiny as they themselves require from the investment managers that they analyse and recommend

A recent research paper from Said Business School, University of Oxford analyse the impact of investment consultants recommendations on US plan sponsor’s performance using 13 years of survey data provided by Greenwich Associates which has conducted surveys of investment consultants since 1988. The data analysed reflect the recommendations of US equity product by investment consultants for the period 1999-2011 during which period an average of 29 investment consultants answered the survey each year, reflecting a 91% share of the US consulting market. The recommendations used are the aggregated recommendations of all the consultants surveyed as investment consultants do not publicly disclose their own past recommendations to allow analysis of recommendations by individual consultants.

The findings of the study is interesting and suggests that a main impact of the recommendations is to drive significant fund flows into the recommended managers and that these managers then tend to underperform the wider market of available (equity) managers in which to invest.

The conclusion of the report is aligned with the recommendations of the Myners Report and discuss in detail the inconsistency that while fund managers testify to the rigor with which investment consultants scrutinize their performance and measure the effectiveness of their decisions, investment consultants themselves are shy of disclosing the sort of information which would allow pension funds, or any outsider, to measure their own performance. In an article in Financial Times on September 22, 2013 Mr Jones, one of the authors of the report highlight that “Since consultants do not disclose their individual recommendations, pension funds are allocating assets on advice the quality of which is impossible to judge” and contrasted the situation with the consultants scrutiny of fund managers.

If you want to know how CLERUS can help you measure the performance of your advisors and enable you to state full compliance with the Myners principle 4 on Performance Measurement please give us a call to discuss.

If you want to read the full research paper referred to herein please click here ssrn.com/abstract=2327042