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Billions of Dollars Paid for Underperformance

By Hal M. Bundrick

NEW YORK (MainStreet) ¿ Universities, foundations, endowments and retirement plans may be spending billions of dollars for investment advice with little, if any, return. In fact, a study by a team of Oxford University researchers says mutual fund recommendations made by investment advisors simply do not outperform other investments.

Over $13 trillion of U.S. institutional assets are advised by investment consultants at a cost of billions of dollars per year. The result? An underperformance of about 1.1% annually, compared to other investments. And that's before fees were deducted.

The academics pored over thirteen years of survey data, examining the fund selection of actively managed U.S. equity mutual funds recommended by 29 investment consultants for the period 1999-2011. As of 2011, these advisors represented a 91% share of the U.S. consulting market.

"The analysis finds no evidence that the recommendations of the investment consultant for these U.S. equity products enabled investors to outperform their benchmarks or generate alpha (excess return relative to a benchmark)," the study concludes. "This raises the question why plan sponsors engage investment consultants to help select fund managers without evidence that they add value."

Tim Jenkinson, Howard Jones, and Jose Vicente Martinez of the Saïd Business School at the University of Oxford conducted the research.

"In many cases, ultimate fiduciary responsibility for the performance of the assets rests with trustees who are non-specialists and require independent and specialist advice," the report says. "Some consultants show their 'value added' by comparing the performance of a portfolio of their recommended funds with that of an appropriate benchmark. However, they do not generally compare this performance with the performance of institutional funds which they do not recommend, nor do they make available the underlying data for scrutiny by third parties."

Since the research considered investment performance before the deduction of mutual fund and advisor fees, Jenkinson and his associates speculate that plan sponsors, foundation boards and others employ advisors for "hand holding" purposes.

"When the performance of recommended funds is shown net of such fees, their failure to add value becomes more pronounced," the researchers say. "In light of the evidence presented, what is striking is that fund sponsors follow such recommendations to the extent and at the expense that they do."

The study admits that there are other reasons to engage investment consultants, including asset/liability modeling, strategic asset allocation and to provide a 'narrative' to explain their actions to their own stakeholders. And then the researchers conclude:

"Assuming plan sponsors knew that they were not being rewarded for following consultants' recommendations, one possible reason for doing so is that plan sponsors hide behind consultants' recommendations when they have to account for their decisions."

--Written by Hal M. Bundrick for MainStreet

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