'Shining a bright light into a dark corner': the journey to investment consultant regulation

When Professor Tim Jenkinson and Professor Howard Jones analysed the performance of investment consultants’ recommendations in relation to their claims, their findings sent shockwaves through the finance industry.

Investment consultants advise institutional investors on approximately USD40,000,000,000,000 of assets worldwide. Despite wielding such powerful influence, their recommendations are rarely checked or measured for performance, and are currently subject to no official regulation.

In 2012, Professor Jenkinson (Professor of Finance, Saïd Business School) and Professor Jones (Professor of Finance, Saïd Business School) embarked on their first project to try and discern whether recommendations given by investment consultants add as much value as they claim.

Their research found that the recommendations of the consultancy they studied did not add value, despite its assertions. The consultancy, who had willingly shared its data, blocked publication of the findings upon learning the outcome. Although Jenkinson and Jones could not share their research, a seed had been planted. Could this be a pattern that went further than just one consultancy?

A trade of tips

As intermediaries between the fund managers they advise and the asset managers they recommend, investment consultants are in a position of power. Traditionally, many have favoured active investments – more complex instruments that require higher fees.

“The cost to the public purse is significant,” Jenkinson explains, “choosing active over passive investments, when passive works just as well, incurs all these extra fees. But if you tell people there’s gold in those hills, then they’ll follow you there.”

The 2012 study hinted that the industry might have a problem on its hands – one it was unaware of or unwilling to admit to. Along with Jose Martinez (then also at Saïd Business School, now at University of Connecticut Business School), the academics undertook a further two studies to see if the issue was more widespread than just one consultancy.

The research looked at recommendations from major investment consultancies and beyond, covering a combined share of 90% of the consulting market in the largest asset class – US large cap equities. The study showed the recommendations of these consultancies were “at worst value destroying, and at best value neutral.”

Sending shockwaves

The industry was shaken by the findings, which received significant attention. The research was covered by the Financial Times, as well as being published in two top financial journals and winning the 2015 Commonfund Prize.

Despite experiencing significant hostility from the industry, Jenkinson says: “I had people coming up to me and saying they saw this in their own work all the time. But most of the players were conflicted in some way – asset holders didn’t have the data, asset managers didn’t have the power. Only academics could have done something like this. We were shining a very bright light into a very dark corner.”

Collaborating with the regulators

The impact of this research led to Jenkinson and Jones collaborating with the Financial Conduct Authority (FCA) on a further study in 2018, working alongside Jose Martinez and Gordon Cookson of the FCA.

“It was very much a collaboration,” says Jones. “Once the constraints were set and procedures were in place, it was a joy working together. A lot of the people we were working with had academic backgrounds themselves.”

Yet again, the findings were unequivocal. The investment consultants in the sample studied claimed to have achieved excess returns of 1.73% per year. The study showed that their claims exceeded their actual performance by 1.95%. The research also found that, as investment consultants exaggerated their performance to varying extents, it was impossible for pension funds to rank them effectively.

The success of the project has gone on to inspire similar collaborations between academics in the Saïd Business School and regulatory bodies.

“Academics and regulators bring different things to the table,” says Jenkinson. “We can get into the detail and they have the power to liberate the data.”

A new era of regulation?

The regulatory and reporting changes arising as a result of Jenkinson and Jones’ body of research mean that investment consultants will soon have to provide a clear record of performance to fund managers, allowing them to make more informed decisions.

More subtly, there has been a shift in thinking around investment consultant advice, undoubtedly contributed to by the publicity surrounding these studies.

“It has emboldened investors to insist that they should invest passively,” says Jones, “and contributed to the overall current trend towards passive management.”

The resulting efficiencies in allocation of pension assets should have a positive impact on pension-holders across the UK.