A robust challenge to the investment consulting industry
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Investors whose blood has a tendency to boil at low temperatures would be advised to skip the recent interview by Pauline Skypala with Andrew Kirton, UK head of Mercer Investment Consulting, in the Financial Times' fund management supplement.
"He fulminates in particular about the anti-benchmark (sic) league, firms who urge pension funds to ask their investment managers to aim to beat cash or inflation rather than an equity index."
Electing not to follow an equity index and pursuing a cash-plus mandate is not abandoning benchmarking, merely replacing a benchmark that guarantees high risk with another that doesn't. Mr. Kirton "does not support moving to an absolute return benchmark instead. He says the idea that adopting a long-only absolute return or unconstrained investment approach improves both short and long-term returns 'defies logic'." It is not clear whether he was asked about the volatility of short-term returns but he certainly appears bothered by them.
Yet he concedes that "If a good manager is given greater investment freedom, long-term relative performance ought to be better" even if the short-term is more volatile (he might also have meant 'absolute' rather than 'relative'). But what is this obsession with the short term ? What on earth is the relevance of short term market noise upon a pension portfolio? And if long-term investment by unconstrained managers does offer the prospect of better returns than those achievable from index-trackers, why dismiss them out of hand?
It gets better. "(Mr. Kirton) dislikes absolute return benchmarks because they do not relate directly to the liabilities and are not something managers can buy." This is true: it is a shame that successful long term liability management is not available at Tesco. Worrying about liability 'compatibility' also seems to be slavishly conflating means with ends. But here is a question. Which is the better asset match for the ongoing real liabilities of a pension fund: the UK equity market, which offers the probability of exposure to real growth in the UK economy over the long term; or the Gilt market, which currently offers the certainty of low nominal returns over the next fifty years - and the possibility of capital loss if Gilt investments are not held to term ? If investment consultants believe the correct answer is equities, perhaps they can explain why so many pension funds, at their explicit recommendation, albeit fuelled by misplaced legislation, are fleeing the stock market for the 'safety' of bonds just when the bond market is at its most expensive levels for two generations. On the subject of investments, many professional traders might take issue with Andrew Kirton's view of the foreign exchange market: "We like it because, of all the markets we would advise clients to invest in, currency markets are the most inefficient." Given the size, breadth and depth of the currency markets, "inefficient" is not an adjective we would choose to use about them.
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One might really question the relevance of benchmarks that "managers can buy". Advising upon and managing pensions risk is not an over-the-counter activity. But then it all becomes clear: Mercer runs a multi-manager fund management operation which it will be rolling out into Europe and Asia this year. Perhaps that is something pension fund managers can buy. And while Mr. Kirton is unsurprisingly hostile to the fee structure of hedge funds ("If they charged something close to what they are worth, they would get much more demand from institutional investors"), the double layer of multi-manager fees is evidently something that Mercer Investment Consulting can live with - we can merely put to one side the inherent conflict of interest that comes from supposedly independent consultants selling proprietary product. And that emphasis on 'product' comes out loud and clear:
"Some innovations will result in successful product solutions.."
If the term 'solutions' is widely over-used, in financial services as elsewhere, some of us find the term 'product' almost offensive - conjuring up images of factories churning out commoditized goods launched upon the triumph of aggressive salesmanship over more nuanced needs analysis.
So what we get is a breathtakingly complacent defence of the late 1990s status quo: index-tracking, equity benchmarking, the primacy of 'product solutions' and a rather peculiar concern at short-term volatility which sits somewhat uncomfortably with the first two preferences. The interview is an object lesson in the dangers of agency risk. And it is almost as if the post-2000 bear market had never happened. One doesn't expect the largest investment consultants necessarily to be at the vanguard of new investment thinking, but since they act as gatekeepers to hundreds of billions of pounds of other people's money, the inflexible dogmatism seemingly on offer here does give rise to more than a little alarm.
Today's commentary is not intended as a brutal ad hominem assault, rather as a robust challenge to the intellectual sloth of the investment consulting industry. As ever, language serves as something of a canard: calling index-constrained managers 'active' is like describing a prisoner in a jail cell as 'active' on the grounds that he can track the bars. If absolute return investing is merely a "fad" or a trendy idea, one wonders how to describe index-relative investment during those periods when markets are falling. We would call belief in relative investing more generally a poisonous and outdated irrelevance. Corporate trustees overlooking the wreckage of their pension funds may have their own views. For those who have difficulty in believing that it's possible to reconcile risk-adjusted and absolute return investing with the delivery of meaningful returns, we enclose the performance of our GBP model portfolios. For those with less of an interest in hard currencies, performance of Euro and USD portfolios is also available on request. In the interests of informed debate on an issue that touches on the wealth of millions of current and future pensioners, correspondence on this topic is genuinely welcomed.
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