Do LGPS consultants add any value?

I was recently sent a paper written by Jay Youngdahl, lab fellow at the Edmond J Safra Centre for Ethics at Harvard, entitled “Investment Consultants and Institutional Corruption”, which turned out to be a very interesting distraction.

I won’t go into the detail of the paper, since you can always read it for yourself but the gist of it summed up in Youngdahl’s own words is that “..(the investment consulting) profession failed to protect asset owners in the recent financial crisis and has yet to engage in serious self-examination”. According to Jay, conflicts of interest in the industry are rife.

Blimey! Having spent a chunk of my career working for a large investment consultancy firm, I must say I didn’t recognize many of the problems, concerns or conflicts that Jay cited – and given the US centric nature of the paper, perhaps I was never going to. However, it did get me wondering – how much value was added by consultants in the run up to, during, and after the financial crisis?

The run-up: I started my consulting career in October 2007, just as things were starting to look a bit unsettled in the financial markets. All of my peers were working with clients to either ‘de-risk’ (predominantly corporate sector pension schemes) and/or ‘diversify’ (predominantly LGPS schemes) investment strategies. This basically involved discussing existing pension fund liabilities, funding positions and investment strategy with clients, undertaking educational activities where possible, and coming up with ideas as to how any particular investment strategy might be better diversified, with modelling underpinning the work done. To my eyes, some clients were more willing than others to embrace this approach, and some were more nimble than others when it came to making decisions and committing to making investments. Value-add by the consultant depended on, ultimately, the ‘trustee body’s’ willingness to listen to the advice being offered, and ability to make changes.

During: It was an incredibly busy, stressful time for both clients and consultants, with more ‘bad news’ coming out almost every day for three months straight. The period from September 16, 2008 (the day after Lehman’s went under) to the end of December 2008 passed in a blur, with many pension funds wondering what was going on, how the crisis had happened, what it meant for them, and what they could do to try to protect their funds. The strategy of ‘diversification’ in its purest sense came undone, since the crisis that was unfolding was truly global in its nature and scope. There are many reasons for that, with some being more contentious that others, but the net effect was almost every asset class and every investor felt a significant amount of financial pain in one form or another.

In his paper Jay asks – could consultants have done more to protect clients in the financial crisis? My view, formed with the benefit of hindsight, is – yes and no. Yes, in that with markets having performed so strongly in the run up to Lehmans, more emphasis could have been placed on considering asset protection strategies – for example, using derivatives to short a particular market or markets. But also no, in that many trustee boards and pensions committees viewed derivative investment warily and thought it was expensive to implement and had no guarantee that it would ever pay off (remember, this is the point in time before the crisis hit). LGPS clients had the added complication regarding the use (or not) of derivatives as permitted by the LGPS investment regulations at that point in time.

After: Corporate credit was the first ‘opportunity’ that I really remember discussing with people in the post-Lehmans world. But since then we’ve had distressed debt, emerging market debt, high yield debt, long lease property, fundamental passive, infrastructure, and Diversified Growth Funds to name a few more such opportunities as put forward by consulting firms. So, on the face of it, consultants have been continuing to look for ways for clients to make positive, and hopefully meaningful, investment returns. But, again, the ability to wring any returns out of opportunities such as these remains as much linked to the willingness of individual pensions committees to take on board the advice, and consider the possibilities in the context of their own fund, as to the merits of the underlying suggestions.

Do you believe that consultants add value in the long run?

The answer may well depend on which side of the fence you are on – consultant or pension fund. During my formal time in the industry (as a ‘gamekeeper’ turned ‘poacher’ as it has often been put to me) I had my worth or usefulness as a consultant questioned just about as often as I was thanked for trying to help clients get to grips with different facets of, what I believe is, one of the most complex business areas there is.

To those who thought/think consultants did/do a good job, or tried their best, I would agree. That was my experience of working with other consultants. It wasn’t just about fees for them (which might have seemed high on an absolute basis, still pale into insignificance when compared to asset management fees), and almost all of the consultants I knew and worked with did actually care about their clients, and genuinely wanted the best for them.

To those who thought/think consultants did/do a poor job, it might be interesting to pause for a moment, and think of a world without them. All of the difficult investment decisions would then need to be taken by in-house ‘experts’ (ex-bankers perhaps?), or outsourced entirely. In my career, actuaries seem to regularly attract quite scathing criticism, so thank goodness I’m not one of them. But again, I think it would be interesting to think of a world without them. How would the average pension fund possibly plan for the future with regards their ageing scheme members? They’d need to make all sorts of assumptions about investment returns, inflation and longevity – in effect, they would end up becoming actuaries themselves.

I don’t recognise the consultants and the consulting industry referred to in Jay’s paper, and indeed if the consultants referred to in his paper were judged next to some of the people I’ve worked with in my career, they’d come off as being significantly inferior. Most I would say are good or very good, but there are a few that are breathtakingly knowledgeable, competent and thoughtful when it comes to working with clients, and trying to help them navigate a difficult course through treacherous waters.

I’m not going to suggest that you, dear reader, rush out and ‘hug a consultant’. But it would be interesting, if thinking about whether your consultant has added any value to your scheme, that you also consider instances where advice provided was not taken, or whether the consultant that you hired was restrained in any way in terms of coming forward with new ideas or suggestions.