The Contested Role Of Investment Consultants: Ambiguity, Contract, And Innovation In Financial Institutions – ValueWalk Premium
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The Contested Role Of Investment Consultants: Ambiguity, Contract, And Innovation In Financial Institutions

The Contested Role Of Investment Consultants: Ambiguity, Contract, And Innovation In Financial Institutions by SSRN

Gordon L. Clark

Oxford University – Smith School of Enterprise and the Environment

Ashby H. B. Monk

Stanford University – Global Projects Center

June 3, 2015


The global financial crisis and its aftermath put into sharp relief the structure and performance of the global financial services industry. Questions have been raised as to what intermediaries individually and collectively add to the production of investment returns and social welfare in general. In this paper, we look at the roles and responsibilities of investment consultants in relation to asset owners of various types, including pension funds, sovereign wealth funds, endowments, and family offices. Focusing upon the relationship between investment consultants and clients, it is suggested that this relationship is characterised by ambiguity; there is a lack of clarity as to the precise roles and responsibilities of both parties. This argument is developed by reference to a set of three prototypical pension funds, distinguished by asset size — a proxy for capabilities and resources. It is argued that ambiguity can be of benefit to both parties. But ambiguity can impose costs upon clients, unable or unwilling to remake their relationships with intermediaries. Our paper highlights instances of innovation, and the ways in which these relationships have been redrawn so as to respond to the challenges of operating in global financial markets.

The Contested Role Of Investment Consultants: Ambiguity, Contract, And Innovation In Financial Institutions – Introduction

Pension funds collect contributions from savers and place those assets with service providers, often delegating the management (though not fiduciary responsibility) for producing investment returns (paraphrasing Diamond 1984). In most cases, these organisations depend upon a network of intermediaries linked in sequence so as to frame and implement their investment strategy. In many cases, asset owners seek out and make contracts with multifunctional financial service organisations, avoiding, as much as possible, the costs and consequences of going to the market for each separate but related financial service. Even multifunctional financial service companies combine insourcing with outsourcing, subcontracting to specialist service providers those activities that can’t be produced internally in an effective manner (Clark and Monk 2013). In this context, intermediation has at least three dimensions: between savers and financial institutions like pension funds; between financial institutions and service providers; and between service providers.

Planning the production of financial returns typically involves entities that advise pension funds on the selection of organisations that provide investment-related services (Goyal and Wahal 2008). This is another dimension of intermediation, which describes the way in which the demand for financial services (buy-side) is intermediated just as the production of financial services (sell-side) is intermediated. Put more specifically, it is standard practice for asset owners such as endowments, foundations, pension funds, and sovereign wealth funds to rely upon intermediaries, including actuaries and investment consultants, to determine the nature and scope of the financial services needed to realise their investment objectives. It is standard practice for these types of intermediaries, which we define as ‘consultants’, to search the marketplace (local and global) for relevant service providers, rank-ordering them in terms of performance and reliability, and conducting ‘beauty parades’ where shortlisted providers pitch their virtues to clients (Shleifer 1985).

In this paper, we focus upon the role of consultants who advise clients on investment strategy and implementation.1 There is a significant literature on the global consulting industry and management consultants (McKenna 2006). Here, though, there is less research although there are strong opinions. For some critics, investment consultants are gatekeepers, standing between asset owners and the global financial services industry, thereby limiting access on a preferential basis to the ultimate decision-making (Coffee 2006). Going further, Youngdahl (2013) contends that investment consultants have undue influence over clients, often exploiting their privileged position to gain long-term contracts, high fees, and even kickbacks. Knight and Dixon (2011) contend that investment consultants have stifled innovation since they have little incentive to go beyond industry norms and conventions.2 Moreover, doubts have been raised about the value of investment consultants, and the money management industry in general, as revealed by the performance of recommended investment managers and products (Gennaioli et al. 2015; Jenkinson et al. 2015).

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