Investment consultants are (quietly) doing great
And one of them says you need not worry
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Investment consultants are the industry's quiet middle-man. They chase clients just like anyone else, but there's also a secretive element around how they choose and what they choose. Anyhow, it seems to work:
This week, a survey by Coalition Greenwich showed investment consultants are wielding more power than ever. They surveyed hundreds of U.S. institutional investors (managing pools larger than $150 million) and found that 85% partner with investment consultants to select managers. With public funds the number was even higher: 95%.
What's more, the market is becoming more concentrated. According to Coalition Greenwich, the top twenty consultants now command 85% of institutional client relationships. In 2014 — just a decade ago — this handful of gatekeepers only took 66% of the market.
These folks tend to exert enormous influence over which managers get selected. Aon did a survey a while back on the relationship between pension trustees and investment consultants. When asked:
"When it comes to investment decisions, how often do you reject the recommendations of your investment consultant?",
Nearly 80% of trustees answered either "Not often" or "Never".
Who are these investment consultant people? What do they want? What are they thinking?
Well, this week we got a peek into one investment consultant's mind. His name is Mark Higgins, and he published a book covering "the financial history of the United States from the late 18th century through modern times."
Now, I don't know about all the other investment consultants, but this one is an endearing nerd:
"Lining the walls of my basement are approximately 3,000 notecards documenting key events, critical principles and memorable quotes," said Higgins
(The release included a photo. There really were lots of notecards. And not scribbles either, each was neatly printed.)
OCD aside, the most obvious question is, what useful stuff did he find out? To caveat, Higgins works for a company called Index Fund Advisors, so there's a tilt here. But the historical nuggets in the article affirm the value of taking a long-term view. Here are my two favorite bits:
One, no financial crash expected anytime soon.
How funny would it be if I write this, and next week the market crashes? But still:
"During the past 230-plus years, noted Higgins, the United States has experienced numerous manias, panics and crashes. So far, the most notable ones occurred in 1792, 1819, 1837, 1857, 1873, 1893, 1907, 1914, 1929, 1987, 2000, 2008 and 2020."
My pattern-seeking brain instantly looked at the distance sequence, which comes out at 27,18, 20, 16, 20, 14, 7, 15, 58, 13, 8, 12. The median is 15.5 years between crashes, as is the average if you exclude the largest stretch.
(Notice I had the audacity to call this guy a nerd.)
Two, the long-wave cycles of alternative asset classes.
Institutional investors periodically pour money into trendy alternative asset classes, private assets being the current hotness. (Whaling and hedge funds were once too.) Historically speaking, they may not be all they're cracked up to be.
Higgins warns that these classes are typically riskier than investors often assume because they are both illiquid and prone to herd mentality, and they often lead to disappointing results for latecomers.
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Treasure Corner: Political themes are short-lived
This week the FT covered the rising interest in defence ETFs. In April, net flows into the three available ETFs in April came in at over $200 million, adding to the $321 million these funds attracted in March.
For a long time, defence stocks were out of favour in Europe on ESG grounds. Even now, according to VanEck (which runs the largest of the three funds), 60% of the ownership is down to retail investors, not institutional ones. Still, the providers are all sensing the winds of change.
For how long are these winds expected to blow?
Luckily, Morningstar has some insights. Back in 2022 they published their Global Thematic Funds Landscape report, which dug into the relationship between flows and themes over a two-year period.
The cornerstone here is a three-tier taxonomy for classifying thematic funds. The top tier includes four big categories: Technology, Physical World, Social and Broad Thematic. Each of those is broken into further categories. And each of those categories is broken down to sub-categories.
'Political' is a category under the big ‘Social’ umbrella. And the themes it contains read like the papers as of end of 2021: 'Korea New Deal', and separately 'Korea Unification'; 'New Silk Road' and 'State Owned Enterprise'; 'Trade War'. While even the tech themes still look mostly relevant, the political focus has mostly shifted elsewhere.
So political themes tend to be short lived. But what about flows? Here the paper offers two insights:
When ranking the top twenty second-tier categories by flows, politics comes in fifth from the bottom, attracting a combined total of just shy of $15bn globally, covering all related fields. Which is to say: politics is in the top-twenty, but not very high up.
More broadly, it's not just that themes change quickly, but also their investment potential. Across all thematic funds, the outcomes over a five-year period are a crapshoot: the odds are near equal the fund either outperforms, underperforms, or shutters entirely.
Also happening
UK tech startup Synthesia reveals AI avatars that can convey emotions like happiness, sadness, and frustration, just through text inputs. I'm not saying fund managers necessarily convey all these emotions when they record their marketing videos, but this story is relevant in two ways:
One, when we talked about AI use cases in asset management, we mentioned the problem of specificity: companies can sense the tech is useful, but struggle to point to specific pain points it neatly solves. Well, here's one. Portfolio managers typically don't enjoy the video-making aspect of their job. this is a neat alternative which
"Aims to eliminate cameras, microphones, actors, lengthy edits and other costs from the professional video production process."
Two, is on the side of AI regulation, which thus far has been mostly performative. Even profit-hungry companies can sense this tech is dangerous. The company says it:
"Requires all of its new clients to undergo a thorough "Know Your Customer" process similar to that used by the banking industry, which helps prevent bad actors from creating fake company profiles to spread misinformation."
Borrowing from financial regulations, which have been around long enough to prove their usefulness, is not a bad idea.
Speaking of regulations, the UKs financial services sector is objecting to the FCA's plan to make its enforcement investigations public before outcomes are decided. There's a consultation, and this week industry groups signed a letter. They worry companies will be unduly harmed because customers will be influenced to pull their money or close their account. They also say the UK market is already fragile, and other countries don't have a similar system in place.
A tricky topic for sure. But as the FCA writes:
“We currently publish very little information about the investigations we have opened before taking action or which do not lead to action."
We talked about employees spilling the beans on their employers. Part of it is the belief regulators will do nothing — which makes for a weak regulatory system.
Recall that sexual harassment at Odey asset management took place for over 16 years, but didn't come into light until several female employees went to the press. They went to the Financial Times, not the FCA. And rightly so:
Reputational damage led to Odey's ousting (and eventual close of the company); meanwhile, the FCA ran a probe and decided to take no action. Which is to say, under current regulations Odey Asset Management could have still been going strong.