Investment consultants are important intermediaries in institutional asset management. Many retirement plans, foundations, university and other endowments, and other so-called plan sponsors engage investment consultants to provide a range of investment services. These include asset/liability modeling, strategic asset allocation, benchmark selection, fund manager selection, and performance monitoring.
It has been estimated that, as at June 2011, over $13 trillion of tax exempt U.S. institutional assets were advised on by investment consultants (out of almost $25 trillion of institutional assets advised on worldwide).3 Goyal and Wahal (2008) estimate that 82% of U.S. public plan sponsors use investment consultants, as do 50% of corporate sponsors. Despite the large volumes under advisement, little academic attention has been paid to the impact of investment consultants on plan sponsors’ performance.
Using thirteen years of survey data, we focus on a key service provided by investment consultants: fund selection. We examine three questions relating to consultants’ recommendations of fund products: first, what drives consultants’ recommendations; second, whether capital flows are affected by consultants’ recommendations (i.e. do consultants have substantial influence on the investment allocation decisions of plan sponsors?); and, third, whether these recommendations predict a fund’s performance.
The funds that are rated by investment consultants are products aimed at institutional, rather than retail, investors. Clearly, a large literature exists on retail mutual funds, and the accuracy of ratings produced by intermediaries such as Morningstar (Blake and Morey, 2000; Khorana and Nelling, 1998). There is also an incipient literature exploring the benefits to retail fund investors of using professional brokerage firms: Bergstresser et. al. (2009) examine these benefits in terms of fund selection, while Gennaioli et al. (2013) analyze other services of financial advisers, notably the confidence these firms give to invest in financial assets at all.
Similarly, there is a large literature on the accuracy of analyst recommendations for individual stocks (see, for example, Womack (1996), Barber et. al. (2001), Jegadeesh et. al. (2004)).