Institutional Asset Management
Ritholtz Wealth Institutional Asset Management was established to provide independent advice and investment management services to a wide range of institutional clients including foundations, endowments and pension plans. Every investment plan is established to fulfill a unique liability or need of an organization’s mission. We combine market wisdom, technological savvy, personalized planning and structured advice to help clients achieve their specific goals. We operate completely independent of any relationships with brokers, dealers, investment managers or banks. This independence allows us to offer unbiased views in our aim to do what’s best for each individual client and fund.
Our primary focus is to offer the highest quality service possible to clients by focusing on what we can control. We believe that successful long-term investing involves the use of a straightforward, uncomplicated approach. We believe long-term performance is important, but we also recognize the need to manage risk within the context of meeting an organization’s goals, objectives and future spending needs. Thus we create portfolios that are easy to understand, operationally efficient, low-cost, transparent and liquid.
Read our thoughts on the herd mentality that exists within the institutional investment community
In the U.S., over $13 trillion of institutional capital relies on consultants for advice on which funds to invest in. Pensions, endowments, foundations and other large pools of money utilize consultants for a range of services, most notably picking different outside money managers to invest in on their behalf.
Research shows that investment consultants as a group add no value through their selection of investment managers. They chase past performance and make far too many unnecessary changes. Data also shows that the managers consultants fired have gone on to perform better than the ones they hire.
The paradox here is that these non-profit institutions need outside advice in most cases. The majority don’t have the time or resources to monitor their portfolios or pick and choose new investments. That’s a full-time job and many of these funds can’t hire full-time investment staff. The problem is they’re paying for the wrong kind of advice.
Warren Buffett seems to agree with me. Here are his thoughts from the Berkshire Hathaway annual meeting last weekend:
Supposedly sophisticated people, generally richer people, hire consultants, and no consultant in the world is going to tell you ‘just buy an S&P index fund and sit for the next 50 years.’ You don’t get to be a consultant that way. And you certainly don’t get an annual fee that way. So the consultant has every motivation in the world to tell you, ‘this year I think we should concentrate more on international stocks,’ or ‘this manager is particularly good on the short side,’ and so they come in and they talk for hours, and you pay them a large fee, and they always suggest something other than just sitting on your rear end and participating in the American business without cost. And then those consultants, after they get their fees, they in turn recommend to you other people who charge fees, which… cumulatively eat up capital like crazy.
And the consultants always change their recommendations a little bit from year to year.They can’t change them 100% because then it would look like they didn’t know what they were doing the year before. So they tweak them from year to year and they come in and they have lots of charts and PowerPoint presentations and they recommend people who are in turn going to charge a lot of money and they say, ‘well you can only get the best talent by paying 2-and-20,’ or something of the sort, and the flow of money from the ‘hyperactive’ to what I call the ‘helpers’ is dramatic.
Like clockwork, every year at non-profit board meetings around the country consultants pitch a few new fund ideas to replace the current cellar dwellers in the portfolio. A steady stream of new ideas makes it seem like consultants are adding value and doing their job while getting rid of the underperformers gives everyone someone to blame.
No one wants to admit there’s a problem with this model of doing business so status quo reigns. It’s hard enough to pick one money manager that can outperform, but when you try to pick multiple outperformers and do that multiple times every year your odds just continue to get smaller and smaller. The degree of difficulty is through the roof on this approach.
Here are three consequences of the control the consulting industry has over the institutional investment landscape:
1. As a group, hedge fund performance has been abysmal over the past decade or so. Consultants and those picking the consultants don’t receive nearly enough blame for this. The hedge funds are, in most cases, just giving these large institutional investors what they ask for (usually a strategy to fight the last war). Consulting firms pitch their “access” to top performing funds, but that’s usually the funds that outperformed in the past, not to be duplicated in the future.
2. Very few institutions know how to evaluate the consultants who are picking money managers on their behalf, let alone how to vet the money managers themselves. So non-profits basically put their faith into these consultants and hope for the best without an understanding of their actual results (benchmarking in the institutional world is often a joke with very low hurdles).
3. These portfolios end up hurting performance through a death by a thousand cuts. They change a few managers each year. Then they change consultants every few years. Or they change investment committee members. There’s no continuity in their investment approach and each time these changes are implemented there are explicit and implicit costs incurred.
Here are a few areas where consultants could add value if they chose to focus their efforts beyond the standard money manager musical chairs:
- Client education and improved communication efforts.
- Behavioral management and modification.
- Useful performance and risk reporting that doesn’t include 100 page reports with useless information no one reads.
- Setting realistic expectations, which can help with both organizational planning needs and keeping investor emotions in check.
- Ensuring the portfolio’s asset allocation matches the risk profile and time horizon of the organization.
- Documenting the investment process to ensure continuity in the program over time.
- Saying ‘no’ over and over again to investments or funds that don’t fit an institution’s mandate, tolerance for risk or stated objectives.
- Ensuring that short-term liquidity needs are always able to be met by implementing cash management guidelines.
- Honesty, transparency and the ability to say “we don’t know.”
- Reminding these organizations of their time horizons and long-term goals.
- Doing nothing most of the time in terms of making changes to the portfolio.
Read our thoughts on institutional investment consulting
Institutional investors are often referred to as the ‘smart money’ or ‘sophisticated investors.’For some funds this is true, but many of these large pools of capital make the same exact mistakes as mom and pop retail investors. It’s just that the reasons are different.
Here are a few studies to consider:
- One study looked at large pension plans, with an average size of $10 billion each. Nearly 600 funds were studied from 1990 to 2011. Researchers found these funds allowed their stock allocation to drift higher during the late-1990s tech bubble. Then they allowed their equity exposure to stay lower at the tail end of the 2007-2009 financial crisis. So they were overweight going into a crash and underweight going into a recovery. Instead of rebalancing they simply chased past performance, thus missing out on the inevitable mean reversion and failed to manage risk according to their stated guidelines.
- Researchers also looked at the performance of the nation’s largest pension plans from 1987 to 1999. Out of the 243 plans in the study, each investing hundreds of millions or even billions of dollars, 90% of them failed to beat a simple 60/40 benchmark.
- Researchers looked at a dataset of more than 80,000 annual observations of institutional accounts from 1984 through 2007. These funds collectively managed trillions of dollars in assets. The study looked at the buy and sell decisions among stocks, bonds, and externally hired investment managers. The researchers found that the investments that were sold far outperformed the investments that were purchased. Instead of systematically buying low and selling high, these funds bought high and sold low.
- Researchers looked at the investment choices from consulting firms that control roughly 90% of the U.S. consulting market. They found, “no evidence that consultants’ recommendations add value to plan sponsors.” In fact, the average returns were much worse in the funds they recommended than non-recommended funds.
The last one interests me the most because I began my career in the institutional investment consulting business. We were a smaller, private shop, but our competition was the bigger players. And these big players basically control the entire market. In the U.K., the six largest consultants control 70% of the market. In the U.S. the top ten consultants have an 81% share. Worldwide, the top ten controls 82% of the market.
I understand why pensions, endowments and foundations use consultants. Not everyone has the expertise or resources to manager money in house or make these decisions on their own.
But if these consultants are considered experts in their field of choosing money managers, why are the results so poor?
A few thoughts:
- Consultants constantly feel the need to give as much advice as possible. They have to try to prove that they’re worth their fees, so they advise changes even when none are needed. This has a lot to do with the fact that these funds are now so worried about their short-term performance measured against the market and their peers.
- People love to have someone to blame. The funds can blame the consultants. The consultants can blame the money managers. And the money managers can blame the Fed. Everyone is happy except for the end investors, the beneficiaries.
- This business model is predicated on scale, which is why the market is so concentrated. But this means that there has to be a herd mentality as everyone is investing in the same managers and strategies. It also means there is little room for personalized advice when you’re overseeing trillions of dollars in assets as some of these firms do. So there is something of a cookie-cutter approach to these models.
- It’s very difficult for these firms to offer objective advice. Consultants typically have a list of approved money managers that they use. It’s not very easy for managers to make it onto these lists, but it is very lucrative once they do because that means they will likely be recommended across many different client accounts. The consultant-manager partnership can be tricky for trustees to understand from a conflict of interest perspective.
- These firms assume that their number one job is to beat the market, provide sources of alpha and help their clients pick the best fund managers. Manager due diligence tends to overshadow things like asset allocation, performance monitoring, risk management and educating the trustees or board members on things like portfolio construction, setting return expectations, reminding them of their overall goals and how the markets and human nature generally work. The search for alpha often blinds investors from paying attention to the basics.
The last bullet point is probably the most critical for these large pools of capital to understand. They waste so much of their time debating the relative merits of the different money managers and short-term investment opportunities that they lose sight of their overall goals and organizational mission. Selecting the best investment opportunities doesn’t matter if your can’t control your behavior or implement within an overarching plan.
Consulting firms can be helpful to institutional investors. They just have to learn to focus on the right areas of importance.
Read our thoughts on the importance of goals-based investing
One of the biggest problems with the way many financial firms operate is that they prescribe before they diagnose. They first create a product or portfolio and then try to convince people to invest in it. They try to make a sale without first gaining an understanding of their potential client’s circumstances. It’s completely backwards.
A number of years ago, the investment office I worked for took a meeting with a large, well-known consultant as a favor. We never planned on using this company’s consulting services, but thought it wouldn’t hurt to take the meeting to see how they viewed the world. The firm didn’t really understand this dynamic and came into the meeting with guns blazing. They had a huge team with a well-rehearsed pitch they used to try and impress us.
The head of the firm wasted no time going into his presentation along with some name-dropping of their current client base. He immediately outlined his firm’s current investment views, which went something like this:
First of all, you need to have at least 15% of your portfolio invested in timber. And if you’re not overweight in middle market mezzanine private equity funds and underweight large market LBOs you’re going to be out of luck over the next decade. Who are your hedge fund managers? We have access to the best long/short manager in the business right now. How long will it take you to shift your portfolio to our platform?
We were immediately taken aback by the presumptuous nature of this pitch. Not only was this firm extremely overconfident in their outlook and abilities, but they never once asked us a single question about our organization before diving into their song and dance.
They didn’t ask about the mission of our organization or what the goals of the fund were.
They never asked what type of liquidity constraints we were under.
They failed to try to gain a sense of our risk profile and time horizon.
They never asked what our stated return goals and assumptions were.
Needless to say, the meeting didn’t last long. However, you can’t blame every financial firm when this type of thing happens. They don’t have time to vet every single investor in their products and hold their hands through the entire process.
But when you’re talking about advisors or consultants, who are providing a service to their clients, then they absolutely have to focus the majority of their time and energy on the client’s needs. Financial services should not be a commodity business. It has to be personal for both parties to succeed.
The problem is that many clients want to be wined and dined. They want someone to tell them exactly what they want to hear, even if it’s an impossible strategy with unrealistic underlying assumptions. Wall Street is not the lone culprit in this game. After all, the consultant in my story had a very large book of business. There were multi-billion dollar funds that they worked with. Someone was eating up what they were putting out there.
My feeling has always been if you’re not approaching the investment process from a goals-based perspective it’s going to be very difficult to ensure long-term success in the markets. Here are a few things I’ve learned over the years when it comes to goals-based investing:
- An investment firm can have the perfect pitch, investment structure, fund or opportunity. In many cases it may not matter if it doesn’t fit within the client’s stated investment policy. Just because there’s a potential for a good investment doesn’t mean it’s the right fit for every client. The markets are always tempting us with new products, risks and opportunities. This is how individuals and organizations end up investing in strategies they don’t understand or have no business performing due diligence on in the first place.
- One of the reasons certain investors constantly change up their investment strategy — usually at the worst possible moment — is because they don’t have the right benchmarks in place to begin with. Many don’t even know how to define whether they’re on track or not. Without a deep understanding of your goals from the start there’s no way to judge your investments going forward. After all, achieving your goals is the whole point of investing your money in the first place.
- It’s perfectly acceptable to admit that your goals can and will change over time. We’re all dealing with an uncertain future. No one knows how life is going to turn out. This is why the process of planning is so important. It allows you to continually work through the new challenges that may arrive in the context of your stated plan.
- It’s much easier to believe in certainty than process, but the right process can lead to much better outcomes in the end.