Small managers are forever griping about the lack of attention from institutional investment consultants. They often complain that their size proves insufficient for the gate-keepers to scale across their clientele and get more bang for their time and resources.
Are the consultants truly to blame? Most consultants today, faced with shrinking operating margins, business succession issues, lean research teams and unable to attract seasoned investment research professionals, have little choice but to keep it simple while mitigating any existential threat from a bad investment recommendation. Hence in both their traditional consulting and reincarnated OCIO forms, they gravitate towards larger managers with known brands and big infrastructures, under the guise of “institutional quality”, which even if they are mediocre would at least not get them and their clients into trouble.
However, we would all agree that the world around us is changing rapidly and investment portfolios are battling more than ever to keep up, let alone meet their elusive return targets to bridge gaping funding shortfalls and/or meet spending targets.
Tectonic changes are sweeping across economics, politics, business and capital markets. Fixed income is no longer “fixed”, 60/40 is questionable, passive-massive is a new force to reckon with, localisation trumps globalisation, populism is rife across nations, supply chains are being reconfigured, China-not just US, sends shockwaves through global markets, private creditors are increasingly filling in for banks, Indian elections matter as much as US 2020 if not more, and the list goes on.
In this constantly evolving investment climate, would it be prudent to let a nugget of potential alpha fleet by right from under our noses just because it lacks someone’s stamp of approval?
The new investment paradigm calls for capturing as many idiosyncratic sources of alpha as possible, not repeating old practices of allocating just to “comfort managers”.
It’s important today for investors to take ownership of their own investment decisions and live with their own convictions as exemplified by many an endowment, corporate pension and insurance company plan sponsor.
This ought to begin with developing a strategic portfolio plan or seeking holistic plan advice such as a health-check from one’s trusted consultants (if plan sponsors have one) just as one would expect from one’s primary care doctor.
Equipped with that, investors should seek investment opportunities (e.g. capitalise on innovation, exploit distress situations or illiquidity, profit from volatility, etc.) more importantly than manager names on consultants’ “buy-lists” that often pose adverse selection bias.
Once investors can define their “opportunity” needs, they should be open to managers big or small across geographies, capital structures and liquidity spectrums, which can execute well within their opportunity set.
What then poses a challenge is identifying and digging deeper into emerging managers, (not on any buy-lists) beyond just screens, filters and boiler-plate DDQs, if they are investment-worthy.
Recognising that the typical consulting model does not lend itself to extensive due diligence on below-the -radar managers, investors (outside of those who run exclusive emerging manager programs and have qualified in-house resources) should seek an independent 360 degree evaluation of a manager customized to the related investment opportunity.
This is quite different from getting just an investment (buy) recommendation. This is akin to independent reviews sought of financial auditors, independent valuators, third party administrators and now even ESG consultants.
The current intellectual gap in the institutional marketplace to source and deep-dive into niche opportunities, is encouraging the emergence of independent investment auditors, each with their own specialty, examples include venture, macro, infrastructure, private equity, emerging markets.
This democratisation of research and due diligence for a new investing paradigm also finds an echo in the newly introduced MiFid II rules (in Europe) that call for separation of investment research from execution where the latter in this context is analogous to strategic investment consulting.
In other words, unbundling consulting dollars to pay for best of independent research ideas and due diligence, to gain an instant head-start for professional trustees with investment acumen, is the need of the hour.
For those asset allocators confined to traditional ways, this might seem a utopian fantasy; for those progressive-minded, reoriented to navigate a new investment world, specialist independent investment auditors are on the horizon.
Kamal Suppal, CFA is chief investment auditor of Boston-based Emerging Markets Alternatives, an independent investment audit firm specialising in the due diligence of alternative strategies in emerging markets.
