False Pretenses in Institutional Asset Management

Abstract

From an initial position engaging mainly in ex post portfolio performance monitoring, investment consultants have come to occupy the central ex ante roles in conventional arrangements, advising on objectives, strategy, asset management structure, and portfolio management selection in the five-stage process that constitutes the standard model. The author identifies the theoretical, empirical, and regulatory factors that facilitated this fundamental change, which cannot be accommodated in the existing literature. As consultants can no longer be regarded as agents but are, in effect, either quasi-principals or principals, the author examines whether they have the skills necessary to execute these enhanced responsibilities, concluding that they do not. So, clients following consultants’ recommendations may be allocating assets on false pretenses, as one recent empirical study suggested. Demonstrating that investment consultants, not asset managers, have become the dominant players in the investment chain, the author’s analysis produces other uncomfortable conclusions from the conventional perspective: first, that regulators and consultants are in a symbiotic relationship, and second, that asset management is necessarily characterized by asymmetric information but consultants are powerless to address it.