In the late 90s, I lived in a big house with four other guys, only one of whom was in finance. One, I’ll call him Rob, was in business consulting. Rob was a recent graduate of one of the world’s top engineering schools, not CalTech or MIT, but always mentioned among them. As a Microwave Engineer he had perfect timing, this being the late 90s during the great information highway build out. His company flew him all over the country and charged $500 an hour for his work plus expenses, the latter including funds to fly home every weekend which, if he didn’t use, he kept (got a nice set of golf clubs for working one weekend).
His biggest project during the period was a TMT company that had been falling behind technologically and wanted advice as to future investment and restructuring. Rob, bulldog that he was, worked 14 hours per day analyzing, interviewing and studying the competition for, if memory serves, about 10 weeks. His conclusion was that the company was unlikely to catch-up in terms of novel technology and profitability would be much better served by “sticking to their knitting” or historical core competency.
The way Rob described it, the process for these things was for him to take his giant binder of full color charts and graphs, the fruits of his expertise and hundreds of hours of effort, and present it to a partner at his firm. The partner, in turn, would present the conclusions to corporate management. After this meeting took place, the partner’s reaction was something along the lines of “ This is excellent work, but I can’t tell them this. There would be no more business in it for us”. In the end, the partner took three graphs from the binder, and built the rest of his presentation to management out of in-house material outlining the future riches available through mass investment in the wonders of new technology.
Thankfully, I have only had passing contact with management consultants; usually they were calling me for insight after winning a new contract (for free – this pissed me off no end). I have no idea if this story is an outlier or if it is indicative of a bubble environment that has changed since. I have had, on the other hand, extensive experience with pension consultants. Some, I’ll mention Northern Trust here, are actually very good. Others show all the hallmarks of Rob’s old partner.
In discussing pension consultants, the key is to recognize that the incentives for pension managers are, with few exceptions, very, very different than for the average investor. Investors are afraid to lose money; pension managers are terrified of underperforming the benchmark. Underperforming the benchmark gets you fired. Following the benchmark lower during a bad year is not notable. Beating the index by a wide margin is usually considered a very bad thing, indicative of risk (they still focus on standard deviation, although will provide 90 pages of other stuff) that could, the following year, result in underperformance of the benchmark. Which will get you fired.
The levels of complexity built into the simple “don’t trail the benchmark, ” rules are unbelievable. There are 25, slightly different terms for index hugging – Information Ratio, Tracking Error, Style Drift* – that turn common sense into particle physics. The creation of “appropriate” benchmarks is, of course, the sole purview of Nobel Prize winners. This isn’t the Paleolithic era – you can’t use 60-30-10! If it weren’t crazy complicated, why would you need a consultant? Of course you need to know about the complicated private real estate transactions the endowments are doing and, for a fee, we can tell you how to do it yourself!
Business and pension consultants make a fuckton of money playing on their clients’ fears of being fired. Consulting companies have armies of brilliant, well paid dudes and lady dudes like my friend Rob who constantly derive new insights for the partners to manipulate into pitches for new business. But in almost every case I’ve seen, consultants are hired to tell managers and management things they already know, the hope being that the shiny new report will give them the backing they need to do things they already know they need to do. The (usually inevitable) failure to implement the strategy results in a new round of consultancy. And so it goes, round and round, proving again that fear trumps intelligence whenever big sums of money are involved.
*”Style Drift” is an awesome, all-purpose weapon for messing with the heads of PMs. If, for example, I were looking to get my way on any question regarding a value versus growth fund, I would just move utility, bank and pipeline stocks between value and growth benchmarks. I’d have good reasons, too – see Appendix 9 for methodology.