Consultants, Fear and Portfolio Manager Incentives

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.

25 thoughts on “Consultants, Fear and Portfolio Manager Incentives

  1. tw says:

    A guy I worked for in construction years ago called them “insultants” for this very reason. He said he could go on a large industrial project, look at the guys sitting around without listening to management, then tell them he would walk around on his own. He would then go and talk to the guys paying most attention to the walk through. These guys (the average tradesman/employee) knew what the problem was and how to solve it….which he would present to management and then charge a rich fee: Insultant. Beautiful.


  2. […] Interloper, “Business and pension consultants make a f*ckton of money playing on their clients’ fears of being fired.”  (Interloper) […]

  3. Duluth 307 says:

    Whose bread I eat his song I sing — with charts if need be.

  4. Great Post!

    “Style Drift” is despicable! As is the urge to “gain exposure” to every asset class imaginable at all times. Another bete noire of mine is “core/satellite” holdings or the extreme decomposition and attribution of performance statistics to the nearest basis point on a weekly or monthly basis.

    These are CFA/MBA taught, and industry consultant fostered wastes of time. They are one of the major reasons that banks feel compelled to employ droves of quant analysts, fund analysts and portfolio construction analysts to produce overly “precise” Excel Noise in a constant treadmill of justifiying one’s own existence that permeates through every level of management.

    • Interloper says:

      It seems like an exercise in constantly moving the goal posts, then convincing clients that “this is what everyone’s looking for”. This from a group of people that could never, in their wildest dreams, manage money or run a company themselves.

  5. Someone says:

    I always thought the only reason these chaps exist is to do the transferral of blame/responsibility for pension funds. Fund of funds too.

    Just came across your blog, some really interesting stuff, keep it up!

    I was thinking of doing similar, had a chat to a guardian journo as a warmup:

    • Interloper says:

      Thank you very much. It is totally a blame/ass covering game. Pls feel free to email me if you have any questions on blogging, not that I’m any kind of authority, but I did only start recently.

    • “A firm put out this very good report, and on page five they wrote: ‘Whoever rips this page out and sends it to us gets £50.’ I believe they ended up paying out only £250. Apparently few of their other clients had gotten as far as page 5 of the report as investors are deluged with information daily.”

      Incredible! I suspected this was the case but that is ridiculous! No-one reads beyond their own house publications. As Marc Faber said “if you don’t read for at least 3 hours a day, you are a fool if you think you’re well informed.”

      • Interloper says:

        The trick at this point is figuring out who’s worth reading, and reading it like a Victorian. Scanning is understandable, but not good.

      • kris says:

        Even Mark Faber just twisted his freaking “prediction”. Two weeks ago he said that stocks will collapse 20% (or sth like that). Today, as per CNBC, “a bottom is forming”. Let me not swear, cause it’s gonna be bad.

  6. I agree, not all strategists are created equal! Or as you discussed, are they incented to tell you their truthful view! Are we all to believe that every sell side equity strategist independently arrived at a 7-10% increase in the index for 2012, and every other year forward forecast in history?!

    I would be interested/grateful if you would share a list (either as a post or in an email) of the strategists/commentators/fund managers/authors you find the most useful.

    • kris says:

      Michael Mauboussin and moreover Kahneman are saying that all is luck. Nobody could forecast based on a trillion moving parts.

  7. I remeber reading that very term “Style Drift” in a Vanguard Prospectus (long time ago, don’t remember which one) had no idea what it meant.

  8. Interloper says:

    ReFaber:No Zimbabwean inflation this time?

    • kris says:

      Nooooooooooooooooo Man! He’s saying that “we should invest in the US for next 3 months. Indian stock market particularly will be a greeeeeeat opportunity”. Kyle Bass is right, my man, do your freaking homework. That’s why we love you, Interloper, you are helping us with the homework.

    • Dennis says:

      2008 left a huge psychological need among certain people to predict the end of the world as some sort of moral punishment for the sins of capitalism/individualism/whatever. They congregate at zerohedge and claim that doom is upon us every couple of weeks.

      I still think my favorite doom predictor was a contributor at dealbreaker who briefly ran a mocking “Obama investment advice watch” around March 09 following the Prez’ ‘buy stocks, they are good investment.’ Obviously the poster stopped once the S&P reached 4 digits again and instead retreated to more obscure corners of the internet to drip venom and doom mongering.

  9. ToNYC says:

    Duh!. That’s why I only talk to CEOs and Founders.

  10. Jonas says:

    Good post. It’s one of the unintended consequences of transparency, when the people doing the judging are no more accurate than the people getting judged.

    So people fairly high up, who ideally you want to be forward looking, instead spend most of their time following the crowd and making hindsight decisions.

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