How to listen to the experts
As private markets become increasingly popular among institutional investors, those with limited resources often turn to investment consultants to help them select the right funds to back. But do they add value? And if so, how?
Dr Onur Sefiloglu
Dr Onur Sefiloglu is a lecturer in finance at Essex Business School, University of Essex. He completed his PhD in finance at Bayes Business School, City St George’s, University of London. His research interests include private equity and financial technologies.
Choosing the right private equity funds to commit to is a complex and time-consuming task for any institution, but it is particularly so for many US public pension plans, which often lack sufficient investment expertise, the resources required to map the market and the time to conduct sufficient due diligence to sort the best from the rest. Given the importance of backing strong performers in an asset class characterised by significant return dispersion, many turn to investment consultants for advice on where and how to deploy their PE allocations.
What contribution do consultants make to these limited partners’ investment performance? A new academic research paper, ‘In Pursuit of Information: Investment Consultants and Private Equity Fund Selection‘, examines this question. We discussed the findings with its author, Onur Sefiloglu.
‘In Pursuit of Information: Investment Consultants and Private Equity Fund Selection‘ by Onur Sefiloglu (Essex Business School, University of Essex) examines whether and how investment consultants add value to the PE fund selection process for US public pension funds.
Using 13,479 commitment observations made by 191 US public pension funds between 1998 and 2020, the research distinguishes between investment decisions likely driven by consultants and those by internal teams, and also between those made by specialist consultants and those by generalists. It finds that consultant-driven PE fund selections outperform internally driven commitments by between 1.0% and 1.3% annually. It also finds that this outperformance is more pronounced (at 2.9% annually) in higher-risk strategies, such as early stage VC and smaller buyouts, where return dispersion is greater and where the probability of losing capital is higher, than in lower-risk strategies (0.5%), such as secondaries or mezzanine debt. This outperformance is concentrated among specialists, with generalist consultants making contributions that are statistically insignificant.
Finally, the results suggest that consultants contribute primarily by offering informational advantages to their clients rather than by providing greater access to the best-performing funds.
Allied to this, the consultants’ contribution is typically greater among public pension funds with the highest level of expertise than among those with minimal expertise. Public pension plans therefore cannot rely on consultants to fill skills gaps but should rather view them as providing complementary expertise to already knowledgeable teams.
