Q&A: Dr Onur Sefiloglu
Why did you decide to research this area?
“It’s a fascinating area in the nexus between PE firms and US public pension funds, which are both interesting types of organisations. PE is a challenging asset class for investors – they have to select and invest in fund managers, but they then have no discretion about how their capital is deployed and they can’t get it back until the manager exits investments. Performance in the asset class is also highly disputed.
“The US public pension plans are massive; they manage almost US$6trn and they invest heavily into PE. They are interesting because they are managed by trustees who are mostly politically appointed, and so they have different incentives and internal mechanisms from other institutional investors. It’s vital that they make the right investment decisions, because they are managing ordinary people’s money; teachers, firefighters and so on who rely on that money for their retirement. Investment consultants are one of the most important tools that they use in making those decisions – and by my rough calculations, they are spending hundreds of millions of dollars annually on them.”
You found some interesting results regarding consultants’ contributions to PE investments, didn’t you?
“Yes, my research split the consultants into generalist and specialist, and I found that the specialists add value, which is not entirely surprising. The generalist consultants are there to set up investment processes and help with asset allocation or other roles within the organisation. By contrast, the specialists have one role, which is to identify the right PE funds, and they are experts at this. This finding highlights the importance of access to information in PE.
“My results differ from two earlier studies. That’s likely to be because those papers examine a different institutional set-up, where consultants are assumed to be directly responsible for investment selection. My study distinguishes the roles played by consultants and internal investment teams.”
Investment consultants are one of the most important tools that US public pension plans use in making investment decisions – and by my rough calculations, they are spending hundreds of millions of dollars annually on them.
So how did you approach researching the effect of these organisational differences?
“My study was designed to capture the different ways that pension plans work with consultants. Some transfer all responsibilities to them, but others don’t. So, I distinguish every PE fund selection according to whether it is driven by consultants or by the internal team. It’s a proxy and it’s not perfect, but it helps to identify a consultant’s contribution.
“I found that when pension funds have better governance, are experienced and have high-quality trustees, these complement the consultant’s expertise and the investments perform better: consultant-driven PE fund selections outperform internally driven selections by around 1.3% a year. This is particularly pronounced for higher-risk strategies, where there is a higher dispersion of returns or where the probability of losing capital is higher, such as in early-stage venture capital and smaller buyouts, where investors might need more support. The caveat is that this does not take account of consultants’ fees, because that information is not available. It is highly probable that fees eat up some of that contribution.”
How do you account for this difference?
“My results suggest that you have to combine consultants with solid internal governance and a collaborative working relationship that lets them work freely, otherwise you won’t benefit from them. Simply hiring a consultant will not lead to outperformance.”
So what do you think is going on there?
“Public pension plans are political institutions. Research already shows that political affiliations can affect their investment decisions – there tends to be an in-state bias, for example. There is also evidence that those with the highest number of politically affiliated trustees tend to underperform others. So, even if you hire the best investment consultant, if you move away from their recommendations because of other motivations or agendas, it is unlikely to turn out well.”
A big message is that LPs need to choose and use their consultants wisely. They need to find PE specialists because these are the consultants that add value.
What does your research tell us about the contribution consultants can make, given the right conditions?
“There is a view that consultants’ main contribution is access. That is based on the idea that inexperienced investors will find it challenging to get into oversubscribed funds – the ones that have performed well in the past. But my research finds that this is not the main contribution. Rather, they add most value through expertise and informational advantage. That’s important for public institutions that may have access to funds because they invest large amounts, but that often have small teams that may not even include a chief investment officer. Unlike many other institutions, they lack resources and investment expertise.”
Overall, what should LPs take away from your research?
“A big message is that LPs need to choose and use their consultants wisely. They need to find PE specialists because these are the consultants that add value. But they also need to be aware of conflicts of interest where a consultant has launched its own PE product as a fund of funds, especially since that adds an extra layer of fees. It’s quite usual for consultants to set up separate accounts for their LP clients, but today, more of them are establishing pooled vehicles. LPs need to be very careful about separating the consultant and fund manager roles.”
What other research would you like to see in this area?
“We are only at the beginning of research on investment consultants because there is limited information out there. One area I’d like to research further is how public pension plan trustees reach decisions on each PE fund. Trustee board meeting minutes contain precious information about the interactions between trustees and consultants. Now, with the development of large language model processing, it’s much easier to dig into the reams of minutes that are publicly available. The other avenue – and I’m currently working on it – is how the US election cycles affect public pension fund PE manager selection.”
