Concerns over investment consultants' impartiality
Investment consultants need to be more tightly regulated amid criticism that some are accepting “finders’ fees” in exchange for broking introductions or deals between their hedge fund and investor clients.
“There is a significant conflict of interest when product providers provide a fee. This may be of very different amounts which can alter the intermediaries’ incentives to make particular recommendations. Disclosure helps but, in the real world, it is not the full answer. In the retail world, the Financial Services Authority (FSA) will try to deal with the same issue via the Retail Distribution Review (RDR),” said Peter Astleford, partner at international law firm Dechert.
RDR seeks to clamp down on financial advisers’ commission, which the FSA argues discourages impartial financial advice to retail clients. “The FSA has been wrestling with this issue for some time” commented Astleford.
Under MiFID (Markets in Financial Instruments Directive), consultants, which are regulated by the FSA, are required to disclose to investors whether they receive commission for introducing them to fund managers. However, some consultants, particularly smaller ones, are not regulated entities and therefore are under no regulatory obligation to disclose whether they receive fees for introducing prospective investors to hedge funds.
There is debate about how widespread finders’ or introductory fees are among consultants. One institutional investor said the practice was more commonplace among smaller consultants as larger ones tend to have better awareness of conflict of interest issues. However, Astleford is somewhat cynical. “It is more widespread than most people would think,” he said.
Investment consultants have captured a significant chunk of funds of funds’ (FoHFs) market share since 2008 and provide advice to numerous institutional investors including pension funds. Many consultants tend to recommend larger, safer managers to their client base in order to mitigate the risk of a bad investment – although consultants do not invest in the managers they recommend. Major consultants will often provide analysis and vetted investment opinion about hedge funds to their investors for a fee.
Consultants have also been criticised, particularly by FoHFs, for focusing solely on established managers at the expense of emerging hedge funds. Managers on consultants “buy lists” are experiencing massive inflows, which could lead to stifling of returns, risk concentration and fewer opportunities for new managers to break into the industry. However, as more pension funds start to allocate into alternatives, consultants are going to keep growing.