Optimism as a business model: Why investment consultants can't afford to recommend simplicity
- Robin Powell
- 1 hour ago
- 14 min read
Investment consultants can't afford to recommend simplicity. Their business model requires optimism about complex alternative investments, regardless of evidence. That's the finding of new research from Stanford and Harvard. Since 2001, consultants have systematically raised their return assumptions for alternatives — not because performance improved, but because complexity generates fees. Billions in pension capital have been allocated accordingly.
Picture the boardroom: A pension trustee sits across from their investment consultant, reviewing a glossy presentation recommending increased allocations to private equity, infrastructure, or hedge funds. The projected returns look compelling — 10% to 12% annually. The consultant's confidence is absolute. The data appears robust. The trustee approves the allocation, trusting the expertise they're paying handsomely for.
Fast-forward five years. The returns haven't materialised. The portfolio's complexity has grown. The fees have mounted. But here's the curious thing: the consultant is now recommending more alternatives, with fresh optimistic projections and new asset classes to consider. The cycle repeats.
How did we get here? And why does this pattern persist across continents and decades, despite mounting evidence that complex alternatives-heavy portfolios often underperform simple, low-cost indexed strategies?
New academic research provides the answer — and it's more troubling than most trustees realise. The entire alternatives boom may be built not on evidence of superior performance, but on a structural conflict that makes optimism essential to consultant survival.
The evidence: A systemic problem
A June 2025 study by Juliane Begenau of Stanford Graduate School of Business, Pauline Liang of Stanford, and Emil Siriwardane of Harvard Business School documents how US public pension funds have fundamentally reshaped their portfolios since 2001. Alternative assets like private equity, real estate, and hedge funds accounted for just 14% of risky investments in 2001 but grew to 39% by 2021.
What drove this seismic shift? The researchers' answer is unambiguous: consultant beliefs about the risk-adjusted returns of alternatives played the central role.
The study analysed capital market assumptions published by general consultants who advise nearly all public pensions on asset allocation. These assumptions embed consultant beliefs about expected returns and risk for different asset classes. The findings are striking: on average, consultant-reported beliefs about the "alpha" (excess returns) of alternatives increased by 58 basis points since the early 2000s.
More importantly, the research establishes causation, not mere correlation. Using sophisticated statistical techniques — including instrumental variables based on geographical proximity between pensions and consultants — the researchers show that rising consultant optimism causes increased alternatives allocations. This causal effect accounts for roughly one-third of the increase in cross-sectional variation in alternatives allocations since the 2000s.
In plain English: pensions didn't independently become more optimistic about alternatives based on improving evidence. Their consultants became more optimistic, and client portfolios followed suit.
"Pensions didn't independently become more optimistic about alternatives based on improving evidence. Their consultants became more optimistic, and client portfolios followed suit."
The use of alternatives in pensions
It's a similar picture in the UK
Across the Atlantic, the UK's Competition and Markets Authority conducted an exhaustive investigation into the investment consultancy sector in 2018, documenting structural conflicts that mirror the US findings.
The numbers tell the story. Approximately half of pension schemes that purchased fiduciary management services appointed their existing investment consultant to supply those services. This matters because fiduciary management fees are generally four to five times higher than investment consultancy fees, while profit margins remain similar across both services.
Trustees recognised the problem. The CMA found that 60% of pension scheme trustees perceived investment consultants using their position to steer clients into their own fiduciary management services as a problem. Among professional trustees and trustees of larger schemes, concern ran even higher.
The CMA also documented how conflicts manifested in practice. Consultancy firms offering both advisory and fiduciary management services rarely mentioned rival providers in early-stage advisory documents. Written disclosure of conflicts often occurred only in later-stage letters — after trustees were already proposing to appoint the firm.
Meanwhile, 54% of trustees perceived that business relationships between consultants and asset managers affected the independence of manager ratings, creating another layer of potential bias toward complexity.
The academic validation
Academic research by Tim Jenkinson, Howard Jones, and Jose Vicente Martinez adds crucial detail. Their 2014 study found that despite consultant recommendations generating massive fund flows and major asset movements, there is no evidence these recommendations add value or successfully predict superior future performance.
Let that sink in: investment consultants move billions in capital, yet produce no measurable improvement in outcomes.
"Investment consultants move billions in capital, yet produce no measurable improvement in outcomes."
The research revealed that consultant recommendations are driven predominantly by "soft investment factors" — whether the manager possesses a capable team or consistent philosophy — rather than historical fund performance. Consultants also tend to favour larger investment products, despite evidence that funds managing more assets often perform worse due to diseconomies of scale.
Perhaps most tellingly, consultants generally don't disclose past recommendations or performance data in ways that allow plan sponsors to reliably measure their accuracy. This opacity means clients cannot determine whether their consultant adds value — a deeply problematic information asymmetry.
Three independent sources. Three continents. The same conclusion: the system is structurally biased toward complexity, and clients are paying the price.
The structural trap: Why investment consultants can't recommend simplicity
To understand why this happens, we need to examine how the investment consulting business model evolved, and why it now depends fundamentally on complexity.
From reporters to product salespeople
In the 1970s and 1980s, investment consultants performed a straightforward service: performance reporting. Institutional clients needed someone to track their investments and benchmark their results. The service was valuable, the fees reasonable, and the conflicts minimal.
Competition changed everything. By the 1990s, performance reporting alone couldn't differentiate firms. Consultancies began adding proprietary asset allocation models and active manager recommendations. They weren't just reporting anymore — they were making recommendations that profoundly shaped client portfolios.
Then came the 2000s and the Yale Endowment model. David Swensen's success with alternatives at Yale gave consultants a powerful differentiation strategy. Suddenly, expertise in private equity, hedge funds, real estate, and infrastructure became premium services. Consultants marketed themselves on their alternatives expertise and ability to construct complex multi-asset portfolios.
The trap had closed. Simple advice — buy low-cost index funds, maintain a sensible asset allocation, rebalance periodically — commoditises the service. Any trustee with basic financial literacy can implement such a strategy. Complex portfolios, by contrast, require ongoing due diligence, manager selection, performance monitoring, and rebalancing across numerous asset classes. This generates recurring revenue year after year.
"Simple advice — buy low-cost index funds, maintain a sensible asset allocation, rebalance periodically — commoditises the service."
Career suicide
Warren Buffett diagnosed this problem with characteristic clarity in his 2016 letter to Berkshire Hathaway shareholders. Describing how mega-rich individuals and institutions ignore his advice to use low-cost index funds, Buffett wrote:
"Instead, these investors politely thank me for my thoughts and depart to listen to the siren song of a high-fee manager or, in the case of many institutions, to seek out another breed of hyper-helper called a consultant. That professional, however, faces a problem. Can you imagine an investment consultant telling clients, year after year, to keep adding to an index fund replicating the S&P 500? That would be career suicide."
Career suicide. Not because the advice is wrong — Buffett has demonstrated conclusively that low-cost indexing beats active management for most investors over time. But because the economic model of investment consulting requires selling something more elaborate than simplicity.
The self-reinforcing cycle
Once you understand the structural conflict, the cycle becomes clear:
First, consultants project optimistic returns for alternatives. These projections stem not from improving evidence, but from business necessity. Optimism justifies the recommendation.
Second, trustees allocate capital based on these projections. They're dependent on consultant expertise; they lack the internal capability to challenge the assumptions rigorously.
Third, complex portfolios require extensive ongoing support. Due diligence on private equity managers, monitoring hedge fund strategies, evaluating infrastructure investments — all of this generates fees and justifies the consultant's value.
Fourth, when performance disappoints (as it frequently does), consultants recommend different alternatives with new optimistic projections. Perhaps private equity returns were below expectations, but infrastructure looks promising. Or perhaps hedge funds underperformed, but private debt offers compelling yields.
Fifth, the cycle repeats. Complexity begets more complexity. Each iteration generates fees. And the portfolio grows ever more difficult for trustees to evaluate independently.
The accountability gap
Perhaps the most insidious aspect of this dynamic is what Mark Higgins of Index Fund Advisors calls the "non-discretionary cloak of invisibility".
Investment consultants make recommendations but don't have discretion. Trustees make the final decisions. This means consultants bear no legal accountability for outcomes. Yet trustees depend entirely on consultants' data, assumptions, and analysis. Consultants even choose the benchmarks against which plan performance is evaluated — a deeply conflicted practice.
A 2023 study by Niklas Augustin, Matteo Binfarè, and Elyas Fermand found that private equity benchmarks have migrated toward lower and lower thresholds of outperformance over time. In plain English: consultants have systematically lowered the bar by which their own recommendations are judged.
Higgins poses a simple challenge: "Ask an investment consulting firm to provide a third-party assessment of their fund manager hire-and-fire recommendations." Few firms voluntarily provide this information, he notes, because they either never thought to analyse their track record, don't want to because of what it might reveal, or have analysed it but won't share the results.
None of these explanations inspire confidence. But the non-discretionary structure shields consultants from having to demonstrate whether their recommendations offer any value.
This is the structural trap: investment consultants compete on expertise in areas where expertise may not meaningfully improve outcomes, recommending strategies that generate fees regardless of performance, while escaping accountability for results. And the entire system is held together by optimism — optimism that happens to align perfectly with consultant business interests.
The cost of optimism: The performance gap
If consultant optimism were vindicated by strong alternatives performance, this analysis would be moot. Perhaps complex portfolios do justify their costs. Perhaps alternatives deliver the superior returns consultants project.
The evidence suggests otherwise.
The promise, the reality, and the reckoning
The story of alternative assets over the past two decades unfolds in three acts.
Act one, the 2000s, was all promise. Consultants projected 10% to 12% returns from alternatives. They emphasised diversification benefits, reduced correlation with traditional assets, and access to unique return streams unavailable in public markets. The pitch was compelling: sophisticated institutions could access opportunities ordinary investors couldn't, and the illiquidity premium would reward patient capital.
Act two, the 2010s, brought reality. Performance varied wildly across alternatives. Some vintages and strategies succeeded; many didn't. Fees mounted relentlessly. Liquidity became a constraint rather than a feature, particularly during market stress. And correlations with traditional assets proved disappointingly high exactly when diversification mattered most.
Act three, the 2020s, has been the reckoning. Academic research now documents the gap between consultant projections and delivered returns with uncomfortable precision.
Hedge funds: Inflated by systematic biases
Hedge fund performance data suffers from severe methodological problems that systematically overstate returns.
Survivorship bias occurs because databases include only funds that currently exist, omitting returns of defunct funds — which are typically the unsuccessful ones. One analysis covering 1996 to 2003 found that average returns for surviving funds (13.50%) significantly exceeded average returns for all funds (9.71%), representing a difference of 379 basis points.
Backfill bias compounds the problem. Managers typically begin reporting to databases only after achieving favourable initial results, which are then retrospectively added. Between 1994 and 2003, backfilled returns were on average over 500 basis points higher than contemporaneously reported returns.
After correcting for these biases, hedge fund returns are substantially lower and funds riskier than commonly supposed. Moreover, research demonstrates that much of hedge fund performance can be explained by exposures to systematic risk factors rather than unique managerial skill. Passive portfolios can replicate a significant fraction of hedge fund returns using liquid, exchange-traded instruments — undermining the entire premise that hedge funds offer unique alpha.
"After correcting for biases, hedge fund returns are substantially lower and funds riskier than commonly supposed."
Funds of funds, which many institutions use to access hedge fund strategies, impose a double layer of fees that substantially erodes net returns. The cure, it seems, is often worse than the disease.
Private equity: A more nuanced picture
Private equity presents a more complex story, though one that still challenges consultant optimism.
Historical data on North American buyout funds for vintage years 1984 through 2010 shows an average Public Market Equivalent (PME) of 1.25, suggesting meaningful outperformance of public equities. However, this historical track record needs important context.
For North American private equity funds raised between 2006 and 2015, the pooled PME relative to the S&P 500 was 0.99 — suggesting performance was generally in line with public equity, not superior to it. Venture capital performance has been highly cyclical, with particularly strong returns for 1990s vintages that dropped dramatically post-1999.
Perhaps most damaging to the case for alternatives: performance persistence in buyout funds has "largely disappeared" over time. The ability to identify top-performing managers based on past results — once a core justification for active alternatives allocations — no longer holds. As fund sizes have increased, performance has deteriorated, reflecting the challenges of scaling successful strategies.
Where private equity has created value, it's primarily through operational improvements within portfolio companies rather than financial engineering or market timing. These operational improvements could theoretically be achieved without paying the significant fee premium that private equity demands.
The fee compounding effect
Behind all these performance questions lurks a brutal arithmetic reality: fees compound.
Alternative investments impose layered fees that cascade through the structure.
Management fees, performance fees, fund-of-funds fees, consultant advisory fees — each layer takes its cut. The traditional "2 and 20" structure (2% management fee plus 20% of profits) remains standard across hedge funds and private equity. Fund-of-funds arrangements add another layer, typically charging "1 and 5" on top of the underlying fund fees. Consultant advisory services add further costs. These fees are often opaque, varying widely even among investors in the same fund.
A simple thought experiment illustrates the impact. Consider two portfolios, each starting with £10 million and earning 8% gross returns annually over 20 years:
Portfolio A holds low-cost index funds with total fees of 0.15% annually. Portfolio B holds a complex alternatives-heavy mix with all-in fees of 2.5% annually.
Portfolio A grows to £43.2 million. Portfolio B grows to £29.2 million. The fee difference — 2.35 percentage points annually — destroys £14 million of wealth, or 32% of what the portfolio should have grown to.
"The fee difference destroys £14 million of wealth, or 32% of what the portfolio should have grown to."
As Jack Bogle observed: "The tyranny of compounding costs can devastate the miracle of compounding returns." Research demonstrates that even a modest 1% annual fee can diminish total returns by as much as 30% over a 35-year investment horizon. Under higher fee arrangements, the damage accelerates. Investors lose not just the fees themselves, but the compounding returns those fees would have generated — what researchers call "negative compounding."
This isn't theoretical. This is what consultants' optimistic projections have cost real pensioners, endowments, and foundations over the past two decades.
Breaking free: What trustees must demand from investment consultants
The good news: trustees hold the power to change this dynamic. The system persists because clients allow it to persist. Demanding better starts with specific, concrete actions.
Demand radical transparency
The first step is simple: ask for evidence.
Request a verified, third-party assessment of your consultant's track record of past recommendations. Not client testimonials. Not marketing materials showcasing winners. A comprehensive, independently audited analysis of every manager hire and fire decision, showing how recommended managers performed relative to appropriate benchmarks.
If your consultant cannot or will not provide this, ask why. The inability to demonstrate value after years or decades of recommendations tells you everything you need to know.
"The inability to demonstrate value after years or decades of recommendations tells you everything you need to know."
Demand full disclosure of all revenue relationships between your consultant and asset managers they recommend or rate. How much do they earn from conferences, data services, or other arrangements? How might these relationships influence their supposedly independent advice?
Require clear explanation of benchmark selection methodology. Who chooses the benchmarks? How are they adjusted over time? Are they designed to make performance look good or to genuinely evaluate whether the strategy adds value?
Finally, insist on all-in cost disclosure. Not just headline management fees, but performance fees, fund-of-funds charges, transaction costs, and any other expenses embedded in your alternatives allocations. Many trustees are shocked when they finally see the total cost of their "sophisticated" portfolios.
Question the assumptions directly
When your consultant proposes alternatives allocations, ask pointed questions:
"What's your evidence that these alternatives will outperform public markets? Not your projections — your evidence from comparable historical cases."
"Why have your alpha assumptions for alternatives risen over time? What changed in the underlying reality to justify higher expected returns?"
"If we simplified our portfolio to low-cost index funds, what would we lose besides your fees? Specifically, what value do you add that couldn't be replicated more cheaply?"
"Can you show us how your past projections for alternatives compared to actual delivered returns?"
These questions are uncomfortable. They should be. The discomfort comes from forcing a conversation about evidence rather than assumptions, about track records rather than marketing, about fiduciary duty rather than business development.
Test the market properly
If considering fiduciary management, formally tender to multiple providers. Never rely solely on your existing consultant's recommendation of their own fiduciary management service — this is the conflict the CMA identified as most pernicious.
Where possible, separate your investment consultancy and fiduciary management relationships. The four-to-five-times fee differential creates powerful incentives for conflicts.
For smaller schemes, explore pooled arrangements that provide institutional-quality implementation without requiring complex advisory relationships. The UK's Local Government Pension Scheme pools, for instance, offer sophisticated capabilities with better governance and fee negotiation.
Consider strategic simplification
Here's the uncomfortable truth investment consultants won't tell you: evidence suggests simple portfolios of low-cost index funds often outperform complex alternatives-heavy strategies, especially after fees.
"Evidence suggests simple portfolios of low-cost index funds often outperform complex alternatives-heavy strategies, especially after fees."
This doesn't mean trustees no longer need consultants. Governance remains crucial. Implementation requires expertise. Rebalancing demands discipline. Risk management deserves attention.
But consultant value must come from these genuine services, not from complexity theatre designed to justify fees. Investment consultants who accept this reality — who acknowledge that their worth stems from helping clients avoid costly mistakes rather than from constructing elaborate portfolios — will survive and thrive.
Signs of hope: Reformed consulting models exist
Change is possible because some consultants are already leading it.
Industry reformers like Charles Ellis and Richard Ennis have spent decades advocating for evidence-based simplicity over complexity. Their work demonstrates that consulting businesses can succeed while prioritising client outcomes over fee generation.
Some firms now focus on governance advice, implementation support, and behavioural coaching rather than constant portfolio tinkering and manager selection. They help trustees understand realistic return expectations, avoid common pitfalls, and maintain discipline during market turbulence.
These consultants voluntarily disclose their track records. They recommend index funds where appropriate. They acknowledge when simpler strategies would serve clients better. And remarkably, they remain commercially successful — because trustees recognise genuine value when they see it.
As Mark Higgins of Index Fund Advisors notes: "Those who accept this reality will discover that clients still need their services. In fact, by spending less time on unnecessarily complex portfolios, hiring and firing managers, and conducting expensive forays into esoteric asset classes, consultants can focus on long-neglected problems and reestablish their reputation as trusted advisers."
The Begenau et al. study makes denial increasingly difficult. The academic evidence is now overwhelming. Regulatory scrutiny is intensifying. The question is whether trustees will act on what they now know before another decade of capital gets allocated based on forecasts designed to benefit advisers more than clients.
The consultant's dilemma isn't going away without pressure from those who pay the bills. Trustees hold the power to demand better — to insist that recommendations stem from evidence rather than optimism, that complexity serves clients rather than consultants, and that transparency becomes the norm rather than the exception.
The academic research is now undeniable. The regulatory investigations have confirmed the conflicts. The performance gap between promise and reality has been quantified. What happens next depends on whether trustees find the courage to ask difficult questions and demand honest answers.
Because optimism isn't a strategy. It's a business model. And after two decades of disappointing alternatives performance, clients of investment consultants deserve better.
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