Outsourced Investment Management: Choosing the “Right” OCIO
A growing number of institutional investors are seeking to improve cost efficiency, governance, and investment decision-making by outsourcing their investment management to an outsourced chief investment officer (OCIO). In what Institutional Investor describes as an OCIO “earthquake,” assets under full or partial management by OCIOs have risen to over $1.6 trillion and are anticipated to exceed $2 trillion within the next five years. What is driving the OCIO renaissance and how can an institution ensure that it picks the right OCIO for its needs?
The OCIO Avalanche
For decades, OCIOs quietly served clients such as mid-sized company pension plans which lacked the internal skills and resources to implement their own investment strategies and were concerned about properly executing their fiduciary duties under laws like the Employee Retirement Income Security Act (ERISA) in the US.
Today, however, OCIO clients include an ever-growing array of institutions, such as nonprofit organizations, large public pension plans, healthcare organizations, insurance companies, and family offices. Such institutions are entrusting ever-more capital to OCIO firms such as Russell Investments, SEI, Mercer, and State Street.
Much of the growth in OCIO assets under management (AUM) has been driven by the increasing complexity of managing assets in the post-crisis environment. The last decade has seen the introduction of extensive new risk management requirements and heightened conduct standards for investment managers. At the same time, returns from alternative assets such as hedge funds and fixed income assets – both of which asset classes are favored by many yield-seeking institutions – have been subdued.
Burdened with additional regulation and struggling to meet their investment goals, more and more institutions have turned to OCIOs, which promise highly professional, alpha-generating investment management services coupled with effective risk management and monitoring.
The growth in the scope and scale of OCIO providers has attracted new entrants to the industry. Asset management giant BlackRock, for example, has expanded its OCIO operations significantly, putting pressure on existing players, margins, and business practices.
The growth in the OCIO space has also had an impact on the broader asset management industry. OCIOs typically have discretion over the selection of managers and day-to-day investment decisions. Thus, many asset managers are reorganizing their processes to better target OCIOs with many billions of dollars under management.
Choosing the Right OCIO
Research by Cerulli Associates, conducted on behalf of BlackRock, indicates that most institutions are satisfied with the services provided by OCIOs. However, many have engaged in a search for a new provider, suggesting that while OCIO services are valuable, finding the right service provider is key.
In addition, few OCIOs report standardized performance data. While money managers usually provide clear performance track records, OCIO providers are generally reluctant to do the same. They argue that their performance varies with client risk tolerances and investment strategies and that track records are thus not a good guide to the quality of their investment management. Clients must simply trust that OCIOs can deliver the returns they need.
Beyond these issues with comparing providers, institutions also face other difficulties when it comes to selecting an OCIO. OCIOs are often subject to significant conflicts of interest (COIs). Because they serve many clients, they must frequently make choices on how to allocate scarce investment opportunities among their client base. Client size and fee structures can play a role in how they make these decisions, potentially putting them at odds with clients’ best interests.
However, many of these potential COIs are invisible to clients. When choosing a provider, they have little choice but to hope that such COIs will not affect the returns and service they receive.
To overcome these challenges and select the right OCIO, institutions should engage in a thorough search process, possibly assisted by one of the growing numbers of OCIO search firms. They should demand detailed information on fees and historical performance and should ask questions about potential COIs. Once a provider is selected, institutional trustees should remain actively involved in the investment management process, engaging regularly with the selected OCIO to monitor the relationship and ensure that performance targets are met and service levels are satisfactory.
Intuition Know-How has a number of tutorials that are relevant to the business of OCIOs and investment management. Click on any of the links below to view an intro video to the same tutorial.
- Asset Management – An Introduction
- Investment – An Introduction
- Asset Allocation – An Introduction
- Investment Policy Statements
- Private Wealth Management – An Introduction
- Private Wealth Management – Investment Services
- Private Wealth Management – Ultra-HNWIs & Family Offices
- Private Wealth Management – Compliance Considerations