'Tipping point'

Variety of investment outsourcing options emerges

Cambridge Associates' Margaret Chen says demand for investment outsourcing from pension funds and endowments and foundations has more than doubled since 2010. View more in this series

Institutional demand for investment outsourcing is accelerating, even as a lack of consensus on best practices in the fast-growing, crowded market segment makes it hard to predict who the winners of an eventual industry shakeout will be.

For now, corporate defined benefit plans, endowments, foundations and other institutions seeking firms to assume discretionary oversight over some or all of their portfolios can find one-size-fits-all, as well as customized, approaches and a variety of fee structures, architecture models and levels of service and partnership.

Investment outsourcing remains “all over the place, (with) different models, pricing schemes, delivery systems and value propositions,” making the task of sifting through it all “a bit paralyzing,” said Kevin P. Quirk, partner with money manager consultant Casey Quirk LLC, Darien, Conn.

The market should eventually coalesce around more widely accepted standards as it moves from one where suppliers lead the way to one where consumers call the shots, predicted Mr. Quirk, who pointed to the growing number of outsourcing RFPs over the past 18 months as a step in that direction.

Others say investment outsourcing appears to have crossed the threshold from niche to mainstream service during the past year.

“The education process is pretty much done. By and large, the industry is now very, very familiar with the concept,” resulting in talks with more institutional investors and some larger ones to boot, noted Thomas Murphy, a senior partner and U.S. head of fiduciary management with Mercer in Boston.

Christopher L. Bittman, a Denver-based partner with Perella Weinberg Partners and chief investment officer of the firm's Agility investment outsourcing business, agreed: “Demand is increasing materially,” as boards realize that “giving up discretion doesn't mean giving up involvement in the process,” he said.

'Tipping point'

The past year might prove to have been “a tipping point,” said Bruce Myers, co-head of Cambridge Associates' CIO outsourcing practice. Going forward, institutional investors reviewing their governance structures are likely to consider investment outsourcing as a matter of course rather than as something exotic, he said.

Mr. Myers said Cambridge Associates has seen a “dramatic increase” in interest for the service over the past six months alone.

Other competitors agree: The “volume of activity is soaring,” said Keith Luke, managing director-strategic planning, with Wilton, Conn.-based Commonfund.

While endowments and foundations led the first wave of institutions turning to outsourcers, a significant pickup is now coming from corporate defined benefit plans, noted Hilda Ochoa-Brillembourg, the former World Bank pension chief who is president, CEO and CIO of Arlington, Va.-based Strategic Investment Group, the investment outsourcing firm she founded in 1987.

Growing corporate demand could reflect, in part, the difficulties of retaining internal staff when so many defined benefit plans are frozen or even closed, she said.

If demand is growing strongly, so is the number of providers offering investment outsourcing services under monikers such as fiduciary management, implemented consulting and outsourced CIO.

The market is starting to see “some interesting differentiation” among the main types of providers, amid the sharp pickup in competition in recent years, noted Nancy Everett, a managing director with BlackRock (BLK) Inc. (BLK) in New York, and head of the firm's U.S. fiduciary management solutions business.

Industry observers list four major types of outsourcing vendors:

  • veteran funds-of-funds firms, which boast credible long-term track records and can marshal strong sales teams, such as Russell Investments and SEI;
  • investment consultants such as Cambridge, Mercer and Towers Watson & Co., with a wealth of intellectual capital and “trusted adviser” relationships with clients;
  • dedicated outsourcing firms whose focus on the endowment, foundation and pension management sectors is a competitive strength. These include Strategic, Investure LLC, Makena Capital Management LLC, Hirtle Callaghan & Co. and Morgan Creek Capital Management LLC; and
  • large multiasset class money management firms (including BlackRock (BLK), BNY Mellon Asset Management, Northern Trust Global Investments and State Street Global Advisors), with broad investment capabilities, experience with complex investment solutions such as LDI and strong sales and client service lineups.

The list of competitors has continued to expand over the past year, with NEPC LLC, Cambridge Mass.; Rocaton Investment Advisors LLC, Norwalk, Conn.; and SECOR Asset Management LP, New York, among the latest to join the fray.

Brian C. Ternoey, a principal with Pennington, N.J.-based Curcio Webb LLC, one of a dwindling number of investment consulting firms that advises clients on choosing providers rather than offering the service itself, said “we are currently following over 50 firms in the investment outsourcing business,” roughly double the 27 competitors Curcio Webb covered five years ago.

Validated by competition

Veteran outsourcing providers point to the rise in competition as validation of the outsourcing model.

“It's good for clients that want to do this to have options,” noted Alice Handy, longtime manager of the University of Virginia endowment and founder president and co-CIO of Investure.

Charlottesville, Va.-based Investure has stopped seeking new clients for now; its policy limits the number of midsize endowment and foundation clients it takes on to ensure it can effectively serve as each client's CIO.

At the same time, the growing number of providers could prove a challenge for institutional investors seeking the right match in a relationship that Cynthia Steer, the New York-based head of manager research and investment outsourcing solutions with BNY Mellon Asset Management, described as akin to a marriage.

Performance will clearly be crucial to those relationships, Ms. Steer said. But over the coming five years, with an industry shakeout likely, the “ability to communicate, to act in the best interests of clients, the ability to create a governance environment of trust” will be equally important in separating winners from losers, she predicted.

According to some competitors, the current rush is more akin to a free-for-all.

“Just about every firm in the world ... has managed to put the word "outsourcing' in the first two words of their marketing materials,” and a lack of clarity makes it hard for fiduciaries to figure out “what outsourcing means, and who's good at it,” noted William R. Miller, managing director and chief operating officer of Makena, Menlo Park, Calif.

It could take three or four years, but market pressures eventually will lead to consolidation in each segment of investment outsourcing.

The winners will be those that offer the best “total package” of money management and client service, said Jonathan J. Hirtle, president and CEO of Hirtle Callaghan in West Conshohocken, Pa. Not surprisingly, he believes firms like his — along with other specialized competitors built around experienced investment teams, such as Investure and Strategic — have some of the strongest skill sets without obvious conflicts of interest.

By contrast, Mr. Hirtle predicts big money management firms that use proprietary strategies in their investment programs and providers affiliated with broker-dealers — while clearly boasting the market savvy that's key to asset management skill — will eventually come to be dogged by questions about conflicts of interest.

But executives at asset managers with outsourcing businesses such as J.P. Morgan Asset Management (JPM) and Goldman Sachs Asset Management counter they've maintained levels of transparency that can satisfy any concerns about potential conflicts.

And they say the unparalleled depth of their market connections should give them a competitive advantage in appealing to institutional investors.

What's offered

J.P. Morgan Asset Management (JPM)'s $23 billion outsourcing business can provide clients with open architecture, proprietary investments or a hybrid, said Robert D. White, an executive director and portfolio manager. He said the proprietary option can offer more efficient tactical movements of capital.

GSAM offers both open architecture and proprietary strategies, depending on client preferences, said Scott McDermott, a New York-based managing director with the firm's global portfolio solutions group. He cited GSAM's market culture and risk systems as competitive advantages.

Mr. Hirtle said consultants, meanwhile, often don't bring highly developed asset management cultures to the table.

That's an issue executives at Seattle-based investment consultant Wurts & Associates have tried to address during the past year, by bringing in an investment team that cut its teeth at Microsoft Corp.

Jeffrey Scott, who was brought in to lead Wurts' outsourcing effort in August 2011, is a former Microsoft assistant treasurer and CIO of the $40.3 billion Alaska Permanent Fund Corp. In an interview, Mr. Scott said Jeffrey MacLean, Wurts' president and CEO, opted to build the outsourcing segment of the firm's business around an established investment team with a strong track record, instead of simply adding a new outsourcing hat to Wurts' corporate wardrobe.

Mr. Scott, who has been joined at Wurts by three former Microsoft colleagues, said his team wants to provide soup-to-nuts service for between 10 and 12 institutional investors, adding clients at a measured pace of two or three a year. He said the team is poised to land its first client — a Canadian pension fund with well over $5 billion in assets that could retain Wurts to manage of portion of those assets. He declined to name the client.

Other consulting firms with longer track records are likewise moving to add investment talent.

On June 25, Stanley Mavromates, the longtime CIO of the $50 billion Massachusetts Pension Reserves Investment Management Board, joined Mercer as CIO for the Americas for the firm's outsourcing business.

There are other signs of providers trimming their sails to better navigate an increasingly competitive environment.

One example is Makena, which, along with HighVista Strategies, is often cited as the prototype one-size-fits-all provider, effectively putting all client assets into the same mix of commingled funds. Makena's Mr. Miller said the firm has evolved in recent years to offer more customized strategies as well to clients who prefer that.

Differing fees

Fees remain another point of differentiation among competitors, with some offering a single all-in fee for the bundled services they provide and others touting the need for greater transparency — breaking out their own fees from other underlying fees, such as the money paid to the various asset managers directly managing investments.

Performance fees are an additional point of contention. Mark W. Yusko, CEO and CIO of Chapel Hill, N.C.-based outsourced CIO firm Morgan Creek Capital Management, said performance fees align the interests of clients and providers: “The worst fee relationship is a flat fee, (which) incents you to do nothing innovative.”

By contrast, David A. Oaten, managing director of outsourced CIO firm Pacific Global Advisors, New York, believes performance fees provide the wrong incentives. PGA executives concluded such fees are more likely to “incentivize you to take risk,” he said. “Our incentive is to do the job for our clients and stay employed,” he added.

Among a wide range of fee arrangements, Michael Rosen, a managing member and CIO of Santa Monica, Calif-based Angeles Investment Advisors LLC, said his firm charges the same fee for outsourcing clients and traditional retainer clients, to ensure no conflicts of interest in the firm's servicing of its client base. Angeles' 31 outsourcing clients account for roughly half of its overall clients, although their combined assets of $1.4 billion are a fraction of the firm's assets under advisement, he said.

This article originally appeared in the July 9, 2012 print issue as, "Clients seeing plethora of choice".