Moving: Dalip Puri cited quick-changing market conditions as a big reason to go with outsourcing.

A growing sense that the traditional advice-driven governance model isn't up to the task of shepherding institutional portfolios through today's volatile markets has spawned a growing number of converts to investment outsourcing during the past year.

The “overwhelming complexity” of diversified portfolios today and the “explosion of volatility” in capital markets are making it increasingly difficult “for serious investors to negotiate the process,” noted Jonathan Hirtle, president and CEO of West Conshohocken, Pa.-based outsourced CIO firm Hirtle, Callaghan & Co. LLC.

In a recent interview, Dalip Puri, who joined Chemtura Corp. in November 2010 as vice president and treasurer, said his company's decision-makers saw two major shortcomings to be addressed:

c decision-making that proved too slow to take advantage of the kind of market opportunities that presented themselves in 2008 and 2009; and

c a lack of time and resources to oversee investment managers and strategies for an increasingly complex portfolio.

At the end of an in-depth educational process, Chemtura hired SEI Corp. in February to oversee the Middlebury, Conn.-based chemical company's $737 million defined benefit plan.

Timothy P. Dykstra, vice president and corporate treasurer with Smithfield Foods Inc. since September 2010, said his colleagues reached similar conclusions when the Smithfield, Va.-based food processing company decided to revamp its governance structure for its $1 billion defined benefit plan, including creating an investment committee at the management level.

Smithfield Foods long followed an absolute-return investment strategy, but the world had changed, due — among other things — to the 2006 passage of the Pension Protection Act, Mr. Dykstra noted.

That new reality led the company to change the focus of its investment strategy to funded status, and conclude that its board — despite a wealth of market experience — didn't have the time or investment experience needed to oversee the defined benefit plan on a day-to-day basis, he said.

Following an RFP process, Smithfield Foods hired Russell Investments on Dec. 15, 2011, to serve as “co-fiduciary” of the company's DB plan, said Mr. Dykstra.

More nimble

Windstream Corp., a Little Rock, Ark.-based telecommunications company with a roughly $1 billion defined benefit plan, likewise looked at outsourced CIO providers in recent months, said Mary Michaels, Windstream's director of investor relations and capital markets.

Like a number of other institutional investors, Ms. Michaels said Windstream's investment committee saw a need to be more nimble in responding to market volatility. But rather than cede responsibilities, the committee opted to bolster the robustness of the company's governance and risk-management oversight, she said.

In recent weeks, Windstream decided to hire New York-based Pacific Global Advisors LLC, the former pension advisory group within J.P. Morgan Chase & Co.'s investment bank.

Impressed by the firm's “sophisticated risk management approach,” Windstream tapped PGA to manage a “hybrid” strategy that left the company's pension investment committee with final decision-making for the bulk of its assets, even as PGA assumed discretionary oversight of the liability immunization portion of the portfolio — which represents roughly 40% of assets at current funding levels, said Ms. Michaels.

For PGA, that means being more “hands on” than a traditional consultant in making recommendations to the committee in response to what's going on in the marketplace. For Windstream's part, “our goal is to be more responsive” in making timely decisions, Ms. Michaels said.

In that sense, the hybrid doesn't amount to an outsourced CIO arrangement, even if one hat PGA will wear calls for the firm to exercise full discretion over the assets within the immunization portfolio, Ms. Michaels said. The system Windstream is structuring simply provides “more structure and discipline around managing the DB and defined contribution plans,” she said, adding “my team is busier than ever with this.”

The reservations some plan sponsors have in embracing the term “outsourcing” might point to the considerable efforts that investment outsourcing firms still need to make to translate growing interest in new governance structures into new business, noted Peter Starr, the CEO of Waltham, Mass.-based market research and strategic consulting boutique Chatham Partners.

According to a survey on the investment outsourcing sector that Chatham released in March, demand for those services should continue to pick up, but in a recent interview Mr. Starr said that growth could be “more of a slow crawl than exponential.”

The survey showed only 6% of organizations that do not now outsource saying they were likely to do so in the coming 24 months, reflecting continued skepticism that “outsourcing will produce better results than they can achieve on their own,” according to Chatham's report on the results.

Executives with investment outsourcing firms concede that not every request for information results in new business, but many say that for the most part the level of interest they're seeing now points to stronger growth.

They say Chemtura, Smithfield Foods and Windstream exemplify two recent industry trends — the strong pickup in demand from corporate DB plans in a space where midsize endowments and foundations have been relatively prominent over the past decade or more, and a move by ever-bigger clients to consider outsourcing as an option.

In a recent interview, Paul Klauder, vice president and managing director for SEI's institutional group, noted that Chemtura, with more than $700 million in DB assets, is well above the average of $150 million for his company's $61 billion outsourcing business, and SEI continues to see growing interest from larger companies.

When SEI releases its results for the June 30 quarter in late July, the company will be able to report two new clients with retirement portfolios of $1 billion or more each, Mr. Klauder noted. He declined to name the new clients.

The right fit

The process of finding the right investment outsourcer remains idiosyncratic, with different institutional investors taking different paths to find the right fit in a market that seems to become more crowded every day.

In a telephone interview, Javier A. Soto, the president and CEO of The Miami Foundation, a philanthropic organization with more than $100 million in investible assets, noted that his foundation's RFP for an investment outsourcer garnered “55 qualified responses.”

With those responses “spread out in the open area of our office here ... it was like tiptoeing through a minefield,” he said. After an exhaustive vetting process, the foundation chose SEI to oversee the roughly $67 million endowed portion of the Miami Foundation's portfolio and J.P. Morgan Asset Management (JPM) to run the roughly $33 million non-endowed portion, after concluding the different risk tolerances of the two pools called for different managers, Mr. Soto said.

John Daly, vice chairman of the board overseeing the Culinary Institute of America's $110 million endowment, said his team picked up considerable market intelligence on the investment outsourcing sector from executives at other institutions that had already outsourced their portfolios and then requested information from nine competitors.

Calling that selection process “relatively opportunistic,” Mr. Daly said his team chose a mix of different provider types, with “three consultants, three firms that were "my way or the highway' and three outsourced CIO firms.”

When those firms sent in 2,000 pages of combined documents, the foundation decided to hire R.V. Kuhns — one of the last sizable investment consultants not to get into the investment outsourcing business — to help sort through responses.

In the end, the team felt the consulting firms brought fewer resources to investment outsourcing than other contenders, while yet another competitor fell out because it had focused more on family offices than endowments, he said.

Conceding that inevitably the process is highly subjective, Mr. Daly said his team narrowed that list of nine down to two customized outsourced CIO providers and two my-way-or-the-highway firms before unanimously choosing Perella Weinberg Partners LP as the customized firm with more extensive resources. Even though the firm's fees weren't the lowest, Mr. Daly said the important point is “what you get after fees.”

Chemtura's Mr. Puri said his firm narrowed the field to six outsourcing firms, including a mix of different types, and used the vetting process as a way for the board to better understand the “differentiators” among providers.

At the end of the day, Chemtura chose SEI, a firm with a long history of helping corporate clients manage risk using sophisticated “glidepath” planning within a liability-driven investment structure that Chemtura already employed. SEI's experience exercising tactical oversight was another factor in that investment outsourcing firm's favor, Mr. Puri said.

The outsourced CIO candidates had fees that were roughly 50% higher than SEI's and promised much more extensive interaction, but Chemtura was looking for someone that “understood what we were trying to do” and could act within defined parameters without “having to call every week,” said Mr. Puri.

He said with SEI on board, Chemtura's investment committee can focus on more strategic goals such as putting in place plans to begin transferring pension-related risks from the company's balance sheet as its funding level — currently around 80% — improves to 90% and above.

Close interaction

Other institutional investors say they were very much looking for providers that could interact with their boards more closely. Windstream's Ms. Michaels said PGA fit her company's needs.

In a telephone interview, David Oaten, a managing director with PGA, said people don't like the term “outsourcing” and PGA looks to forge much closer partnerships with clients, involving greater interaction with regard to “what's going on in their pension plan.”

With a focus on plans with $1 billion or more in DB assets, PGA manages nearly $20 billion for clients, Mr. Oaten said. He said his team talks to clients at least weekly and usually on a daily basis.

“We're not a cookie-cutter shop ... it's very much a customized plan-by-plan, client-by-client approach,” necessary in today's dynamic market environment,he said. PGA's job is to give the CFO, treasurer and others overseeing the company's pension plan the tools they need to do the right things as fiduciaries, he said.

Smithfield Food's Mr. Dykstra said he reached out to four providers: Hewitt EnnisKnupp Inc., Mercer Investments, Wilmington Trust Co. and Russell Investments, and asked each what they would do if they assumed oversight of the company's defined benefit plan — a good means, he said, to see, in their respective responses, which provider would be most compatible.

“It came down to style and fit,” with Russell winning the mandate on the strength of its experience implementing glidepath strategies over time, experience with tactical oversight and overlays, as well as the firm's long track record and deep resources, Mr. Dykstra said. In addition, Russell's appointment of a lead professional responsible for the portfolio that Smithfield Foods can call at any time appealed to company management, he said. n

This article originally appeared in the July 9, 2012 print issue as, "Complexity pushes funds to seek help".

— Contact Douglas Appell at dappell@pionline.com | @Appell_PI