With the COVID-19 pandemic outbreak, market uncertainty and significant financial ramifications that asset owners continue to deal with, the OCIO (outsourced chief investment officer) model has been put to the test this year. The discretionary control of the investment portfolio provided OCIO managers with speed and flexibility to respond to the market dislocations and allowed their institutional clients to focus on immediate needs without worrying about managing their portfolio’s strategic investment goals, said Christopher Philips, Principal and Head of Institutional Advisory Services at Vanguard, speaking at Pensions & Investments’ Evolution of OCIO virtual conference series.
A Positive Test Result for OCIO Sparks Engagement
“One of the things that came to the forefront this year was the reality that we're dealing with human beings—CFOs, Treasurers, Investment and Finance Committees, all made up of people with distinct behaviors that tend to surface during times of stress,” he said, at the session titled ‘Using an OCIO in a Crisis Environment.’ “In particular, the governance around managing the organization’s long-term strategic objectives was something that most investment communities were unwilling or unable to do on their own. The nonprofits and pension plans were faced with extreme near-term pressures, both personally perhaps, as well as professionally. The value of an OCIO partner takes this responsibility off their hands and allows them to manage the day-to-day needs of their organization, whether it is meeting the needs of the community they serve or meeting payroll,” Philips said.
“Another advantage is the ability of the OCIO to re-balance the investment portfolio proactively in the
face of a market downturn as significant and severe as we had in March and April and to continue to move pension plans down their LDI glidepath during extreme interest rate movements,” he added. “That was truly a critical element in risk control that we were able to provide our clients. Quite frankly, it adds significant excess returns and risk control relative to what the asset owners would have been able to do on their own.”
Market dislocations, including the severe market volatility in Q1 following the pandemic, opened up good investment opportunities that OCIO managers could execute on for their clients. “The simple act of re-balancing itself is often considered to be a mechanical process as a specific threshold where you deviate from your strategic posture by a given amount, whether it's 2%, 5%, 10%. But there’s also a proactive element to it. This year, we proactively re-balanced a lot of client portfolios where we had the flexibility within their OCIO agreement and we actually did so multiple times this year. Everyone thinks about that re-balancing on the way down as a key value add. We've actually re-balanced a number of our clients on the way back up,” Philips said, adding that it has added a significant amount of excess returns for a number of clients and has been a huge benefit.
Vanguard is looking closely at the opportunities in private markets that have opened up from the global dislocations. “While private equity might take 10 to 15 years for a given vintage to mature and distribute all its earnings over time, I think we're going to look back on 2020 as one of those vintages that provided significant opportunity for general partners who deployed capital in the early part of this year,” Philips said. Plan sponsors need to have a detailed conversation around their liquidity appetite and needs to determine if they are able to take advantage of that illiquidity premium in private equity.
“The other nuance is that liquidity is a very individualistic conversation, as each organization I work with has its own distinct needs and circumstances,” Philips said. He provides the example of a museum that gets revenues from parking, admissions, the gift store, and donations. “All of a sudden, all that dries up. So, going into the crisis they may have had a large appetite for illiquidity because of multiple income sources to meet their spending needs. In the teeth of the crisis, a lot of those revenue sources just haven't come back. So, the changing nature of that illiquidity appetite differs client by client and we really seek to assess it both qualitatively and quantitatively.”
Other aspects of the OCIO service that have seen significant demand include spending and cash flow analysis, Philips said, noting Vanguard has done three times as many of these versus the prior three years combined. “We were able to help the nonprofits see how much they could afford to spend this year in responding to the situation, without creating significant hurdles for their long-term viability and success in fairly rapid fashion for our clients,” he said.
Interest in pension risk transfers, both partial and full, have also increased as pension plans have started to meet their funded status targets and are thinking about transitioning part or all of their pension plan to an annuity provider or insurance company, Philips said. “As a discretionary OCIO, we can take this off the plate of the plan sponsor and help facilitate that process, whether early-stage planning or late-stage execution while they can continue to focus on running their businesses.”
While OCIO searches ground to a halt when the pandemic hit in March and its aftermath, search activity has increased significantly from asset owners and OCIO search consultants. “Besides some clients revisiting everything that went on hold, we've seen new activity from organizations going to OCIO for the first time or exploring it, as well as those that have become dissatisfied with their existing provider and are looking for a new provider,” Philips said. “In each case, organizations are looking for a partner who understands their needs, operates with a true owner's mind-set, and focuses on what truly matters,” Philip said. “The common theme we’ve seen with changing OCIO providers is one of frustration, either as the OCIO was focused on tactical issues, or trying to explain what went wrong or why their bets didn't pan out, versus actually owning the decision, explaining the process, validating their investment thesis—all the things that we preach, but seem to fall apart during the crisis itself.”
“It comes down to the stability of the model, the governance, and the perspective that we’re able to provide that truly allows all our clients, from the smallest to the largest organization, to have the comfort that they can manage their day-to-day operations and their businesses to meet the needs of their community or their retirees while not worrying about the risk management, the governance, the portfolio management being in very good hands,” Philips said. “For plan sponsors, the events of this year was either the re-affirmation of that or the light bulb going off as to why they actually hired us to help them and to manage their portfolio. If nothing else comes of it, that to me was a huge positive over the course of this year.”
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