Outsourced assets catapult 59% to $1 trillion in 2 years

Updated with correction

Nearly $1 trillion is managed for institutional investors worldwide in investment outsourcing, an industry that barely existed five years ago.

In aggregate, $955 billion was managed on a partial or fully discretionary basis as of March 31, Pensions & Investments' second survey of investment outsourcers with at least $1 billion under management shows. That's up 59% from two years ago, the first time P&I conducted the survey.

And while the 2013 universe of the $1 billion-plus managers covered 56 firms — nearly double the 32 in the 2011 ranking — many of those participating in both surveys showed double-digit asset growth, or better, in the two-year period. (More than 60 managers overall responded to this year's survey.)

The number of institutional outsourcing clients reported by managers as of March 31 also was very healthy — 17,849, thanks to the addition of the 13,406 institutional outsourcing clients reported by new survey entrant, Bank of America Merrill Lynch. In 2011, outsourcers reported they managed accounts for 2,707 institutional investors.

A few outsourcers have long track records, including money manager Vanguard Group Inc., dedicated outsourcer Hirtle Callaghan & Co. and investment consultant Cambridge Associates LLC. But most investment outsourcing assets have been amassed since the financial crisis.

“About five years ago, I was on a conference panel with the institutional marketer of an outsourcing firm and it was very clear that the audience and other panelists thought we were crazy when we predicted growth of this industry,” said Kevin P. Quirk, principal, Casey Quirk & Associates LLC, Darien, Conn., a consultant to money managers.

Mr. Quirk's predictions for industry growth were, in fact, low.

CQA forecast that assets managed in fully discretionary investment outsourcing programs — where the money manager has complete control over management of the client portfolio — would total $391 billion by the end of 2013.

P&I's survey data, however, shows that fully discretionary outsourced assets totaled $434 billion — about 45% of total outsourced assets — as of March 31. The growth of outsourced investment management assets shows no sign of abating. Indeed, outsourcing managers say their new-business pipelines are full.

The growth prospects for investment outsourcers is supported by a burgeoning number of institutional searches and hires, an upward trend in the size of investment portfolios slated for outsourcing and the fact that public pension plans finally are trickling into outsourcing.

Among the recent outsourcing searches and hires:

• Foundation for the Reichhold Center for the Arts at the University of the Virgin Islands, St. Thomas, is seeking an outsourcer for its $10 million portfolio;


• San Jose (Calif.) Federated City Employees Retirement System issued a request for information in mid-June for discretionary investment outsourcing services for its $1.95 billion defined benefit plan;


• Shell Australia Superannuation Fund, Melbourne, outsourced discretionary management of its A$700 million (US$730 million) portfolio to Plum Financial Services Ltd. in March;


• The $220 million Brookline (Mass.) Contributory Retirement System is searching for a discretionary outsourcer for all but the $30 million to $40 million of its assets that are invested in private equity;


• Montgomery County Employees' Retirement System, Norristown, Pa., went for a double-barreled outsourcing solution, in December hiring SEI Investments Management Corp. to manage 10% of the $430 million fund in active strategies and Vanguard Group to manage the remainder in passive funds; and


• Western Conference of Teamsters Pension Trust, Seattle, in January delegated full discretionary authority to hire and fire investment managers for $27 billion of its $32 billion of assets to its long-term investment consultant Alan D. Biller & Associates Inc., Menlo Park, Calif.

The Teamsters' decision to outsource investment management of such a large portfolio to its consultant of 20 years was an unexpected boon, said Alan D. Biller, president of the firm. “We weren't even expecting it,” Mr. Biller said in an interview.

Prior to the Teamsters' assignment, Mr. Biller's firm had just one outsourcing client with $100 million of assets. The union plan hire catapulted the firm to 12th place in its first appearance in P&I's ranking.

Russell Investments retained its first-place ranking with $108.5 billion in investment outsourcing assets, 22% of which was managed with full discretion. Russell's assets rose 43% as of March 31, compared with the same date two years ago.

The remainder of the top five outsourcers as of March 31 were:

• Cambridge Associates, which held onto second place with assets of $87.5 billion, up 20% from the previous survey, with 8% of assets managed with full discretion;


• Mercer Investments, moving to third position from fourth, with assets of $73.9 billion, up 44.9% from the prior survey, with 100% of assets managed with full discretion;


• SEI Investments, which was nudged to fourth place from third, with assets of $67.1 billion, up 22.7% from the last survey, with 37% of assets managed with full discretion; and


• Towers Watson Investment Services, which remained in fifth place with assets of $59.4 billion, up 18.9% from March 31, 2011. The firm did not provide the breakdown between full and partial discretionary outsourcing assets.

Mercer Investments, New York, enjoyed the largest asset growth among the top five, thanks to continued interest from corporate defined benefit plans seeking to outsource liability-driven investment strategies, a steady stream of endowment and foundation hires, and a zero-to-$10 billion boom in business from corporate defined contribution plans.

“Outsourcing for defined contribution plans has been a very strong area of growth for us and shows no sign of slowing down,” said Thomas P. Murphy, senior partner and Mercer's U.S. head of fiduciary management. Year-to-date inflows as of May 31 for investment outsourcing are ahead of the two prior years, he said.

Nearly all of Mercer's DC plan clients select a traditional outsourcing approach, handing off all aspects of managing the plan, including full investment discretion, Mr. Murphy said. Companies want to “simplify their plans, reducing the number of managers and investment options, and often adding customized target-date funds,” he added.

Investment pool sizes also have risen demonstrably in the past two years, Mr. Murphy said. “We are seeing interest from plans with assets of $1 billion, $2 billion, $3 billion and larger these days. Two years ago, it was very ad hoc to see a prospect of that size.”

Hewitt EnnisKnupp, Chicago, is another example of institutional investors' inclination to turn to investment consultants for outsourcing expertise. HEK's outsourcing assets jumped 179.1% to $37.3 billion in the two years ended March 31, with 74% of the assets managed on a fully discretionary basis.

Corporate defined benefit plans seeking LDI approaches have dominated the firm's client base for the past two to three years, pushed by federal pension funding regulations and bad memories of the 2008-'09 market crash, said Kemp Ross, senior partner and head of investment solutions. “Many corporate defined benefit plan sponsors knew they needed to manage their assets dynamically, but found it very hard to do internally,” Mr. Ross said.

“The daily monitoring of the plan's funded status — and the required shift in assets in response to triggers encountered — requires a strong infrastructure, including technology and dedicated portfolio managers,” something most corporations are unwilling or unable to provide, Mr. Ross said.

HEK's corporate defined benefit plan clientele averages about $250 million in assets, but “the size of prospective investors is trending upward and our pipeline is very strong,” Mr. Ross added.

HEK launched its outsourcing service in 2009, while NEPC LLC launched its investment management services in January 2011, said Steven F. Charlton, director of consulting services for the Cambridge, Mass.-based consulting firm.

NEPC squeaked into P&I's 2011 ranking as last, with $734 million. In the 2013 ranking, the firm ranks 40th in a much larger universe with $3.2 billion — a 339% increase over the two-year period.

Mr. Charlton said the vast majority of NEPC's investment outsourcing clients are new to the firm; by design, the consulting firm was “not out to cross-sell to our existing clients. Most already have good governance and are doing well in consulting relationships, rather than an investment management relationship,” Mr. Charlton said.

Marco Consulting Group Inc., Chicago, saw a significant 39.4% growth in investment outsourcing assets in the two years through March 31 to $7.7 billion, managed with full discretion, from its predominantly Taft-Hartley plan client base, confirmed Amy F. Forebaugh, vice president, division of fiduciary services.

Marco, which launched its first core investment outsourcing strategy in 2005, spent 2012 expanding its investment lineup with the addition of a hedge fund portfolio and other alternative investments, she said.

The success of investment consultants in persuading institutional investors to trust them with their assets despite the absence of a substantial track record is “pretty positive news,” for investment consultants, said CQA's Mr. Quirk. He declined to name any such firms. A number of investment consulting firms have struggled with the transition to money management, Mr. Quirk said.

Despite the eye-popping asset gathering success of some smaller players, industry observers predict the investment outsourcing bubble eventually will burst, but they won't hazard a guess as to when this might happen. Outsourcing, especially in the U.S., still is “an immature industry” that currently is experiencing “a huge land rush,” said Andrew McCollum, consultant, Greenwich Associates, Stamford, Conn., a research consulting firm.

“There are 65 outsourcers in the U.S. and as with any new industry, consolidation is inevitable with maturation. There definitely will be a shakeout, with winners emerging and losers dropping out of sight, but it's not clear exactly when this will happen,” Mr. McCollum said.

Mr. Quirk agreed, predicting that the “very overcrowded field will consolidate dramatically and assets will be concentrated under management within a group of 10 to 15 of the players with the best infrastructure, returns, fees and marketing.”

P&I's data already show signs of impending consolidation. The 10 largest investment outsourcers in P&I's universe controlled 62% of total reported outsourced assets under management, while the 25 largest managers held 87%.