DB and DC plans contribute to surge in assets managed with full, partial discretion
OCIO managers reported a 23% surge to $1.74 trillion in assets managed worldwide for institutions with full or partial discretion in the year ended March 31, data from Pensions & Investments' latest money manager survey showed.
The high growth rate of outsourced investment management programs — up from 9.4% the prior year — was fueled by an influx of U.S. and European defined benefit plan mandates, particularly for pension derisking, and innovative outsourcing of defined contribution plan investments, conversations with the industry's top players showed.
"This is a hot, sexy, competitive space. Managers are anxious to show their growth and capabilities," said Amanda Tepper, CEO and founder of Chestnut Advisory Group LLC, Westport, Conn., a consultant to money managers.
The three largest managers of outsourced assets under investment management with full or partial discretion retained their dominance of P&I's ranking. for the second year in a row.
Mercer LLC remained the largest manager with $212 billion under management as of March 31, up 34.6% from the previous year; Russell Investments Group LLC held second place with a 32.4% increase to $163.8 billion; and Aon Hewitt Investment Consulting Inc. remained in third place with asset growth of 47.5% to $151.8 billion. Each of the top three firms only manage outsourced assets with some degree of discretion.
By contrast, the larger universe of managers with worldwide institutional assets in OCIO programs managed with or without discretion as of March 31 increased 17.4% to $2.09 trillion — topping $2 trillion for the first time in the eight years P&I has been surveying managers active in this area.
Cambridge Associates LLC ranked first on P&I's ranking of managers of total worldwide institutional outsourced assets with $227 billion as of March 31, up 14.2% from the previous year. Cambridge reclassified a portion of its firmwide assets and included them in its outsourced assets in both 2018 and 2017.
Mercer and Russell Investments remained in the second- and third-place spots in the total worldwide institutional outsourcing ranking.
Goldman Sachs Asset Management, New York, broke into the top five ranking, moving up from seventh place, due in part to the acquisition of the strategic partnership outsourcing business of Verus Investors, Seattle, last July.
The deal brought $21 billion of institutional outsourced assets under supervision to GSAM, increasing the firm's worldwide institutional outsourced assets 37.2% to $135.2 billion. Without the Verus assets, GSAM's year-over-year growth in outsourcing was 15.9% in the year ended March 31.
Over a longer time frame, assets managed worldwide for institutional investors in outsourcing programs managed with or without discretion more than doubled in the five years ended March 31 from $1.038 trillion as of the same date in 2013 while worldwide institutional outsourced assets under investment management were up 84.5% in the period.
Industry experts pointed to the 101% growth of total worldwide institutional outsourced assets over the five years as a sign of maturation in the industry.
"Growth in the wider asset management industry is flat, but we're pretty bullish on the future growth of the outsourced-chief-investment-officer model. OCIO is still a fairly young industry that's beginning to show signs of maturation. Outsourcing has made the leap to a business from a hobby as assets have grown exponentially," said Justin White, principal at money management consulting firm Casey Quirk, a practice of Deloitte Consulting LLP, Darien, Conn.
One of the biggest factors in the success of managers of outsourcing programs is their ability to scale up their businesses, Mr. White said, noting that among the 20 largest firms on P&I's ranking of firms by discretionary assets managed "most are treating OCIO as a key area of growth for their companies."
In fact, similarly to the traditional universe of asset managers, outsourced assets were concentrated within the tier of the largest managers, analysis of P&I survey data showed.
For example, the 25 largest managers of worldwide institutional discretionary outsourced assets managed 89% of the $1.7 trillion of assets while the 25 biggest managers of worldwide institutional outsourced assets held 90% of the $2.09 trillion of assets in that pool.
Large managers of discretionary OCIO assets said one of their biggest sources of new business in the past year and expected to be going forward is from corporations contemplating the fate of their defined benefit plans.
Two years ago, managers blamed pension risk transfers in part for the 1.1% decline in outsourced assets under management with full/partial discretion in the year ended March 31, 2016, found in P&I's survey (P&I, June 13, 2016).
Now managers of OCIO programs — including Aon Hewitt Investment Consulting, Cambridge Associates, Goldman Sachs Asset Management, Mercer, Russell Investments and Willis Towers Watson PLC — said they've hit the sweet spot in terms of advising defined benefit plan sponsors about managing pension risk and subsequently managing all or part of restructured defined benefit plan portfolios.
OCIO managers reported high demand from corporations in the U.K., Europe and increasingly in the U.S. for advice and subsequent OCIO services for pension fund terminations through pension-risk transfers to insurers or the creation of low-risk liability-driven investment portfolios, known as hibernation plans.
"All defined benefit plan sponsors have to go down this path eventually," said Bryan Weeks, head of Seattle-based Russell Investments' Americas institutional business. About 50% of Russell's corporate clients worldwide now are working with the firm to figure out the best course of action — pension risk transfer or hibernation — for their pension plans, Mr. Weeks said.
Corporations increasingly are turning to outsourcing managers to manage the entire process "in a holistic way," said Margaret Chen, managing director and head of CA Capital Management, the OCIO investment management unit of Cambridge Associates, Boston.
"Creating hibernation plans from traditional defined benefit plans can involve large amounts of money," Ms. Chen said, stressing the process of pension derisking is complicated and requires expertise at all levels, including plan design, investment manager selection, portfolio construction, reporting and governance.
Depending on their choice, many corporations turn to outsourced management of hibernation plans as well as the diversifying growth portfolios many create to generate returns to help maintain or improve plan funded status and protect the plan from rising interest rates, said Gregory D. Calnon, managing director and head of OCIO at Goldman Sachs Asset Management.
About 80% of corporations that elect to take the pension risk transfer route don't convert 100% of the defined benefit plan assets to annuities and maintain a growth portfolio that many turn over to investment managers, Mr. Calnon said.
GSAM began working with clients on pension risk transfers "focusing on the liability side of pensions" in 2014 and has consulted on the process with approximately about 150 defined benefit plans with over $60 billion of liabilities over the past three years, Mr. Calnon said.
The firm manages LDI-oriented hibernation plans and their companion growth portfolios as well as the growth portfolios for companies that opted to transfer the risk of most of their defined benefit plans.
GSAM managed $81.6 billion with discretion in outsourced strategies, up 33.4% from the prior year, and was the eighth largest manager in that ranking.
Corporate defined contribution plans are another area of strong growth, said OCIO managers, who noted the size of DC plans opting for outsourcing is rising in line with fresh demand for innovative, customized investment solutions.
"Defined contribution is the next big trend for outsourcing. That part of the investment industry will change very dramatically over the next five years with outsourcing playing a big part," predicted Russell's Mr. Weeks, adding that DC plan management is under more scrutiny because of concerns about the retirement income gap.
"Target-date funds and indexing, the defined contribution plan default for so many plans, has to change," Mr. Weeks stressed.
Russell managed $9.2 billion in outsourced defined contribution plan assets as of March 31, according to survey data.
Goldman Sachs' Mr. Calnon agreed: "DC is ripe for disruption. Things have been done the same way for too long, partly due to risk aversion about the potential for litigation which drove investment committee behavior that was not always best for participants."
GSAM did not break out the amount it managed in outsourced defined contribution plan assets as of March 31.
Among the areas OCIO managers said they are working on with defined contribution plan sponsors for 401(k) plans, and increasingly for 403(b) and 529 plans:
Linking management of defined benefit and defined contribution asset pools for individual plan sponsors.
Customizing target-date funds and white-label portfolios.
Diversifying multiasset-class funds including real estate, managed futures and other alternatives that include a liquidity buffer.
Much of Mercer's growth in the year ended March 31 was from "megaplan" defined contribution sponsors, said Rich Joseph, U.S. business leader of delegated solutions, who is based in the firm's Boston office. He declined to name Mercer's new clients.
Mercer's work with large defined contribution plans is leading toward the launch of personalized glidepath funds delivered in a managed account format as well as strategies that offer retirement income for DC plan participants who have entered the decumulation phase, Mr. Joseph said.
Mercer was the largest manager of outsourced defined contribution plan assets with $36.9 billion as of March 31.
"The holy grail of defined contribution plans is retirement income protection," a strategy Willis Towers Watson is developing, said Clinton S. Cary, the firm's Chicago-based managing director and head of U.S. delegated investment solutions.
Willis Towers Watson did not break out the amount it managed in outsourced defined contribution plan assets as of March 31.
Aon Hewitt Investment Consulting, by contrast, is developing outsourced investment programs for multiemployer retirement plans in Australia, Europe, Middle East, Africa, the Netherlands and the U.K., said Andrew S. Cox, the firm's London-based global business officer and head of EMEA and Asia-Pacific.
Aon Consulting also is in early stage talks with EMEA sovereign wealth funds about creating customized outsourced portfolios of alternative investments such as private credit and real estate. The firm also is seeing strong demand for partial portfolio outsourcing by asset class from small U.K. defined benefit plans.
Client demand for a less aggressive outsourced hedge funds-of-funds strategy prompted Aon to make its existing portfolio more conservative and to add a second portfolio with amplified risk and volatility, said Stephen T. Cummings, global investment officer and head of North America investment consulting, who is based in Chicago.
Investor interest also has prompted Aon to ramp up research and development work on outsourced environmental, social and governance strategies as well as cheaper, factor-based investment approaches scheduled for launch at the end of this year, Mr. Cox said.