Record asset volumes are shifting over to outsourced chief investment officer firms as asset managers, consulting firms and institutional investors embrace the OCIO model with increasing fervor.
Despite the surge in OCIO popularity, fee structures, methods of evaluation and even commonality of service offerings continue to be elusive. As the OCIO market continues to scale, sophisticated evaluation standards must mature to ensure that the most capable firms are the recipients of the new engagements.
Recent OCIO growth trends
Previously considered the domain of traditional corporate pension plans, OCIOs are now controlling money across the institutional gamut. In 2017, assets under partial or full discretion of an OCIO firm grew to $1.56 trillion, with $1 trillion of that accounted for in U.S.-based assets alone.
Cerulli Associates, an asset management research firm, is projecting that U.S. OCIO assets will continue to increase by $671 billion over the next five years. The sectors most likely to convert to full outsourced options from consulting are family office trusts, hospitals, endowments, foundations and defined benefit plans with assets less than $1 billion. This, of course, affects regional consulting firms and Wall Street wirehouses that specialize in consulting for these midsized groups.
Investment committee and board members often lack the time, sophistication, macro-level investment knowledge and required tools to optimally administer their investments. Increased awareness of these realities couple with the great weight of their fiduciary responsibility, creating an environment where they are increasingly eager to be relieved of the burden of maintaining an investment platform, even with the aid of a consultant.
As institutions look closer at OCIOs as an option for discretionary management, traditional consulting and investment firms are seeking to absorb some of that business and diversify away from solely non-discretionary management.
The merger between Meketa Investment Group Inc. and Pension Consulting Alliance, expected to close in the first half of 2019, is just the latest example of an investment consulting firm merging with an OCIO model firm to offer discretionary services.
The last quarter of 2018 saw Mercer acquire and merge with two separate firms to further broaden its consulting and OCIO reach. And signs point to consolidation continuing for the foreseeable future.
The largest of firms will continue to try and outpace each other to become one-stop investment firms as businesses roll up retiring and/or smaller OCIO firms to bring expertise from different markets into one firm, or simply acquire to increase market share.
Evaluation, standardization needs
Despite the sharp increase in merger and acquisition interest and investment growth in OCIO firms, standardization is still lagging behind. For decades, traditional money managers have had standardized and validated track records to show to prospective clients. Many institutions won't invest without a GIPS-compliant track record of at least three to five years. In stark contrast, many institutions will often hire an OCIO to run their entire portfolio without so much as asking to see a track record.
Many OCIO firms do not volunteer their performance history, and some will not provide it even if requested. One reason given is that the performance of an OCIO firm's clients can vary, as management is often tailored to individual clients. This may be true in theory, but in practice, many OCIO processes, especially those newer to the discretionary business, have simply not been consistently applied among their client base.
With the stampede of assets flowing into the OCIO market, many of today's OCIOs were originally traditional consultants that simply added discretion to their incumbent relationships in order to join the market. For some, this created an environment lacking uniformity among their books of business, as well as in their implementations.
As a result, performance histories are often opaque, creating an environment where an OCIO might provide selective, cherry-picked composites. Other times, they hedge around questions about performance, stating performance can vary entirely based on the client's situation.
All too frequently, evaluations are made without regard to demonstrated investment capability altogether, instead having been reliant on relationships, representative client lists, credentials and compelling marketing — especially when not led by a competent search consultant.
Similarly, fees and cost arrangements have been inconsistent across the board. Some OCIO firms charge basis-point fees, while other firms charge fixed fees or even performance-based fees. Some firms have fees embedded in commingled vehicles, while others charge different fees for different asset classes.
However, the same commingled vehicles that may obscure or complicate fee evaluation may also add cost savings due to economies of scale at the submanager level. There is no easy answer to the question, "Which model is best?"
Evaluating OCIO services and capabilities requires more than the ability to administer an RFP, often putting the institutional client at a disadvantage. Organizations that hired an OCIO in the past five years, but did not use a well-established method for evaluation, will likely re-evaluate their OCIO relationships to validate their selection or make a change if warranted.
OCIO models in the future
Despite the obvious lack of regulatory case studies to guide those with fiduciary responsibilities (even in the ERISA space), the OCIO market will continue to grow and expand. Likewise, the market must continue to mature, and all signs indicate it will do so.
As larger consulting firms continue to expand their OCIO offerings, whether organically or through acquisition, more assets will continue to move toward OCIO models from consulting relationships. The consolidation will require more in-depth due diligence into incumbent relationships or acquiring firms to ensure clients' interests are protected and considered a priority.
Most importantly, as the OCIO market continues to scale and mature, sophisticated evaluation standards regarding track records and data transparency must be agreed to and universally applied. While standardization regarding fee and cost structures is unlikely to occur, transparency and disclosure of fees and costs in the OCIO model need to be a priority.
Jim Scheinberg is managing partner and chief investment officer at North Pier Search Consulting, a Los Angeles-based firm. This content represents the views of the author. It was submitted and edited under Pensions & Investments guidelines, but is not a product of P&I's editorial team.