Commentary: 4 key questions that drive OCIO matchmaking

The last decade has seen tremendous growth in outsourced CIO assets, to more than $2 trillion today from just $100 billion globally in 2007. However, the term OCIO is broad, at best. A wide spectrum of firms are expanding the breadth of their OCIO services with different goals, strategies and fees.

A side industry of search consultants — advisers that charge handsome fees to conduct an OCIO search — has emerged to assist institutions with negotiating the complex OCIO landscape. Yet even with the assistance of a search consultant, an institution's decision-makers must be able to clearly articulate their goals and needs to navigate the OCIO landscape and ultimately select the best provider to help meet their objectives.

Combined with each firm's specific nuances, and the layer of additional complexity by involving a search consultant, an institution's decision-maker is likely to have a difficult time directly comparing each firm using common criteria.

At the foundation of any OCIO search are the institution's goals, pain points and needs, which determine how that institution navigates the OCIO landscape and ultimately selects a provider. Below we discuss four key areas of differentiation and list associated questions to drive an institution's focused OCIO search.

Targeting an OCIO provider that partners with institutions like yours is a good place to start. Whether your primary goal is risk mitigation for defined benefits, long-term appreciation plus payout, or something in between, there are OCIO providers specializing in an investment strategy to suit your needs. Some specialized strategies include:

• Low-cost passives that minimize fees and offer greater liquidity.

• Manager selection and alternative strategies, seeking to capture a return premium for illiquidity risk.

• Rigid strategic asset allocation driven by a top-down framework.

• Thematic-driven investing, such as ESG or sustainability mandates.

Having a clear vision of your institution's risk and return goals and decision-making abilities will significantly narrow the type of OCIO provider whose services best fit your needs.

One of the main criteria to consider is whether an institution's decision-makers want to retain discretion over investments, or if that should be delegated to the OCIO provider.

Some OCIO firms may require full discretion, and with that added responsibility likely comes a higher management fee. Other firms may offer a more consultative OCIO service where they propose investments that are ultimately chosen by the institution's decision-makers.

Some OCIOs offer the ability to meet somewhere in the middle, with a model where institutions can make complementary allocations to asset class vehicles or to liquidity pools, allowing them to customize their asset class exposure, risk and return profile, and liquidity. While the OCIO maintains discretion over these vehicles, their institutional clients maintain discretion over the size of their complementary allocations and therefore their exposures. In the case of liquidity pools, clients maintain an additional layer of discretion since they decide which investments to include — typically passive vehicles of stocks or bonds — and how to allocate among them.

Many investment committees have regular turnover, which presents a challenge to continuity. In these instances, delegating discretion to an OCIO provider's dedicated team can provide the continuity required to ensure an institution meets its goals over the long term.

Discretion is also relevant to an institution's ability to make timely investment decisions, especially in a volatile market when you need to act quickly to protect against permanent capital loss.

Investment discretion should be detailed in the investment policy statement, as well as items such as benchmarking, reporting guidelines and client service expectations.

Customization is often perceived as a clear benefit because it allows institutions to fine-tune risk, return and liquidity parameters to fit their specific needs. For example, if institutions have stringent ESG requirements, full customization may be a great option.

However, OCIO firms offering custom portfolios may approach customization differently, and it is critical to understand what level of customization is offered. Some provide completely bespoke investments, while others customize using commingled pools as building blocks, enabling custom allocations but not bespoke investments. A commingled approach can be favorable when capacity-constrained alternative investments are included, removing potential allocation conflicts. A commingled approach might also better align interests among clients; a customized approach could lead to misalignment among clients, especially if a particular client pays higher fees compared with other clients.

OCIO fees may be advertised anywhere from 10 basis points to 100 basis points or more. But these numbers have little meaning without clarity on what costs are included or excluded. Depending on the provider, a la carte services and expenses such as customized reporting, legacy investment management, audit, tax, custodian and administrative may be excluded.

Equally important, fees should represent the level of service provided. Actively managed or alternative strategies will cost more than passive strategies because of the resources required for optimal execution.

OCIO fees come in several different flavors: flat management fees, tiered management fees, performance fees, negotiable fees, supplemental fees for add-on services (e.g., access to alternatives or legacy portfolio oversight), etc.

Transparency is also critical when comparing fees among OCIO providers. If the OCIO provider allocates to third-party managers, what fees do they earn? Are third-party managers affiliated in any way to the OCIO provider?

The OCIO industry has a vast spectrum of choices. Even when two OCIO providers may appear comparable at first glance, there are likely nuances and intangibles (concerning anything from track record to fees to client service) that must be approached with caution and transparency to accurately compare them. Understanding your institution's needs and ensuring alignment in these four key areas of strategy, discretion, customization and fees are critical to navigating the vast and diverse OCIO landscape.

Luke Proskine is co-managing partner at Makena Capital Management LLC, Menlo Park, Calif. 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.