Pensions & Investments: What’s the status of the outsourced CIO market today?
Heather Myers: First of all, many different types of asset pools are looking at OCIO; whether it’s corporate defined benefit plans or endowments, foundations, religious institutions or insurance assets. There is recognition that managing money takes a lot of work, that it’s good to have a professionals actively involved. Being able to make tactical tilts and being much more dynamic with investment strategy, rather than making decisions on a quarterly basis, is necessary and can be beneficial. In addition, OCIO may be more cost-effective than the structure that’s been in place. The buyer of OCIO services now has a lot more choices. You go back 20 years and there were only a couple of types of OCIO solutions. Typically there were pre-allocated commingled funds, thus limiting the asset allocation choices. Fast forward to where we are today, and the buyer has more options to choose from. You could say, “OK, I just want to only outsource manager selection for a particular solution.” “I don’t want to be in commingled vehicles.” “I want an open-architecture approach.” The buyer now has a lot of opportunity. It makes it more challenging for them because there are so many providers out there, and they really need to think about what is the end solution that fits best for them.
Rich Joseph: We frequently refer to OCIO as a trend, but the reality is that after 20 years, I think it has moved past trend to become a proven concept. It now has a greater comfort level among institutional investors, and with the recognition of the successes in the OCIO space, asset owners with much larger pools are more interested in an OCIO approach. Delegated solutions are much more heavily focused across business sectors than 10 years ago, when OCIO was generally limited to defined benefit or defined contribution plans. We now see OCIO growing in the not-for-profit and insurance arenas. Health-care OCIO has been a constant, largely because very few of these institutions can work across all the asset pools they have.
In addition, OCIO is being used in new asset classes. Where before it might have been an all-or-nothing approach, larger organizations are now asking, “Can you get me access to alternatives? Are there specific asset classes where it’s cost-effective to do this?” We’re calling this OCIO 2.0, in which a vibrant OCIO market has evolved pretty significantly from where it started. There’s still lots of upside.
Thomas Meyers: It’s clear that the OCIO market is very strong, and there’s been robust secular growth over the last 10 years that everyone expects will continue. From my perspective, the validation of OCIO is the way it’s moved upstream and that larger, more sophisticated asset owners have been adopting it, which is a really strong proof point for the value of such an offering. OCIO is a long wave, something that’s fairly secular, powerful and evolving. We’ve definitely observed increasing [uptake] by noncorporate DBs, insurance, foundations, endowments and large asset owners. I think the benefits are access to things like alternatives that they couldn’t get on their own; some leverage with respect to fees; quicker, more tactical decision-making and the ability as a board from a governance perspective to focus on more strategic things and allow their OCIO provider to be responsible for the market and manager interface.
P&I: Did the financial crisis of 2008-2009 trigger a boom in popularity for OCIO?
Thomas Meyers: It’s an interesting question. Certainly, the financial crisis raised consciousness on the part of boards that control assets as to how hard making those investment decisions really is, and the importance of having really strong support on the part of their consultant and in this case, OCIO, where the engagement level and responsibility for the decision-making and the tactical decisions really rose to the forefront. If you were waiting for the normal board cycle decisions, which can sometimes roll into the next quarterly meeting, I think the crisis certainly brought to life the fact that sometimes things happen really quickly and unexpectedly, and having a strong partner and an extension of your team through an OCIO provider, I’m sure, proved valuable at that time, due to improved agility.
Rich Joseph: The use of the OCIO model expanded during and after the financial crisis, but it was really because asset owners started to recognize that there were other issues beyond financial performance that were important to the plan, such as liquidity and securities lending. When investment committees met once a quarter and saw good performance, they tended to think that everything was fine. But when the market turned, committees had to make decisions intra-quarter and didn’t have the ability to facilitate that quickly. That has made the OCIO model more appealing, and I think that’s continued to this day.
P&I: What are institutional investors looking for in an OCIO arrangement? Are there any general themes that institutional clients look for from an OCIO?
Thomas Meyers: I’ve done some work on the investment committees of a few nonprofits where we’ve actually engaged OCIO providers. I think for us, we were looking for … relief for our [investment] staff, more tactical and timely decision-making, reduced paperwork, access to managers that we otherwise would not have been getting on our own. Given our size, some reduction in complexity and an ability to focus on more strategic things are sort of all tangible and quantifiable benefits. I mean, the soft stuff is important, as it is in any decision — Who do you trust? Who do you like? Who do you like to work with? Comfort with the organization’s culture — all those sorts of things which are arguably more subjective. But to go back to OCIO 2.0, it was a seminal decision to abandon traditional structure and go to an OCIO. We ended up getting the decision right in terms of going to that framework. But ultimately, once we had been doing it for a while, we found out [more precisely] what our needs were and ended up going back to search in a few years, hiring another provider with some different requirements once we knew how to engage in that framework. I think we became smarter users over time.
Rich Joseph: OCIO providers often recognize that depending on the asset pool, asset owners are trying to solve a problem or meet an objective, pursue not-for-profit missions or, in the case of defined benefit sponsors, exit their DB plans. And this process creates two needs. First, asset owners are looking for creative ideas to help them meet their objective. Second, the majority of institutions are moving into an OCIO-model framework for the first time. So getting asset owners comfortable with the fact that the provider understands their needs is critical from an education standpoint. This is because their role changes a fair bit when they move to an OCIO approach — not in terms of what their fiduciary responsibility is, but how they actually meet their fiduciary responsibilities.
Heather Myers: At the end of the day, you want to partner with an OCIO that is culturally aligned, that understands you and with whom you feel comfortable. Some investment committee members get a little nervous. They like picking managers — and with OCIO, is there going to be a role for them? They need to understand that their role is still really important and that they can focus on those critical strategic issues and let the OCIO pick the managers, do the tactical tilting and all. It is interesting now that we are in this next phase, because you’re starting to see [requests for proposals], searches from people who have been in OCIO relationships and have liked them, but they’re a little disappointed in the relationship they have. So now they’ve had enough time under their belt to say, “You know what, I think we’re at the right place, but I’m not with the right provider. What else is out there and how can I kind of shift responsibilities a little bit, get a little more hands on in a particular area, take back some of this other responsibility?” That’s an interesting evolution that we’re seeing. It’s a more knowledgeable buyer now.
P&I: Why are asset owners who already have OCIO relationships issuing new RFPs, and what are they looking for?
Heather Myers: There are a variety of reasons why. Here are a few: One is where performance is disappointing and they want to look for another provider who has stronger performance. Second, some of it has been turnover. You’ve seen some OCIOs with some significant turnover, organizational change, and that’s led to, “OK, let’s look for another solution or re-evaluate who we currently have and see if they are still the best.” And a third reason is lockups. It’s interesting, some vehicles that the investor is in have longer locks or more restrictions than initially expected. There’s some discomfort with that, and they want to look at other options for investment, recognizing it might take them a little bit of time to get out, but once they get out, they want something that has better investment terms. Finally, access to strategies is another reason for issuing an RFP, “What are the investment strategies you have access to?,” “Do they meet your needs?”
Rich Joseph: There are several drivers of search activity, in my view. First, people are more comfortable with the OCIO model. They know what they’re looking for, so there’s more turnover among OCIO provider firms. We’re also seeing more turnover on investment committees, and that tends to lead to more provider searches and RFPs. Secondly, from a fiduciary perspective, a lot of organizations feel like every five years or so it may be a good idea to go out and see what’s available in the market. Finally, there’s a big push toward customization. There are certain aspects of the OCIO model that are now interesting to asset owners, where [under] OCIO 1.0, an OCIO provided everything. So I think it’s just a more sophisticated buying center, more knowledgeable.
P&I: How can asset management firms best serve OCIO providers and their clients?
Rich Joseph: We break it up into three components. Clearly, creative thought and creative investment ideas are No. 1, where we’re not managing individual securities or funds, asset managers are comfortable bringing their best ideas to us. They know that we’re not going to try to implement without them. No. 2, the ability of the best partners to work with us operationally is a big advantage for us. A major part of the OCIO model is to execute on the precise activities that are needed to get results, meet liquidity and allocate assets quickly and efficiently. And the last piece is leveraging scale and buying power to reduce cost for asset owners. The best OCIO providers should be able to meet all three requirements.
P&I: Given the current economic situation, are there reasons why now would be a particularly good time for newcomers to try OCIO?
Thomas Meyers: I would say timing is not a principal consideration. I think [choosing to use an OCIO] is really a policy and governance decision that’s more strategic in nature. I think, from an acceptance perspective, it is viewed as a best practice. In many parts of the market, it’s easier to consider this decision now versus 10 years ago, but I don’t see a lot of market-induced decision-making here. It’s just a way of conducting business as an asset owner that’s solidly established.
Heather Myers: I would agree, in that it’s not specifically time-driven. That said, in recent conversations I’ve had with endowments and foundations that are currently in a consulting model, they have concerns that there is a lot of market uncertainty right now. Their current structure of quarterly meetings, where they’re looking at asset allocation and not able to make quicker decisions, may not be a good situation for them going forward. That’s why they’re looking at OCIO. So for some, it is timing. They’re asking, “What’s going to happen to the market and is there a better solution for me going forward in this time of uncertainty?” and “Will an OCIO help me be more flexible or more responsive to the markets?”
P&I: What are the different types of OCIOs, and how do institutional investors make comparisons when selecting one?
Heather Myers: What I find interesting in the OCIO market is that you have firms that have started in the asset management business and then they’ve moved to OCIO — and taking on an OCIO role is also taking on consulting. You [also] have firms that have started as consultants and moved into OCIO — and that’s asset management. So to be a really great OCIO, you have to be strong in asset management and you have to be strong in consulting. When you look at a solution provider, you need to take that into account, because if you hire a firm that’s an asset management firm that is now an OCIO, you probably will be missing some of that consulting — and vice versa. Some consultants have moved far into asset management. Some asset managers have moved further into consulting. But there is a different culture between asset managers and consultants. There is a different mindset, and there’s a different deliverable. And then you have a whole slew of boutique firms that have spun out of in-house asset management — at universities, for instance. So when the buyer is looking [for an OCIO], there’s kind of a matrix approach that they have to attack. Do you want a big firm? Do you want a small firm? Do you want an asset management culture? Do you want more of a consulting culture? Do you want someone who just knows your space in higher education but only has a few clients and it’s going to be a single strategy? There’s a lot to unpack there.
Rich Joseph: I’m not certain there’s an apples-to-apples comparison that can be made among OCIO providers. Performance is relative to custom benchmarks and how much volatility and how much of a risk appetite there is. So, even comparing performance isn’t as straightforward as one might think. It’s really important to invest the time to understand the culture, the committee’s history, its governance. There isn’t a one size fits all in any of this. So culturally, does the OCIO team understand what the client’s objective is? Does the team ultimately focus attention in the areas that are important or valuable? Investing that time upfront is really the best way that you’re going to conduct a meaningful comparative analysis.
Thomas Meyers: I think there is a movement toward trying to capture performance, but it’s hard to make it purely apples to apples. It comes down to what you are looking to accomplish from the relationship, and then the fit in relation to that set of requirements — but also getting into the whole notion of being a trusted partner and talking to peers in your space and getting referrals. Those are the sorts of things that hopefully come down to a proper decision for everybody who’s involved in the relationship that extends most directly from the asset owner to the OCIO, but also to people in the circle, like asset managers and others who are providing support around the edges. I think [you should quantify] what it is that you’re looking for and do referrals. Sometimes the idea to go to an OCIO framework comes from an existing service provider, so it could come from your custodian, asset manager, consultant or actuary. It could come from any number of circles who are trying to promote their own firm’s particular offering. Not that it’s wrong, because sending this sort of decision into committee for somebody to evaluate is right. But ultimately, you want the decision process to be pure and not just from the angle of a custodian or an investment bank who has an existing tie-in for different reasons. You want it to be an unbiased decision to the extent that’s possible. And I think the market’s heading that way.
P&I: Can you use an OCIO to target specific investment asset classes, like alternatives?
Rich Joseph: Yes, actually, OCIO is a good fit for implementing an alternatives mandate. Moving from the OCIO framework of 10 or 15 years ago, when we did everything for everybody, we have seen a fair number of clients begin to use us as the investment manager for an alternatives sleeve. It could be a small portion of the portfolio or it could be a larger portion of the portfolio. In most cases, we’re not the all-encompassing OCIO, so we’re not necessarily providing asset allocation on the entire portfolio. This is a benefit of firms like ours and the larger firms in the space. Investors gain access where they might not have been able to get it before. They’re getting scale and some cost-efficiency. And they’re getting the consulting piece: For example, they might be in the right asset class, but how do they know what part of that asset class is best for them? That’s an aspect of OCIO that’s evolved significantly over the last 10 years.
Heather Myers: The asset owner who chooses to allocate only part of their portfolio to an OCIO solution, say it’s alternatives, can do [it in different ways]. They could have the whole thing as an OCIO but have two different providers. That happens. For instance, you have a provider for the long-only assets and provider for private capital and real assets. Or there are some that just want advisory for one part and OCIO for another part of the portfolio. One of the main additional considerations is the asset allocation decision and how that works with the onus remaining on the investment committee. For example, if [an asset allocation] is 30% alternatives, 70% long only, and then there is a decision to reduce alternatives to 20%, the investment committee needs to be more proactive in managing that change, and consideration of the lockups therein, than if all the assets were outsourced. So it’s absolutely doable. It’s something we see a lot. There may be additional operational considerations or additional work for the staff or the committee with selecting the two providers.
Thomas Meyers: There are all different ways to combine either traditional or outsourced investing as well as splitting up the components [among] people who specialize in liability-driven investing or alternatives. There are a lot of different ways to hybrid it, and there are successful versions of all of the examples that were listed. As we evolve more in the 2.0 world for OCIO, I think there are more ways that people are adapting and adopting pieces of the model to their specific requirements.
P&I: Should one of the questions that asset owners ask in RFPs be how much control of noninvestment decisions, such as custodian selection, is ceded to their OCIO?
Thomas Meyers: There’s an incredible amount of complexity and drag that comes through the form of contracting, generating and signing. A huge lift is the ability for OCIO providers to take the burden of documentation, like policy statements, off the shoulders of the asset owner. Reducing some of that processing and paperwork complexity is one of the principal advantages that most users probably experience.
Heather Myers: I think what’s important is the question of what institutional investors are looking for from an OCIO arrangement. Sometimes the [asset owner] staff is overwhelmed by the operations component of having a portfolio, dealing with a custodian, dealing with securities lending, dealing with the offering documents and all that. There are all these other ancillary services that are available, and you need to determine the importance to you, the cost, etc. Some people don’t want to give up their custodian. With some OCIOs, you have to give up your custodian to go with their custodian. Again, the buyer has a lot of choice right now. They just need to know what they want. ■