Volatile markets, growing complexity underscore demand for OCIO

Increasing complexity of assets. A need to move quickly to adjust to volatile markets and uncertainty. Those are just a few of the reasons why industry experts and consultants say demand for outsourced CIO managers will only continue to grow.

According to data compiled by Pensions & Investments, OCIO assets managed for institutional investors worldwide with full or partial discretion surged to about $2.66 trillion as of March 31, up 5.4% from 2021 and 86.1% from 2017.

“Looking at (asset owners’) cost structures and resources, it just makes more sense for them to outsource their investment management,” said Michael Cagnina, Oaks, Pa.-based vice president and managing director of the institutional group at SEI Investments Co. “Plus, the market has more esoteric asset classes like private equity, cryptocurrency, infrastructure, real estate, etc., that OCIOs are more likely to have expertise in and familiarity with.”

SEI had $100.7 billion in worldwide outsourced institutional AUM with full or partial discretion as of March 31, making it the eighth-largest OCIO manager, down 5.3% from $106.3 billion in the prior survey.

Kane Brenan, Radnor, Pa.-based CEO of TIFF Investment Management, agrees that one of the principal reasons behind the growing popularity of OCIOs is that more asset owners have realized using outside experts can lead to better investment outcomes and improved governance, particularly important right now given the current state of the markets and the overall economy. TIFF Advisory managed $7.81 billion in outsourced assets as of March 31, up 5% from a year earlier.

“Organizations have to focus on the core of their businesses, and many simply do not have the time nor expertise to focus on their investments,” he said. “And as we now have entered a period of extreme volatility in the markets, in conjunction with rising demand for higher-returning alternative assets, I expect the demand for OCIO services will accelerate.”

Volatile markets rattled by rising inflation as well as interest rates can test even the largest asset owners.

The S&P 500 Total Return index was up 15.6% in the year ended March 31; AlphaNasdaq OCIO Broad Market index, up 3.3%; and the Bloomberg U.S. Aggregate Bond index, down 4.2%. That’s in sharp contrast with the prior year, when the S&P 500 Total Return index was up 56.4% in the year ended March 31, the AlphaNasdaq OCIO Broad Market index was up 30.7% and Bloomberg U.S. Aggregate Bond index was up 0.7%.

One OCIO cited another factor contributing to the rise of industry: the Great Resignation whereby millions of Americans either quit their jobs or retired due to the pandemic.

“This phenomenon has also hit asset owners and institutions,” said Samantha Davidson, New York-based senior partner and U.S. leader of Mercer LLC’s OCIO business. “Key investment staff and board committee members have either left or retired and this has placed a greater burden on entities which manage assets. They find it increasingly more viable to shift asset management to OCIOs amid all this confusion and uncertainty.”

The Great Resignation, she added, has been particularly challenging for human resource teams, prompting more defined contribution plans to seek out OCIOs.

According to data compiled by P&I, Mercer had $370.2 billion in worldwide institutional outsourced AUM with full or partial discretion as of March 31, placing it first among OCIO firms, up 0.9% from a year earlier. Mercer also ranked No. 1 among OCIO managers of DC assets, with $72.3 billion.

From one asset owner’s perspective, help with diversifying investments and greater investment expertise proved the selling point in making the jump to an OCIO.
Lawrence Bernert, board chairman of the $1.5 billion Norfolk (Va.) Employees’ Retirement System, recently completed a search for an OCIO to run the pension fund’s assets.

He declined to name the firm selected, saying a contract had not yet been signed.

“The retirement plan had been investing in a balanced model index portfolio, both stocks and bonds,” Mr. Bernert said. “But we recently decided to take the OCIO route to manage our assets and retained a consultant to help us.”

One of the reasons for the shift, he noted, was that the investment committee board wanted a broader diversification in its holdings, including allocations in higher-returning alternative assets. The committee decided that an OCIO with expertise in this arena would be better suited to manage and oversee.

Mr. Bernert said by email that currently “roughly 15% of the portfolio is split evenly between MLPs (master limited partnerships) and real estate.”

Fees were an important consideration during the search but not the dominant factor, he noted. Expertise in a broad array of investment assets and a good track record of performance were important considerations. “Fees actually were not a major part of our discussions with OCIO firms, and we were not necessarily committed to hiring the OCIO with the lowest fees,” he added.

Mr. Bernert is also a portfolio manager of Wilbanks Smith & Thomas Asset Management LLC. Wilbanks Smith has no business relationship with the Norfolk pension fund.

Michael Hradec, vice president, deputy director of business services at Savannah River Nuclear Solutions, Aiken, S.C., said in an interview that its $4.1 billion pension plan transitioned to an OCIO arrangement with Aon Investments USA Inc. in October 2021 after managing assets via an in-house investment committee using 3(21) advisers and fund managers.

“One of the major reasons we decided to hire an OCIO was because our committee would meet quarterly and our process would not allow tactical changes with agility,” said Mr. Hradec, who is chairman of the company’s savings and pension administrative committee. “That led us to miss out on opportunities with shifts in the markets and the overall economy.”

Mr. Hradec cited the dramatic emergence of the COVID-19 pandemic around March 2020 as one example of the need for an OCIO.

“When the market adjusted — we could not move quickly enough in our fixed-income portfolio to take advantage of the gaps in Treasury yields and credit spreads and missed out on this opportunity for additional returns and reduced interest rate hedge,” he said. “We expect to capture those opportunities with OCIO.”

While fee and cost structure were definitely key factors in determining which OCIO to hire, Mr. Hradec added that the most important considerations for the committee were the OCIO’s track record of risk-adjusted returns as well as the “quality of personnel” at the OCIO.

As OCIO business grows, so are the size of investor mandates.

Jim Scheinberg, the Marina del Rey, Calif.-based founder, managing partner and chief investment officer at OCIO search consulting firm North Pier Search Consulting, said in an interview that when his company began running OCIO searches about 10 years ago, he saw mandates in the $100 million to $400 million range. Those now routinely exceed $1 billion and $2 billion. Over that time, Mr. Scheinberg estimates, OCIO industry assets have about quintupled, suggesting rapid adoption of OCIOs by a wide array of asset owners.

“We have seen a large increase in OCIO searches from most types of asset owners. Foundations, both public as well as those of private families, continue to move in that direction. Most searches we conduct in that space are from $100 million to $1 billion, though lately we are seeing more requests as small as $25 million.”

Corporate pension funds have been very active, Mr. Scheinberg indicated, since regulations, notably ERISA, mandate that plan sponsors regularly evaluate their defined benefit plan consultants and OCIOs. “Those cases for us tend to start around $200 million and go well into the multibillions,” he said.

Lately, he added, his firm is seeing more searches from the public funds space as well as some Taft-Hartley pension plans. “I suspect we will see that area start moving more and more to delegated mandates in the coming years, especially with the recent market volatility,” he added.

For defined contribution, Mr. Scheinberg noted, the sky is the limit. “We are working on one project right now well in excess of $10 billion, and we just requested to bid on another for a plan three times that size,” he said.

The OCIO industry experienced a mega deal about a year ago. Citing intensified regulation, rising operational costs and increased investment complexity, British Airways said in 2021 that it had signed BlackRock Inc. as outsourced CIO. At the time, the airline’s two plans held £21.5 billion ($26.4 billion) in assets.

The plans had been managed by the in-house provider British Airways Pension Investment Management Ltd. Some internal staff members joined BlackRock as part of the deal.

Experts, including Greg Calnon, the New York-based global head of the multiasset solutions group within Goldman Sachs Asset Management, said OCIO mandates are likely to keep getting bigger, though not necessarily as king-sized as the British Airlines deal.

In late April, GSAM was appointed by Canadian business jet-maker Bombardier Inc. to provide investment management services for $5.4 billion of its pension and insurance assets.

GSAM managed $239.93 billion in full or partial discretionary OCIO assets, ranking second among U.S. firms, a 15.5% jump from the year-ago figure of $207.7 billion.
Ryan Marshall, co-head of multiasset strategies and solutions at BlackRock, said in an email: “We continue to see demand for outsourcing from all regions and client segments, and in 2022 we expect to onboard some of our largest mandates ever. Over the past year, we’ve added significant resources across investments, research, operations and technology to support recent and anticipated future growth.”

BlackRock managed $184.5 billion in full or partial discretionary OCIO assets as of March 31, ranking fourth among U.S. firms, a 16.3% jump for the year.

But as demand and competition increase, fees are coming under pressure, OCIO managers noted.

Not only can OCIOs speedily deploy capital, but as these firms become larger — and gain significant economies of scale — they can negotiate lower sub-manager fees for asset owner clients, making their service even more appealing, North Pier’s Mr. Scheinberg said.

While Mercer’s Ms. Davidson acknowledged that fees charged by OCIOs have been falling in recent years, she feels that at some point, they will have to stabilize.
“This decline in fees is not unique to OCIOs. It has been seen across the asset management industry,” she said. “But at some point, the decline has to end or there might be a fall-off in the quality of service. Thus, there’s a trade-off here.”

She also noted that management fees compressed during the recent 12-year bull run where the top performance came from U.S. equities — that in itself made passive investing popular and hurt fees earned by active managers. “Now that we are in the tail end of that bull run and have entered a very difficult market climate, active investing — and fees — should likely stabilize,” Ms. Davidson said.

TIFF’s Mr. Brenan agreed. “It’s the value proposition,” he said. “You get what you pay for and if you want high-quality asset management services, you need to pay a sufficient fee. I think the overall trend of falling fees has stopped. Clients have moved from making a selection based on simple fees to more of a value decision based on investment results and service and headline fees.