“Price is what you pay. Value is what you get.”
As Mr. Buffet alluded to in one of his most famous quotes, value is a much deeper concept than just price. It varies greatly depending on the context, and while price is indeed an important factor in customers’ buying decisions, perceived benefits must outweigh the cost for a product or service to be attractive (or valuable) at any point in time. Outsourced chief investment officer (OCIO) services are a good example where an increasingly favourable context and a positive change in benefits perception drove their value higher.
In their early days, OCIO services were regarded as a niche solution, primarily used by plan sponsors to help manage their closed or frozen defined-benefit (DB) pension plans as they shifted to a defined-contribution (DC) approach. However, as financial markets became more complex due to factors such as globalization, increased volatility, and tighter regulation, many smaller institutions1 outsourced their investment management activities instead of developing internal capabilities. More recently, we’ve even seen institutions with billions under management partner with OCIOs, as their services are now perceived as a preferred option for numerous asset managers, from DB and DC pension plans to endowments and foundations of different sizes.
Global OCIO assets have more than doubled since 2013
Source: Pensions & Investments. The dollar values are as of March 31 of the respective year.
While we believe OCIO providers, in general, have proven to institutional investors that the value they bring to an investment platform outweighs the cost, partnering with the right provider is critical, as there are elements that separate a good OCIO from a transformative one.
What are these critical elements to look for?
OCIOs’ primary duties
There are many aspects to consider when partnering with an OCIO provider, but first and foremost is its ability to offer risk-adjusted value added on the investment side. As with all asset and portfolio managers, an OCIO’s track record is the ultimate testament to its expertise and should be one of the top criteria in the selection of an OCIO provider. However, we believe that looking at historical long-term performance numbers doesn’t provide the full picture, and scrutinizing the investment process and, particularly, the elements listed below is crucial.
|Ongoing active management||In-house management requires a significant time and resource commitment, and due to stretched budgets and schedules, investment and pension committees usually meet only every three months to rebalance their portfolios. While we agree that quarterly meetings are adequate for periodic rebalancing and strategic allocation decisions, we believe that daily oversight is essential to make sure the portfolio stays on track and optimized. As such, OCIOs can increase portfolio governance, and those with the leeway and the ability to act tactically can also take advantage of market dislocations and volatility as they occur.|
|Access to the best investment teams||Once the strategic asset allocation mix is established, diligently selecting asset managers that are the best suited to deliver on return and risk expectations is crucial. OCIOs with a broad open-architecture platform can access complementary strategies and source the best investment talent in the world.|
|Access to alternative investments||Alternative assets can provide significant diversification, risk, and return benefits for institutional investors. However, these investors—particularly those with smaller AUMs—often lack access to such assets thanks to large minimum investments. OCIOs with depth and breadth managing alternative assets can help level the playing field by granting their clients access to alternatives, regardless of size.|
|Liability-driven investing (LDI) and actuarial expertise||We believe that sound risk management starts by closely modeling liabilities based on actuarial and investment projections. Liabilities are a concern for all institutional investors, but every situation is unique and OCIOs offering a tailored approach armed with a wide range of LDI solutions should be favoured.|
|Innovation||From new products to ever-changing regulation, capital markets and the financial industry are constantly evolving. A good OCIO provider will stay at the forefront of industry research, develop state-of-the-art investment solutions, and keep up with and be part of financial innovation.|
In addition to helping clients generate more robust investment returns, OCIOs can also contribute to improving overall efficiency and reducing administrative costs.
Plan sponsors can have multiple external administrators/providers to manage every aspect of their pension plan—investment decisions, actuarial valuations, group benefits, custody, DC plan administration, and DB plan administration—potentially involving significant coordination work to keep up with all the moving pieces. A good OCIO can take on all these duties, reducing the number of providers to one and, ultimately, making it easier to do business. By having the investment and actuarial capabilities under the same roof, for example, the investment arm can access crucial data such as the plan’s funded status at any point in time and make better-informed, timely tactical investment decisions.
By pooling assets with those of other clients and even with their assets (for OCIOs that are also asset managers), OCIOs usually benefit from better scale than small to midsize pension plans and institutions, and therefore can negotiate more competitive pricing when it comes to group benefits and plan administration, as well as with subadvisors and custodians.
OCIOs’ value added
Building a customized investment strategy that can help institutional investors meet their objectives, as well as providing an infrastructure that can ease their administrative burden, is the foundation of OCIOs’ value. That said, because of the holistic nature of OCIO services, most OCIO providers are large asset managers and consultants that can do it all (advice, portfolio management, and administration).
However, an OCIO shouldn’t just be there to act as a service provider—it should be an agent of change able to transform and improve your organization. To find those types of transformative OCIOs, we believe the selection process must continue beyond the aforementioned criteria. In our view, the true value added (or the differentiating factors that make an OCIO stand out) comes down to more subtle yet extremely important elements:
|Communication||Although there are many advantages to outsourcing investment management activities, this doesn’t mean OCIOs’ clients can take their hands off the wheel. It’s a partnership that requires continuous communication and collaboration between both sides from the start. In addition to periodic meetings, best-in-class OCIOs will make themselves available for ad hoc discussions and encourage a constant dialogue.|
|Education||Ongoing reporting (e.g., transaction details and performance attribution) is essential to keep clients informed about their investments. However, institutional investors’ appetite for information and explanation is usually bigger than that, especially during market crises. Elite OCIOs will share their opinion and market views through timely and proactive thought leadership while providing ongoing advisory to help investors deal with episodes of uncertainty and better understand market conditions and trends.|
In general, OCIO fees are competitive across the industry, with half of OCIO providers charging between 0 and 10 basis points to clients with more than $1 billion in assets.² However, the underlying investment strategies (e.g., global equities, emerging-market bonds, infrastructure) also charge a management fee to any investors, including OCIOs; trustworthy OCIOs will disclose to clients a comprehensive pricing structure.
Moreover, while some OCIOs are asset managers and have in-house investment teams, they can’t excel in every area and asset class, or may just not have strategies that are a good fit for any given client’s profile. As such, OCIOs must always put clients’ interests first and diligently choose the manager mix that suits best every client’s investment strategy and needs.
|Liquidity||By understanding and closely monitoring its clients’ business and spending needs, an OCIO provider can help increase liquidity control and establish the right mix between private and public assets. Strong OCIOs will also use their connections on the secondary market to help source liquidity, when needed.|
While these criteria may be more difficult to quantify or qualify than the ones listed in the first section, we encourage plan sponsors and other institutional investors looking for an OCIO to incorporate them in their selection process to make sure they can benefit from the full potential of an impactful OCIO.
Seek an OCIO willing to go the extra mile
Every institutional investor’s situation is unique, and so is the value proposition of each OCIO. While OCIO services may seem to be created equal from a good provider to another, dig a little deeper and you’ll find that, in fact, they’re not.
Selecting the right OCIO for you is no easy task, but no matter what your needs are for outsourced expertise—whether it’s for a specific mandate or for a holistic solution—don’t settle for a good OCIO when there are transformative OCIOs willing to go above and beyond.
A widespread health crisis such as a global pandemic could cause substantial market volatility, exchange-trading suspensions and closures, and affect portfolio performance. For example, the novel coronavirus disease (COVID-19) has resulted in significant disruptions to global business activity. The impact of a health crisis and other epidemics and pandemics that may arise in the future, could affect the global economy in ways that cannot necessarily be foreseen at the present time. A health crisis may exacerbate other pre-existing political, social and economic risks. Any such impact could adversely affect the portfolio’s performance, resulting in losses to your investment.
Investing involves risks, including the potential loss of principal. Financial markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. These risks are magnified for investments made in emerging markets. Currency risk is the risk that fluctuations in exchange rates may adversely affect the value of a portfolio’s investments.
The information provided does not take into account the suitability, investment objectives, financial situation, or particular needs of any specific person. You should consider the suitability of any type of investment for your circumstances and, if necessary, seek professional advice.
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