Part of the Multi-Asset Strategies Investing, North America 2017 report, we asked our expert panellists 'how the outsourced chief investment officer (OCIO) model differs from traditional investment management models'.
- Tom Heck, CIO, Ball State University
- David Veal, CIO, City of Austin Employees Retirement System
- Hal Peterson, Chairman, Investment Committee, Austin Community Foundation
David Grana, Head of North American Media, Clear Path Analysis: Tom, what were some of the factors that led to hiring an outsourced chief investment officer (OCIO) at Ball State University?
Tom Heck: We conducted the selection process back in 2010-2011 after evaluating our performance through the Financial Crisis and determined that we had a governance problem. We had an investment committee with an outside consultant. The committee would meet three times a year, and the decision making process was cumbersome and ineffective in a dynamic market environment. Since adopting the endowment model of investing in 2004, identifying and accessing managers, particularly in the alternative space, was difficult because of our size, at $200 million. In addition, we felt that, much like many university endowments, resources were always an issue. We ended up going through a buy, build or outsource decision. We ended up deciding to go with the OCIO model.
David Grana: David, you had a different experience from your previous role - a strategic partnership. How does that model work?
David Veal: I was the director of the strategic partnerships group at the Teacher Retirement System of Texas (TRS), and we are considering a similar arrangement here at the City of Austin Employees Retirement System (COAERS). In doing so, we are considering what we might be able to adapt from my previous experience. Many pension funds today are organized to invest with managers in verticals such as stocks, bonds commodities, and so on. However, they aren’t getting a lot of great strategic advice from these managers on a day-to-day basis. In a strategic partnership structure, you can develop a deep relationship with a large asset manager, which can manage a trillion dollars or more and offer a range of investment insights through their vast pool of resources. The value-add of this kind of approach is very different what you would normally get from simply hiring a large cap core manager, for example.
David G: Hal, what is your set-up at the Austin Community Foundation?
Hal: It is a traditional, thinly staffed, non-profit community foundation with almost $200 million in assets today. Internally, the only financial officer we have is the CFO and one support person. When I got to the Foundation, we thought about evolving the sophistication or increasing the fiduciary responsibility of the committee. The first aim was to diversify the committee with practitioners in the industry, since so many decisions were falling on them to make asset allocation and investment policy decisions. We ended up bringing in people from academia, UTIMCO, and other, similar organizations.
Since we meet quarterly for a total of 6-8 hours in total per year, we realized that we needed to hire an outside firm to advise us. The committee could handle broad allocation decisions, but anything related to do with managers, due diligence, or anything granular was not possible. We ended up hiring a traditional consultant after an in-depth RFP process. They run almost everything by us, whether it be a manager change, policy shift or relatively substantial reallocation or rebalance. They do have the discretionary authority, but in practice, they operate more like a consultant.
David G: Tom, is this a similar relationship to what you have set up at Ball State?
Tom: In many ways, it is. However, in our relationship with our OCIO, we define success, our investment objectives, risk parameters, and a target asset allocation that, in effect, creates a benchmark. Our policy allows for wide choices around asset allocation, and the OCIO is free to tilt the portfolio at its discretion. In our relationship, they have full discretion over manager and strategy selection without approval by us. When they come and talk to us, they will discuss how they are managing the portfolio, any changes they are making and thinking about making, but pre-approval is not required. We may ask about their logic or thinking behind certain issues, but we have little to no authority or influence on their decision. This puts the entire onus of success on them as an organization.
Hal: That to me is what is considered a true OCIO relationship.
Tom: Yes, and when we went through our process, we did consider a number of OCIO organizations with different models, some of which operate on a single pool concept, and others that had more of a consultant-type relationship, requiring approvals when it came to manager changes or strategy decisions. In our case, we chose this model of OCIO relationship for very clean and quick responses.
David G: Does this differ greatly from the strategic partnership, David?
David V: It is similar in the sense that the asset owner retains discretion over the selection of strategies and the underlying managers. And that performance is derived from a benchmark that looks a lot like the strategic allocation with tactical bands around the asset class weights.
Hal: When hiring an OCIO, the fiduciary responsibility that you have is to do the due diligence on that OCIO. Once you have done that, then that is how you fulfill your fiduciary duty. You have to benchmark them, monitoring them, and reviewing them in-depth. Does this take lot of weight off the shoulders of an investment committee, board, CIO or CEO?
Tom: It does, and we did have some discussions about it, especially coming from a consultant model. We discussed what our investment committee would do under the new model. Would it continue to be an engaging way for board members to participate in the foundation? The improvement here is that, where we used to come to the investment committee and discuss issues around asset allocation or manager selection, we now get to discuss broader themes, such as the rise of the middle class in China or the Fed raising interest rates. The discussions are at a higher level and more relevant to the knowledge and experience of our investment committee members.
What we had to get comfortable with was the concentration of risk. Before, we had a consultant who oversaw the entire portfolio but had no discretion. They partnered with individual managers who had discretion over small pieces of the portfolio. We then migrated to an environment with one external organization with discretion over the entire portfolio. The due diligence and monitoring responsibility became that much greater.
David G: Where would you see an arrangement like this being useful?
Tom: This is a bit of a grey area. In our case, we are outsourcing the entire portfolio. There are certainly organizations that are either multi-asset specialists or OCIOs that do invest in specific asset classes and manage a portion of the portfolio or do a slice of the portfolio across asset classes. They may be managing half the portfolio in a multi-asset kind of structure, while the other half of the portfolio is internally managed or with a consultant. It is a way of differentiating and benchmarking the two styles of management against each other.
David G: Hal what are your thoughts on this?
Hal: It makes me wonder whether hiring an outside CIO might require a more sophisticated investment committee to make that decision and to feel comfortable in their ability to evaluate the performance attributions and results over time. I wonder if there might be committees who feel that they need a little more hand holding along the way. The traditional consulting model might feel better to some boards or investment committees. There is a little bit of a larger leap that has to be made in order to hire that outsourced OCIO. Once you understand it and have found good firms who can play that role, it is something that almost all fiduciaries ought to consider. If we consider the limited amount of time that you have to meet and discuss these matters as a committee, in some ways you might be undercutting your fiduciary effectiveness by getting yourselves, as a committee, involved in anything other than the largest, highest level decisions. Anything beyond this, and you could be dragging the process down and costing yourself returns.
Tom: I agree. Part of the challenge for an investment committee is in trying to select an OCIO based on process and relationship. But as a long-term investor, to evaluate performance requires a long-term timeframe, maybe a timeframe that is longer than even the tenure of the investment committee members who are making the decision. This can create a challenge in making that decision properly.
David G: David, how do you view what is applicable to the different types of organizations? How does the strategic partnership differ from those two models?
David V: One of the key issues that was mentioned earlier is the idea of these organizations being resource constrained. Ultimately, one of the chief constraints is the available time with the board or investment committee. As in Hal’s case, they may only meet for 8 hours per year, so a very important question is how best to spend those hours. Many committees also meet fairly infrequently, such that a couple of months can go by in between the meetings. In today’s capital markets, a lot can happen in 3 months. If you are unable to discuss key issues until 6 to 9 months down the road, that just won’t cut it.
As such, some of the more important decisions revolve around how to best address the constraints that these organizations face. Granted, some of these constraints do go away as you get into bigger organizations. We are a $2.5 billion fund, which is a decent size, but not compared to a very large fund like Texas Teachers. There, you might have a team of people devoting their time to specialized efforts, such as overseeing research projects and conducting regular meetings. The industrial logic is even clearer at that level, where you can see that you are going to get some completely different things out of the relationship. That should be viewed as solving a different organizational problem. At our size, the goals are simply to tease out strategic insights from the relationship and harvest the incremental value. For an even smaller organization, it may be about how to alleviate that time constraint at the board level, which often creates a strong desire to make just one major decision, rather than many small ones. However, a question is whether the OCIO firm that makes those decisions should also be the one to monitor them.
David G: What are the communication and decision making processes in a strategic partnership?
David V: During my time with TRS, a full-time employee was dedicated to each partnership structure. That person was in day-to-day conversation with the strategic partners, gathering their insights and relaying those to the rest of the organization, where they may or may not be acted upon.
Here at COAERS, where the staff is much smaller, we envision a different kind of structure where we might speak to the strategic partner once a week at the most, and probably more like once a month, to see how the their thinking may have changed with respect to the portfolio. We would also like for them to talk to us whenever they do make a significant change. Because we are limited in our ability to act quickly, being notified that an asset class is being bought or sold may take 6-months to be reflected at the broader asset allocation level for the fund.
David G: Where do you see differences between multi-asset strategy and an OCIO/strategic partnership?
David V: I would make the distinction between a simple multi-asset strategy and an OCIO or strategic partner type of relationship. There are firms out there that offer a premium package-wrapped approach in stocks and bonds. While these multi-asset strategies are certainly interesting, they fall short of what we typically think of as an OCIO or strategic partnership relationship, whereby the manager has greater discretion over not just the specific assets, but also underlying manager selection. Likewise, a strategic partner would typically have a custom benchmark as their index rather than a 60/40 portfolio. The partners are providing value through more regular insights and feedback to the organization, rather than just through pure alpha. In short, multi-asset is a key aspect of OCIO/strategic partnership, but it is not the whole package. I would add that it is much more aligned than most manager relationships in the sense that you have to eat your own cooking. In an OCIO/strategic partnership, you have to put your marker down on what asset classes you like and live by that decision.
David G: Is there any concern that an OCIO may not be good at managing every type of asset class?
Hal: I often think of the OCIO as someone who doesn’t need detailed expertise in every single asset class and sub-asset class, but yet someone that really understands more macro and thematic issues, portfolio construction, asset allocation, portfolio design and implementation. The OCIO is in a position to go out and hire the most appropriate managers for each particular asset class.
Tom: In our relationship with our OCIO, their team has personal money in the same vehicles in which we have our investments, so they have a vested interest and an alignment of interest with us in selecting the best quality managers.
David V: There is also a broader question around what types of organizations are best suited to function as an OCIO or as a multi-asset provider. For example, there are a lot of traditional investment consulting firms who have moved into the OCIO space, and there are large asset managers who are doing it as well. We consider it to be a grave conflict of interest for our traditional consultant to be getting into the OCIO business. Since OCIO is so much more profitable than traditional, retainer-based consulting relationships, it tends to drains resources away from the side of the organization that serves us. We also believe that having an OCIO business influences their advice in a lot of other decisions in ways that we are not happy with.
Hal: I think of myself as more of an OCIO than anything else. It would be much harder for me to play the role of consultant than it would to serve in an OCIO role. An OCIO doesn’t have a large organization that is staffed with managers of different strategies down the hall. The OCIO is a point of intellectual capital that then goes out and seeks best-in-class solutions, the best representing the client in doing so. As a result, each portfolio would be customized for that client.
I see the OCIO as not someone who has to come from a large organization but almost as one person who has great relationships, good tools, technology and access and someone who has a lot of experience and who has been around a long time.