Among the most important decisions a fiduciary body may be called upon to make is whether or not to outsource its organization’s investment program, and which outsourced CIO to choose. In his bestselling book “Pioneering Portfolio Management,” Yale CIO David Swensen writes of investment decisions: “Casual commitments invite casual reversal.” The same could be said of OCIO selection. The decision must be made with an eye toward the future, as long-term relationships with an aligned partner tend generally to yield the highest returns.

There are several reasons why the boards of pension plans, endowments or foundations might find themselves in need of an OCIO: insufficient resources to maintain an in-house investment team, a desire to have access to a greater pool of talent or dissatisfaction with a current outsourcing partner. The latter situation may arise in the event of a disruptive leadership transition, long-term underperformance, inadequate and unsatisfactory communication or other problems. 

Whatever the motive, the complexity of the decision — and the dizzying array of outsourcing options available — make retaining an OCIO search consultant a prudent move. While it is possible to conduct an OCIO search independently, institutions may end up casting too wide a net and consequently wasting limited time. An experienced consultant may be in a better position to judge the good from the bad in a rapidly growing and sometimes confusing space.

Just as the OCIO market has grown dramatically in recent years, so has the number of search consultants. The ideal consultant is an independent individual or company with no conflicts of interest. While they should naturally have a wide range of contacts at various OCIOs, they should play no favorites and objectively guide their clients toward the firm that offers the best fit. The OCIO consultant should be willing to state an opinion to the group making the selection.

A consultant familiar with the industry will be able to explain that a number of different entities refer to themselves as OCIOs, even though they may be very different. Among the various types are:

  • commercial and investment banks with an OCIO division;
  • consultants;
  • funds of funds; and
  • dedicated OCIOs

The first benefit of a decision to outsource can be enjoyed even before an OCIO has been retained: an opportunity for a board to take a step back and crystallize its investment philosophy and agree as to the investment objectives for the portfolio. Is it more important to establish some target level of return — say 7.5% for a pension or 8.5% for an endowment — or is it more important to perform well against a defined set of peers? Once these issues are decided, it is important that a fiduciary body, often with the guidance of a consultant, then clearly define the mandate.

A definition of the mandate must answer the question, “How much discretion are we willing to grant an OCIO?” Boards and committees are generally made up of sophisticated people — often finance experts themselves — and they may feel that retaining an OCIO will lead to a loss of control. But partnering with an OCIO does not entail relinquishing fiduciary responsibility — ultimate authority always rests with the board. And the board will still retain discretion regarding long-term asset allocation, allowable asset classes, and approved ranges for each asset class. When it comes to manager selection, more and more OCIOs offer multiple discretionary options, but will explain that a greater grant of discretion leaves them freer to aggressively pursue alpha on behalf of the client and eliminate costly implementation delays.

Another consideration is the extent to which socially responsible investing or environmental, social and governance investing are priorities. An institution practicing SRI would avoid owning certain stocks that conflict with its mission or values. An entity wishing to practice ESG may consciously construct a portfolio that reflects its identity. In either case, the creation of a customized portfolio designed to reflect these priorities without compromising long-term returns is a complex endeavor. If these are important considerations, it is vital to ensure that any prospective outsourcing partner has the skills and experience to incorporate these approaches in a manner that benefits both the conscience and the bottom line.

Once the fiduciary body and the consultant have clearly defined the philosophy and objectives, the search can begin, often with the creation of a request for information or request for proposal. More and more organizations are first sending an RFI to a larger group of OCIOs and subsequently issuing an RFP to the most likely candidates. This allows the prospective client to broadly survey the OCIO landscape, then move to asking more specific questions to a limited number of possible outsourcing partners. This greatly reduces the huge time commitment required to review 20 responses that may average 50 pages each. A consultant can help draft an RFP that is tailored to the specific concerns of the client and designed to elicit the most important information from prospective OCIOs. Possible questions may include:

  • What resources will be brought to bear on the account? Who will be the principal points of contact, and for how many other clients are they responsible?
  • How many clients do you have that are similar to us? Do you have specific experience with endowments, foundations, pensions, etc.?
  • What is the average length of the relationship with your existing clients?
  • What is the role of risk analysis in the construction of your portfolios? Do you have advanced proprietary risk analytics?
  • Are you a dedicated OCIO? If not, from what other sources does your firm derive its revenue? And what potential conflicts may arise given your business structure?
  • Are you confident that you will still be offering OCIO services 5-10 years from now?
  • What is the background and tenure of your leadership team? Have you developed a succession plan? If yes, please share it. If not, why not?
  • How have you dealt with the issue of “key-person” risk? Do you have built in redundancy for key investment personnel?
  • How lengthy is your live performance record for discretionary OCIO mandates, and what is that performance net of all fees (advisory and managers)? Please indicate if synthetic performance is used.
  • What is the total cost? Please include your OCIO costs and the potential manager costs for an allocation you believe is a reasonable estimate based on what you know about us.
  • What is your back office capacity and how will it be applied to our needs?
  • How do you implement client portfolios of our size? Commingled vehicles or separate accounts?
  • Outline any and all ways you may earn additional revenues from our account/portfolio.

The above questions are vital in determining which OCIOs should be under serious consideration. A consultant will help sift through the mountains of data generated by this process and explain what it all means. When evaluating data pertaining to investment performance, committees should be wary if a firm is reluctant to provide actual discretionary client results, net of fees. And care must be taken in reading the footnotes: if words like “simulated” or “model” appear, the results do not reflect actual client results.

This process can yield revealing insights into how various OCIOs conduct their business and how successful they have been.

However, as a consultant is likely to say, the RFP process can occasionally be problematic and excessively time-consuming for both parties. While it is an important first step in soliciting information from an OCIO, prospective clients should require relatively brief responses so as to save the committee members’ valuable time. And there is no substitute for a face-to-face encounter. Only by meeting with a prospective outsourcing partner can you determine whether there is the necessary chemistry and compatibility for a long-term fiduciary relationship. An OCIO should ideally serve as a seamless extension of an organization’s staff. Just as a hiring manager should consider whether a prospective employee would be a harmonious addition, committees should keep the same thing in mind when meeting the representatives of an OCIO. It would also be wise to do an office visit before hiring an OCIO.

The search for an OCIO may seem daunting at first, but the process can be highly beneficial if a committee seizes the opportunity to sharply define its goals and philosophy. An experienced and knowledgeable search consultant can make it much easier. And finding the right OCIO can lead to a long and productive relationship that provides access to top investment talent, increases the potential for strong returns, and allows an organization to focus on its core mission.

Source: Pensions & Investments