In Tom Wolfe’s The Bonfire of the Vanities, published in 1987, masters of the universe were the bond traders of Wall Street. When the financial crisis hit some 20 years later, hedge fund managers, born out of the meltdown, inherited the title.
As we head toward the 10-year anniversary of this crisis, the baton is about to be handed over again—but not to whom you might have thought.
“If hedge funds were the masters of the universe, fiduciary managers will soon be known as the masters of the masters of the universe,” says Anthony Webb, UK head of fiduciary advisory at KPMG. Each year, Webb and his colleagues publish a snapshot of the outsourced-CIO (OCIO) sector, illustrating its growing hold over the investment industry.
“Fiduciary managers will dominate the asset management industry and dictate terms,” says Webb. “If you don’t keep them happy, it will be very difficult to do business.”
Consultants have always been important gatekeepers between investor and fund manager, but on a pure advisory basis. The client has the final say on manager selection.
Now, that power is shifting—and shifting more rapidly than many imagined.
A decade ago, fiduciary management or OCIO was seen as just another idea dreamed up by consultants—and some fund managers—to eke fees out of clients who wanted to offload long-frozen pension plans to someone else.
How times have changed. Today, Mercer is one of the top five institutional investors in the UK, with more than $38.5 billion under its control in that country alone. Russell Investments has a global $70 billion in outsourced assets, putting it in the ballpark of Ford’s pension. Aon Hewitt has around the same, while SEI comes in at just over $75 billion.
Towers Watson manages a global $75 billion on a delegated basis—more than Boeing’s pension fund or the Gates Foundation, and how many asset managers have banged on those doors?
And unlike asset management’s traditional hunting ground of defined benefit pension funds, outsourced assets are growing.
In the summer of 2014, KPMG reported that assets managed on a fiduciary or OCIO basis in the British Isles alone stood at £72 billion ($109 billion)—an increase of 22% over 2013. Webb expects to see a similar uptick in the 2015 report.
This is not just a UK phenomenon.
Art by James YangCIO’s own survey on this sector shows a 79% increase
in assets over the seven years ending February 2015.
Fund managers once worried that consultants would take investing entirely in-house as they became OCIOs, but experts say that hasn’t happened.
“The majority of OCIOs use external managers,” says Niall O’Sullivan, head of investments at Mercer’s dynamic de-risking solutions group. “The extra layer of governance provided by them will put increased pressure on external managers to perform as there will be more active oversight and more capability to change managers that are not performing.”
Asset owners promised the best in class expect exactly that—and often in-house teams don’t qualify. It is important to consider this new breed of institutional investors as just that, says Webb. “Fiduciary managers do actually have effective Chinese walls.”
So far, they sound like a pension fund. But do the providers see themselves as part of the world inhabited by Britt Harris, Mark Wiseman, and Barry Kenneth?
Well, kind of.
Each of them is set up differently and, unlike Texas Teachers, there is not just a single (relatively) small team. Russell, for example, has 65 analysts it can access for its OCIO clients. Aon Hewitt has hired 62 people in the UK since 2009 purely to work on its fiduciary offering.
There are banks of desks in most consultants’ offices dedicated to this sector—in addition to the swathes of work areas they can tap for information.
One of the biggest differences between OCIOs and in-house teams is the range of issues each has to face. The CIO of the Ontario Municipal Employees Retirement System has his own funding level front and center—but that’s not the case for this new breed.
“If you have 400 different clients,” says Jason Collins, head of SEI’s portfolio management unit in the UK, “it means you have 400 different problems.”
Additionally, you have 400 different takes on sustainable investing, proxy voting, risk budgets, and benchmarks. So how can one investor wear all these hats, yet still honor its fiduciary duty to all—and be available to be called out on it?
“Fiduciary managers will dominate the asset management industry and dictate terms. If you don’t keep them happy, it will be very difficult to do business.”“Whomever we are running the money for is paramount,” says Russell’s David Vickers, a senior portfolio manager in multi-asset solutions. “We don’t have members to report to like a CIO would, but we do have to report—and as an external supplier, we are hired and fired more easily.”
In a world of 24-hour news, communication, and huge amounts of data, each of these 400 clients knows what it wants—and what it’s paying for.
“Each client has a bespoke portfolio,” says Sion Cole, head of European distribution at Aon Hewitt, “and its objectives are unique and based on its profile.”
The others provide a similar service, which is perhaps why they have not been seen as large institutional investors by the markets. That is, until now.
“Some managers might prefer working with an OCIO rather than several smaller funds,” says Collins. Certainly working with similarly experienced staffs that meet more than four times a year to discuss investment objectives can make investing more streamlined.
However, with their own necks on the line, OCIOs are less likely to accept any “it was market movement” excuses when poor performance occurs.
With their existing operations—consulting, investment management, actuarial services, benchmarking—these fiduciary managers are only going to grow. The business of taking the place of a sponsoring employer will see upside in information technology and talent investments, unlike most pension funds.
But is there a capacity issue? The largest institutional investors in the world are so engorged with assets that they are unable to innovate—and their returns have often suffered.
“The business is reasonably scalable,” says Cole at Aon Hewitt, “and we are far from where we would close the book as all our clients are invested differently.” The client service team needs consistent bolstering in this growth environment, he adds.
“Theoretically, there is a capacity issue,” says KPMG’s Webb. “At that point, the OCIO must be careful it does not change its strategy to suit the amount of assets it holds rather than what the client wants. But we’re not there yet.”
One notable difference between these firms and the other powerful investors in this magazine is that none of them have a distinct figurehead, such as the aforementioned Harris, Wiseman, and Kenneth. Which raises another point: As long as the assets aren’t truly theirs, the ascendant OCIOs are just borrowing the title of masters of the universe from their clients.