How to Transform an Investment Process

Art by Dalbert B. Vilarino

Tim Barrett started as chief investment officer of the $2 billion Texas Tech University retirement system about seven years ago with a mandate: reshape the system’s investment process from a board-driven one to one that is staff-directed. So imagine his surprise when the effort, including winning the investment committee and board of regents’ buy-in, ended up taking, oh, about a year. “This is a huge transformation,” says Barrett. “If the process hasn’t been set up before, it’s a big change for any institution.”

Multiple models exist, of course, for how investment processes are shaped. In some places, the board basically makes the final decision about such issues as asset allocation and the hiring and firing of managers. In others, much of the work is done by consultants or OCIOs. Then, there are others where the board assumes a more hands-off role, with responsibility for areas such as oversight and resource allocation, and puts the CIO in the driver’s seat.

But, as Barrett can testify, no matter how enthusiastic the board may be, CIOs can expect the transition to be slow and often unwieldy. “When board members are used to pulling the levers, to put it in the hands of your staff—it’s difficult,” says Barrett.

That’s not to say having a consultant doesn’t make sense in many cases. Smaller organizations with less-complex portfolios and staff-thin resources, for example, can get access to investment strategies they couldn’t otherwise tap. Global OCIO assets were close to $2 trillion in 2018, according to Cerulli; assets in the US grew 7.8%. “At a bigger portfolio, you’re able to fund more esoteric options than at a smaller one, which is more likely to focus on more traditional investments,” says Alyssa Rieder, CIO of CommonSpirit Health. Plus, a consultant with multiple clients might be able to negotiate lower fees with accounts than a one- or two-person investment staff could.

Reasons to Make the Move

Still, there are lots of reasons to change an investment process to a system controlled by the CIO and investment team. A case in point is CommonSpirit, which was formed by a 2019 merger between Dignity Health and Catholic Health Initiatives. Rieder was hired in 2011 as CIO of Dignity Health, where she worked with a consultant who had handled investments for many years. She describes the process as a hybrid staff-consultant one. Over the next six or so years, as assets grew, she built up an investment team to about 10 staffers—including staff from Catholic Health—and, last year, stopped working with the consultant. The portfolio grew from under $5 billion in 2011 to over $11 billion just before the merger; assets are now $22 billion.

As for changing from a board-directed process, top of the list is a need to allow for speedier and more-informed decisions. If a board meets, say, four times a year, and CIOs seek more-sophisticated strategies, like direct real estate or co-investments, waiting for board approval can undercut potential performance. “A GP calls you up and says, ‘I need to know your decision by next Monday,’ but the board isn’t meeting for another week—If you don’t have the authority, you’ll have to pass on that opportunity,” says David Kushner, a partner in Global Asset Management Consultants and former CIO of Los Angeles County Employees Retirement Association (LACERA) and San Francisco Employees’ Retirement Association.

Infrequent meetings also lend themselves to being hijacked by a few forceful personalities. “You end up relying on the strong opinions of one or two board members who typically tend to sway decisions,” says one former CIO.

According to some industry observers, the trend towards a staff-driven process is especially pronounced in certain sectors. “In endowments, I see a monumental shift in this direction,” says Barrett. That’s largely due to the increasing complexity of factors affecting decisions. According to current and former CIOs, board members don’t have the time or inclination to stay on top of everything from the Federal Reserve’s latest moves to the state of the balance sheet and trade relations with China, much less tracking the progress of managers.

The move from an investment process where the board has manager hiring and firing discretion is most problematic among public pension plans, according to many accounts. For one thing, they tend to have non-finance experts on their boards. Plus, there’s also a tendency for board members to be reluctant to give up some of the perks. “All too often, board members like to feel they need to be in control,” says one industry expert. “If not, who’s going to take me out to play golf and nice dinners?”

The Slog

These changes generally happen when the board has already made the decision to take the step. But the task can be a slog. “It’s an iterative process that takes a lot of work and buy-in,” says Barrett. He was hired in 2013 as CIO after stints as Eastman Kodak’s director of pension investments and San Bernardino County Employees’ Retirement Association’s CIO. He was given the task of building up an investment team, which now has nine people, and creating a staff-driven process. What he discovered was, “You have to sell your vision across multiple constituencies,” he says.

That involved many discussions over many months with the investment committee to hammer out policies and strategies that often were much more complex than previous ones. Often it required education sessions going step-by-step through each part of the proposed portfolio. Once one section was finalized, then they’d tackle the next. “When people aren’t used to derivatives and portable alphas, it’s a huge undertaking to explain how all that works, how it will be managed, why it’s safe,” he says. Finally, when the process was completed, Barrett had to sell it to the board of regents, though in considerably less detail.

While the CIO had the authority to do things like hire and fire managers and determine investment strategies, Barrett decided the most persuasive approach was to make presentations to the board that included a summary of recommendations. “We pitched everyone the old school way,” he says. There have been only two or three times when the board vetoed a proposed strategy, according to Barrett.

In some cases, it’s comes down to reality vs. theory. One former CIO says that the board of his organization had authority to hire and fire managers as well as strategic asset allocation decision-making authority. But all recommendations were made by the staff and almost always approved by the board, which usually paid close attention when only the biggest managers were suggested. Plus, the board handed over responsibility for the hiring of certain alternative investment categories, partly because board members knew they lacked the necessary expertise to evaluate those choices.

Building a Portfolio and a Team

As for whether or not to stick with the existing portfolio, at least in the case of consultants or OCIOs, CIOs often decide against starting from scratch when they determine investment performance has been strong enough. In 2015, Stefan Strein joined the Cleveland Clinic, which had been working with an OCIO since 2009. By 2017, the investment office made the full transition away from the OCIO. But Strein decided to transition the portfolio intact, while going through an underwriting of each manager and strategy to decide what would stay. Assets are now around $12 billion, up from about $8 billion when he started.

But, Strein still faced the task of building a team from scratch. It took 18 months to organize the investment office, create job descriptions, and hire his investment team, which now includes 12 people. To make sure he had a wide array of expertise, Strein brought on staff from a variety of sectors, from endowments and insurance companies to health care systems and family offices. “We borrowed the best practices from all those organizations,” he says.