2017 Outsourced-Chief Investment Officer Survey

Art by Jody Hewgill

As firms outsource because they lack internal resources, bigger shops benefit.

This year, the bigger players in the OCIO industry got even bigger, while the smaller ones showed much less growth, according to our Outsourcing Chief Investment Officer buyer’s guide and 2017 survey. Aon Hewitt’s assets under management with full discretion grew by $17 billion. Goldman Sachs’ grew by $13 billion. Russell Investments’ grew by $8 billion, and Northern Trust’s grew by $3 billion. Mercer reported the most assets under management at $150.7 billion.

Colleges and university endowments had a tough year, and it’s no secret that they’ve needed to find answers. When it comes to institutions’ endowments, the latest NACUBO-Commonfund Study, released in late January with data from 805 US colleges and universities, is a good barometer. It found that participating institutions’ endowments returned an average of -1.9% (net of fees) for the 2016 fiscal year July 1, 2015, to June 30, 2016, following a low 2.4% return reported for 2015. This is far below the median 7.4% they need to earn to maintain their endowments’ purchasing power after spending, inflation, and investment management costs, according to the study. Yet 74 percent of the study’s respondents reported that they increased the dollars spent from their endowments. The median increase was a hefty 8.1%.

These details are in lock step with our survey, which found a firm’s reason for outsourcing is fairly consistent. “Lack of internal resources” topped the list for outsourcing this year, as well as 2016, with nearly six in 10 respondents citing this as a “critical” reason for outsourcing. It was deemed “important” by another 33%. Cost savings, by contrast, was considered a “critical” reason for outsourcing by only 18% of respondents, and “not very important” by 25%.

The top reason for selecting an outsourcing firm was the “experience of top management,” listed by 93%. When asked about outsourcing goals, absolute returns outweighed de-risking by 4%.

Full discretion mandates–where the OCIO provider can hire and fire managers without prior client approval–are still the preferred arrangement to a “recommend” situation where the OCIO provider cannot hire or fire managers without the client’s approval. Overall, nearly two thirds of asset owners that outsource have given full discretion to their vendor. Smaller asset owners are somewhat more likely than larger ones to give full discretionary responsibility to an outsourcing provider.

Staffing
There’s also a bit of irony occurring in business of outsourcing CIOs, and some staffers at institutions will breathe a sigh of relief. According to our 2017 OCIO survey, somewhat counterintuitively, the asset owners that outsource have more internal investment staff (14) than the asset owners who don’t outsource (9). Predictably, the number of staff goes up along with the size of the asset owner’s investable portfolio, but a surprising finding is that smaller asset owners are more likely to outsource than larger ones. As in past surveys, European asset owners usually tend to employ more investment staff (10) than US asset owners (7).

Their Profile
That being said, of the 148 different organizations that responded to our survey, 40% percent outsource or plan to outsource within the next 24 months.

Of the organizations that plan to outsource, most, or 63%, are defined contribution (DC) plans whose average size of investment staff is two, in contrast to another high number on our list, public pensions, whose average size of investment team is around 15 people, of which 41% intend to, or already are, outsourcing.

These numbers have some sharp increases compared to our survey in 2016, when the numbers of those who were or planning to outsource were 52% for DC plans and 32% for public pensions. Of portfolio sizes of less than $100 million, 70% outsource or plan to, which is up from 48% last year.

Most, or more than six in 10 asset owners who choose to outsource do so for 100% of their portfolios. That percentage rose to 68% in the under $500 million category and hiked up to 100% in the $500 million to $1 billion category.

Trends from the Field
“Outsourcing by larger defined benefit pension plans (over $1 billion) is becoming more commonplace, for the same reason that smaller plans are outsourcing: fewer dedicated staff, lean resources, delays in execution,” says Joseph McInerney, managing executive, Multi-Manager Solutions at Northern Trust Asset Management. He is also starting to see more DC plans evaluate the outsourcing model for similar reasons, in addition to having increased litigation concerns and the desire to create more customized solutions for participants. Endowments and foundations are looking to outsource for more access to dedicated investment expertise and to increase their sophistication of alternative investments. “We’re also seeing greater involvement by third-party overseers in the search process and periodic independent oversight after the relationship begins,” he says.

Greg Calnon, managing director–Global Portfolio Solutions, Goldman Sachs finds pension funds are focused on hedging liability and increasing expertise. Endowments and foundations are heavily focused on environmental, social and governance (ESG) investments.

Another strong reason for outsourcing was “additional fiduciary oversight,” with 43% of our survey respondents listing it as a critical reason for outsourcing. Russell Investments, which won high scores for customer satisfaction in our survey, has been a fiduciary for more than 40 years. Part of itsapproach is to meet frequently with clients and offer multi-asset investing once an organization has reached the point where they’re comfortable delegating more discretion to a co-fiduciary. “In today’s investment environment, there is not enough low-cost beta for the outcomes most institutional investors need to achieve,” said Bruce Clarke, managing director, institutional investment services, at Russell Investments. “Investors are realizing they can beat their asset class benchmarks, but still not make the progress they need toward achieving their broader investment goals. That is why multi-asset investing is so important.”

Choosing When to Outsource
The choice to outsource usually occurs without a quantitative measure. “I think it ends up being more of a fatigue situation,” said Calnon, such as when returns have been disappointing over the past five years.

“For pension plans that are focused on de-risking, actuarial capabilities and experience with designing and implementing investment glide paths and incorporating pension risk transfers is important,” said Northern Trust’s McInerney. For defined contribution plans, experience with customizing white label funds and target date funds is important. An endowment with a knowledgeable internal staff and an investment process that runs well might want to outsource the management of an asset class in which they don’t have a lot of experience.

Before outsourcing, due diligence should at least include reference checks and evaluating how the firm works with you, said Kane Brenan, Global Head of Global Portfolio Solutions at Goldman Sachs Asset Management. To evaluate the firm’s past performance, ask for their GIPS compliant composites, (which require a firm’s discretionary, fee-paying portfolios to be included in at least one composite.)

Your assessment checklist should also include the firm’s ability to customize; the breadth of its capabilities; its acumen; risk management capabilities; service capabilities; and it should have a deep understanding of liability and liability capabilities, Brenan said.

“Make sure your prospective OCIO has experience in managing plans of similar size and nature as yours,” adds McInerney. Consider an on-site evaluation to meet with general partners and risk takers. Cultural alignment is also important, as well as investment expertise, manager research, portfolio construction and operations. Also review whether the firm has a designated compliance practice in place. “Keep in mind, there is no one-size-fits-all approach: Clients don’t always use fiduciary management services in the same way,” McInerney said. –CIO