Introduction & Methodology
Asset owners seek OCIO partnerships to navigate increasingly challenging conditions amid a growing lack of internal resources and the need for better risk management
In 2018, our annual outsourced chief investment officer (OCIO) survey shows institutional investors across the board have been working hard to find the right OCIO partnerships to navigate increasingly challenging conditions.
The key challenges for the year: a jump in the lack of internal resources, even as the need for better risk management also climbs. A lack of internal resources was cited a “critical” reason for outsourcing this year by 71% of respondents, up sharply from 58% the year prior. Better risk management, meanwhile, was cited as “critical” by 52% of respondents from 32% last year.
That follows the trends of 2017, when OCIO services were key to diversifying investments and helped to navigate returns through the frothy waters of geopolitical risk. In 2016, a bifurcation began between the largest and smallest OCIO firms, as asset owners leaned away from a boutique approach.
As conditions become more challenging, institutional investors are asking for more from the best providers.
“The barrier to entry in a fragmented OCIO market is currently low, but the combination of scale, infrastructure, and results will increasingly matter and differentiate successful firms from marginal players. Providers are building risk management, technology, pricing, and performance capabilities that will ultimately differentiate them along with performance results,” Bryan Weeks, head of Russell Investments’ Americas Institutional business, told CIO. “Increasingly, we hear from clients that OCIO experience really matters, i.e., clients do not want to give their OCIO provider on-the-job training,”
Accountability has been a key theme since the financial crisis. Asset owners are strong believers in hiring OCIOs, sometimes in an effort to handle larger portfolios, sometimes to add more accountability and take on more fiduciary responsibility. A growing trend that Russell Investments is seeing: some asset owners are adding internal management structures to improve accountability.
“To improve risk management, institutional investors such as Harvard Management Company are moving from a portfolio of asset class sleeves to a model in which all members of the investment team take ownership of the entire portfolio,” said Weeks, “for example, near the end of the investment cycle, bond portfolio managers gravitate toward high-yield bonds and equity managers seek out the scarce companies that could grow when the economy slows down.”
The model works smoothly if the investment decisions are well coordinated, but if they aren’t, a portfolio may develop unintentional risks. “To meet the need for holistic risk management, OCIOs are offering a multi-asset approach and total-portfolio perspective,” said Weeks.
This year, 36% of respondents said they currently outsource or intend to outsource. Behind the lack of internal resources and better risk management, additional fiduciary oversight was a key driver, with 48% of respondents (up from 43% last year) expressing it as a critical need; 19% expressed a critical need to increase returns (down from 28%).
Most of our respondents were from corporate pension plans (43%), and endowments and foundations (31%), with 23% from DC plans, and 20% from public plans. Most (55%) are outsourcing to de-risk their portfolios. Those with smallest staff and portfolios in the range of $100 million to $500 million tend to outsource the most.
Europe is showing an avid interest in outsourcing, with 50% of respondents planning to, or already using, OCIO services, up from 11% in 2017. In the US, the number rose to 42% from 40% last year. Yet, as the industry faces augmented pressures from institutional investors for increased transparency, reduced fees, and skepticism from lack of hedge fund performance, the number of respondents who outsource or intend to dipped by 4% from 2017. In the UK, other factors are also at play that could lead to an uptick in 2018.
“My view is that the reasons for outsourcing investment management for pension funds remain the same so, to start with, there would be no reason for a reduction in activity,” said Nigel Bottom, FPMI, international pensions manager, Motorola Solutions, UK Limited. “However, I can add a personal opinion, which is that the UK-based FCA review, which is currently underway, may have dampened immediate activities as potential participants wait for the outcome. If my view is correct, I would expect a subsequent increase in activity.” —By Christine Giordano
Methodology
Responses from 70 asset owners, aggregated for the charts that follow, were accepted for the survey from January 16 to February 6, 2018. CIO would like to extend a special thank you to all those who submitted responses for the survey, as well as those vendors, asset owners, and consultants who helped the CIO editorial and survey teams construct the survey. For more information, contact surveys@strategic-i.com.