A Primer on OCIO in the DC world

The term outsourced chief investment officer, or OCIO, describes a service offering or model, where an institutional investor delegates certain decision-making responsibilities to a third-party provider. Once the investor makes the original delegation, the OCIO provider makes ongoing decisions related to the investment and administration of the plan, within agreed upon parameters. Initially the OCIO model was designed primarily for defined benefit plans. However, over the last few years, a number of defined contribution OCIO offerings have been launched in the Canadian market.

In a traditional DC plan, the plan sponsor selects a recordkeeper. They then select a range of investment options that will be offered to plan members. They monitor their recordkeeper and investment options on an ongoing basis and make changes where warranted. The sponsor remains responsible for plan member education, which includes explaining the plan terms, the investment options and prudent considerations for making individual asset mix decisions using plan investments.

For DC plans, the OCIO delegation can include all or a portion of the following decisions or responsibilities: selection and replacement of investment options, monitoring of investment performance, selection and monitoring of the plan recordkeeper, development of member education tools and the delivery of member education.

There are two primary structures for Canadian DC OCIO offerings. The first is a flexible model, which allows the plan sponsor to select their desired recordkeeper. Under this model the DC OCIO will have a pre-selected range of approved investment options that they utilize, which have been selected from the investment platforms of the selected recordkeeper. The DC OCIO will manage its approved investment line-up with that recordkeeper, making changes to the options as warranted. The DC OCIO may tailor communication and education material to the line-up, providing a more integrated feel to the member education. The primary advantage of this structure is that it allows the plan sponsor to select their desired recordkeeper.

The second model is a dedicated model. Under this structure the DC OCIO partners with one recordkeeper to accommodate all of its DC plan clients. It then structures a single DC investment line-up with its chosen recordkeeper partner. This option may generate more scale, as there will be more assets invested with one recordkeeper. This additional scale may enable the DC OCIO to negotiate lower fees, which may be passed on to the participating plan sponsors. Additionally, this structure may allow more customization of the offering. These dedicated models may use proprietary funds and target date funds customized by the OCIO and may also leverage the fund-of-funds investment products created by some OCIO providers for the DB market. This model may facilitate more tailored member education material that may be more integrated with the single family of investment options.

The benefits of a DC OCIO model include that it allows for timely decision-making. Most DC pension committees will meet between one and four times per year. When an issue emerges with a plan investment option, changes to the investment will often wait until the next pension committee meeting. This can make DC plans slower to react to emerging issues with investment managers. Under a DC OCIO there is a dedicated team following the managers on a daily basis. The white label structure of the funds allows for quick changes to the investment managers, without the need to communicate changes in advance to members.

This model also helps with managing complexity. As DC investments and communications tools become more complicated, they require more time and effort for the plan sponsor to properly oversee the plan. Where a consultant is engaged to support the committee, more analysis and support may be required for the committee to remain advised of all relevant issues. This may increase the time required for management to dedicate to overseeing the plan and the cost for external investment support. In a DC OCIO model, these functions are outsourced to the DC OCIO.

That said, there are challenges associated with a DC OCIO model, relating to the plan sponsor’s continuing fiduciary responsibilities. Unlike in the U.S., service providers cannot assume the sponsors’ fiduciary responsibility under a Canadian DC plan. Accordingly, there remains an obligation to have some sort of monitoring process to oversee the decision making of the DC OCIO. This erodes some of the value of the delegation and requires the pension committee to implement some form of formal oversight of the DC OCIO.

Finally, it’s important to consider fee levels. DC fees must be carefully managed, since the sponsor negotiates the DC fee levels, which act to reduce the net investment performance of the funds in members’ accounts. DC OCIO introduces an additional level of DC fees to the arrangement. Any additional fee associated with a DC OCIO offering must be carefully weighed against any service enhancements associated with the offering.

Overall, the decision to consider a DC OCIO offering will depend on the philosophy of the DC plan sponsor and also on the internal resources available to oversee and maintain the program.

In an upcoming expert column, I will discuss a framework for assessing the effectiveness of a DC OCIO offering.