The outsourced chief investment officer market is growing with low barriers to entry contributing to the number of players of all sizes in the space, according to research by U.S.-based institutional investment consulting firm Callan.
In evaluating the work of an OCIO, plan sponsors and other institutional investors should go well beyond simply looking at investment results, noted the research. “While investment performance is very important, we believe monitoring OCIO performance needs to incorporate factors specific to the services in question.”
Success must be assessed on a case-by-case basis, since OCIO relationships with institutional investors can differ dramatically. Regardless of the nature of the relationship, the research outlined certain factors that apply to all OCIOs, noting they must keep the best interest of the funds and their beneficiaries top of mind.
Further, the research suggested OCIOs that use an open architecture approach are better suited to meet the needs of each individual client, compared to OCIOs that use only proprietary funds, a single fund or just one suite of products. “This approach also helps eliminate potential conflicts of interest inherent in a proprietary fund framework.”
OCIOs should also keep their systems simple, the research noted, as added complexity can lead to mediocre results and higher fees. For this reason, anything added to the overall portfolio must enhance diversification and risk-adjusted return potential. Even in situations where specialized strategies are usable as the assets under management grow, reducing complexities is the best approach, the research found.
It also highlighted fees as an element that OCIOs should keep a close eye on. The institutional investor should understand clearly how the OCIO is compensated, what administrative costs are covered by the plan, how much the underlying investment managers are compensated and whether that compensation is directly through the client or via the OCIO fee structure. “We believe this level of transparency is very important for the success of a discretionary institutional investment program,” the research said.
The use of tactical investment strategies is also an area where OCIOs should exercise caution. Using these strategies to take advantage of market anomalies usually demands higher fees, the research noted, and OCIOs are limited in their ability to provide consistent results through these methods.
As well, the success of the OCIO is contingent upon the success of the asset managers it selects. “OCIO providers need to have a well-documented manager search process that supports quality, operational efficiencies, value creation and operational continuity to help identify long-lasting product solutions for clients,” the research said. “The process needs to avoid a manager-selection process driven by any economic interests between the OCIO and other third parties, and needs to focus on identifying the best possible product solution for the mandate in question.”
As the OCIO industry continues to grow, it’s important for plan sponsors and other institutional investors to have clear and realistic expectations of what their OCIO will provide, according to the research.
“There is a fine line between employing aggressive sales practices in pursuit of new business and setting the right expectations with clients and prospects. This dynamic may tempt some service providers to over-promise and under-deliver, impacting the quality of their services and contributing to a situation that may not be sustainable or tolerated by clients. In our experience, some OCIO service models have failed because of this particular issue.”