Understanding Outsourced CIO
A call for enhanced oversight and accountability
To the point
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Global investment consultants have sought to diversify their businesses through the development of delegated consulting offerings. These delegated consulting offerings go by different names including implemented consulting, fiduciary management, and Outsourced CIO (OCIO) and are rising in popularity, especially amongst small to medium-sized institutional investors ( Under an OCIO arrangement, responsibility for setting investment objectives and strategic asset allocation (SAA) continue to rest with the institutional investor, albeit with reliance on advice from their OCIO. However, the OCIO also takes on responsibility for implementing the agreed SAA, often using their own range of multi-manager funds. Many institutional investors have moved from traditional investment consulting arrangements to the OCIO model either for governance reasons (they may not feel equipped to make investment decisions) or to access, in the words of the OCIO, sophisticated investment portfolios at reduced investment management fees. The global OCIO industry nearly doubled between 2016 and 2021, from US$1.3 trillion assets under management to more than US$2.5 trillion. In this article we will use our knowledge of the global delegated consulting industry, and experience reviewing OCIOs on behalf of existing and prospective clients, to explore the benefits and drawbacks of these OCIO arrangements in more detail.
Why choose OCIO?
As discussed in our introduction, OCIO arrangements are primarily targeted at small to medium-sized institutional investors across the full range of sectors, including pension schemes, insurers, endowments, charities and other “for-purpose” clients.
These investors are often sold on several claimed benefits of OCIO, specifically:
- Governance: The boards or committees responsible for the investor’s assets often don’t feel suitably knowledgeable or have sufficient capacity to make informed and timely investment decisions.
- Speed of execution: OCIO’s can use their delegated authority to respond to investment market and investment manager developments in a more timely fashion.
- Cost savings: OCIOs commonly use their own suite of multi-manager funds, enabling them to combine investor commitments in a relatively small range of investment vehicles. This increased scale facilitates negotiations for reduced investment manager fees which can be passed onto their clients.
Testing the rationale
In our experience, does OCIO offer the promised ease of governance and cost savings?
The governance burden on the institutional investor may have decreased given that boards and investment committees are no longer required to review and select multiple investment managers. However, a more pertinent consideration is whether the investor’s governance requirements are reduced or merely shifted.
When appointing an OCIO, institutional investors are reliant on their investment strategy advice and are delegating significant levels of investment decision-making to their OCIO covering areas, such as dynamic asset allocation, investment manager selection, portfolio construction, risk management and monitoring. To ensure accountability, OCIOs should undergo monitoring proportional to the breadth of their delegated powers.
On potential cost saving, while the increased scale of the OCIO model can create savings, investment decisions made by the OCIO can also add cost. For example, we have observed that the belief among many OCIOs in the superiority of active management can result in higher fees paid to underlying investment managers. It is also important to note that the appointment of an OCIO introduces an additional layer of fees. Consequently, the institutional investor should primarily consider the total fees payable to implement their chosen investment strategy.
Recognizing OCIOs as delegated investment managers
OCIOs are providers of whole-of-portfolio investment management solutions, not dissimilar to individual investment managers offering multi-asset funds. However, in our experience, OCIOs are not always subject to the same level of scrutiny as specialist investment managers. Specific areas of focus should include the following:
What steps should institutional investors take when considering or having already appointed an OCIO?
If the investor decides to adopt an OCIO approach, the focus shifts to selecting the best candidate for the role. The investor must recognize that they are appointing both an investment consultant to provide investment strategy advice, and an investment manager. Consequently, there are a wide range of key considerations including:
Similarly, the investor must ensure that there are clear and appropriate governance structures in place prior to the OCIO’s appointment. We suggest that detailed investment reporting requirements be agreed in advance as part of the initial contract negotiations.
Providers of investment advisory and investment management services should be subject to periodic reviews. A detailed review of investment performance may be warranted to better understand the key drivers of recent investment performance trends and the impact of the appointed OCIO’s decision making. However, investment performance shouldn’t be the primary consideration with the OCIO’s core capabilities and costs ultimate determinants of past and future investment outcomes.
Conclusion
Like all investment advisory and investment management approaches, OCIO offers a series of potential benefits and potential drawbacks. While acknowledging its suitability for many, our experience highlights the need for increased scrutiny, both initially and on an ongoing basis. Once appointed, substantial reliance is placed on OCIOs, necessitating institutional investors to ensure not only their financial strength to fully research all asset classes, develop new and sufficiently diversified pooled vehicles and retain key personnel, but also their use of wide-ranging discretion to ultimately improve investment outcomes. In our view, external independent specialists providing informed insights promotes greater accountability, and should ultimately improve the generally quality of the OCIO industry. |
