Articles - How to use an Outsourced Chief Investment Officer

 Peter Daniels, FIA, Partner and Head of Outsourced Investment Services at Barnett Waddingham

 It involves delegating certain aspects of investment, typically relating to implementation and execution.

 To understand more about what an OCIO model is and where it might provide a good fit, read The differences between OCIO and fiduciary management. It also explains the difference between OCIO and fiduciary management, a popular form of delegated investing for UK pension scheme investors.

 "Whether or not an OCIO approach is right for you will depend on your desired governance characteristics as an investor. The pros and cons will resonate differently with different groups."

 An OCIO provider’s mandate is bespoke to each investor with flexibility around the division of decision-making responsibilities. The model therefore has flexibility to deal with a range of investors with different preferences and requirements, provided there is sufficient scale. Smaller investors are not likely to have access to the full range of flexibilities, but options do exist.

 Speed and ease of executing investment decisions is often what appeals most. Once a decision is made, the OCIO provider is usually responsible for making sure that decision is executed efficiently, managing both market and operational risks. This could involve asset allocation changes, risk management, moving money between investments, new manager appointments and more.

 There have been some large pension scheme examples where the move to OCIO has also involved the movement of an in-house investment team to a third party OCIO provider. This has potential advantages to the corporate sponsor as a pension scheme matures and the 'investment problem' simplifies.

 What are the drawbacks of OCIO?
 There are potential governance and investment drawbacks of the OCIO model.

 From a governance perspective, higher levels of delegation imply less investor control, which means increased oversight is needed. This is not a problem as such but does change the responsibilities of the investor and, in our view, it points to a need for independent advisory support.

 From an investment perspective, having a single provider responsible for all the assets in your portfolio creates concentration risk and potentially overreliance on a single entity or person. It is unlikely, for example, that a single OCIO provider can be considered 'best-in-class' for all asset classes within your portfolio. How might you deal with one part of the portfolio underperforming? Would you be comfortable replacing a large proportion of your portfolio in one go if changing provider? These are all questions to consider before adopting an OCIO model.

 How do we decide if an OCIO model is right for us?
 There is no right or wrong answer here. As with any investment governance model, the answer depends on the characteristics and requirements of you as an investor. Ultimately, it is a question of how you wish to operate from a governance perspective, recognising the implications for decision-making and costs, and potentially compromising on some of the trade-offs required.

 For example, we see charities and endowments often using an OCIO model to support with the implementation of a bespoke ethical or responsible investment strategy which could be more cumbersome directly, whereas pension schemes and insurers often seek to take advantage of liability and risk management.

 Our approach with clients is to go back to first principles of articulating preferences around investment governance and decision-making. That means, agreeing what decisions you wish to retain and what you would prefer to delegate to a third party. We then help our clients construct an investment governance model which facilitates their desired division of responsibilities, while minimising compromises on other governance aspects.

 Cost considerations are also pertinent and can vary materially by provider. These include the level of ongoing fees, possible transaction costs and how these could be mitigated.

 How do we select an OCIO provider?
 By this point you may be clear that OCIO is the right model for you as investors. Alternatively, you may wish to explore some live proposals further and test whether they are cost-effective in practice.

 The market of providers is varied, including global asset management firms, global investment consultancies and specialist providers. The universe of providers is much wider than with fiduciary managers, as the ability to provide regulated investment advice to a UK pension scheme isn’t a prerequisite.

 We encourage our clients to define a set of key selection criteria. Using our proprietary research and provider ratings system, we then help our clients match with providers who are strong in these key areas. For example (and this is not intended to be exhaustive):

 Investors which need to generate a reasonable rate of investment return will require a provider with strong growth asset capabilities.
 Investors with advanced responsible investment policies and/or climate targets may require a provider with significant ESG research, integration and stewardship credentials.

 For defined benefit pension schemes in low risk portfolios, providers who specialise in Liability Driven Investment (LDI) and with in-house credit investment capabilities could provide a natural fit.

 Different providers will fit better with different investors and their varying requirements. It is important to be clear on what you need from your provider and get under the bonnet to find the best match.

 How do we transfer to OCIO?
 Once you have selected your OCIO provider and your contract is in place, you will need to agree a set of investment objectives and guidelines. This is a critical step in setting the boundaries within which your provider can operate under their mandate. It is also vital in ensuring that the division of decision-making responsibilities is well-documented and understood by all parties.

 Your OCIO provider can assist with drawing up these objectives and guidelines – including performance targets, asset class ranges and liquidity ranges – but we would strongly recommend independent advice is taken; otherwise, your provider will in effect be setting its own exam rules and pass mark!

 With the objectives and guidelines agreed, your providers mandate will be formalised. The provider will usually take responsibility for the physical transfer of assets under their control. How this works in practice will depend on the nature of your investments and whether any of these are expected to be retained or redeemed.

 Your OCIO provider should provide you with a detailed transition plan ahead of the transfer, and a post-transition report once the transfer has been completed. We would recommend that both are reviewed independently so that potential conflicts of interest are managed and an impartial view is formed on how well the transfer was executed.

 How do we evaluate the performance of an OCIO?
 Unlike with a fund manager, for an OCIO provider there is rarely a single market benchmark against which performance can be assessed. Performance evaluation is multi-faceted and should cover assessments against mandate-specific objectives and where possible peer group performance. Industry standards such as GIPS® methodology have been designed to support this in a pension scheme context, but it does not necessarily apply to all OCIO mandates.

 In assessing performance against mandate-specific objectives, the focus should be on whether decisions taken (or not taken) by the OCIO provider have added value. For example, this could include asset allocation decisions, risk management decisions and underlying manager selection decisions. The execution of these decisions should also be considered, i.e. were the benefits of delegation achieved efficiently?

 In making these assessments, market context is important, for example any outperformance during a period when markets are rising may need to be tempered, and vice versa for underperformance in a volatile market.

 It is also vital to consider any restrictions placed on the provider in their decision-making, as well as the impact of any decision-making retained by you as investor.

 It can be a complex task to undertake these assessments in a balanced and informative way. We provide a specialist OCIO performance evaluation service which builds on our professional skills and expertise as investment consultants, to deliver critical analysis in plain English.

 In summary
 Whether or not an OCIO approach is right for you will depend on your desired governance characteristics as an investor. The pros and cons will resonate differently with different groups.

 If you decide that an OCIO approach would be a good fit, then it is critical to build the correct governance around it. That means a robust selection process, mandate design, transition plan and ongoing oversight framework.