From market volatility to an increasingly complex regulatory environment, the challenges confronting institutional investors continue to grow with every year that passes. It comes as no surprise that many pension plans, endowments, foundations and other institutional investors are searching for better ways to achieve their investment objectives while controlling risk and managing costs.
A growing number of institutional asset owners are discovering the beneﬁts of outsourcing all or part of their investment management functions. An attractive, ﬂexible alternative to in-house asset management and traditional consultant models, outsourced investment solutions can provide an effective way for institutions to enhance their investment capabilities and gain much-needed ﬁduciary support.
Institutional Asset Owners Face a Challenging Environment
The capital markets landscape is undergoing profound changes, and staggering demands are being placed on today's institutional asset owners and investment committees. Among the most signiﬁcant challenges and obstacles are:
- More difﬁcult future environment for achieving investment objectives
- Growing scope and scale of risk management oversight needs
- Limited time and budget resources
- Proliferation of complex investment strategies that expand research requirements
- The need for responsiveness in implementing investment solutions
- Increasingly complicated regulations
It is no wonder that “ﬁduciary fatigue” has set in as investment committees and in-house asset management professionals cope with the challenges of today’s investment environment. And life is likely to get even more difﬁcult in the days ahead.
For many institutional investors, the timing could not be better to consider outsourcing their investment functions.
Outsourced Investing — A Flexible Solution for Institutional Investors
Outsourced investing is about delegating responsibility for the day-to-day management of the investment program. Speciﬁcally, it involves shifting discretionary investment responsibility for some or all investment functions from the asset owner to an investment advisor. Often called OCIO (outsourced chief investment ofﬁcer), outsourced investing has been used by institutional investors for decades.
Outsourced investment solutions provide institutional asset owners with ﬂexibility and a wide range of options for delegating investment authority. The scope of outsourcing can vary signiﬁcantly depending on the needs of the asset owner. As an example, the speciﬁc functions delegated to the investment advisor can vary: The asset owner may outsource virtually all investment functions or choose among certain responsibilities to be outsourced. To illustrate this, institutions may choose to delegate full responsibility for asset allocation and manager selection to an OCIO or they may retain approval authority. Of course, even if all investment functions are fully outsourced, the asset owner continues to have ﬁduciary responsibility for the selection and monitoring of the OCIO and overall authority over the investment program. With that said, delegation of a portfolio or function to a qualiﬁed OCIO provider can help the asset owner demonstrate a prudent investment process, which can help to satisfy the ﬁduciary obligation of the board, trustees or other responsible parties for the assets.
Outsourced Investments Versus Traditional Consultants
While traditional consulting services encompass the same functions as outsourced investing, there are signiﬁcant differences between the two. In the traditional consultant model, the asset owner contracts with a consultant to provide services such as advising on the investment policy statement (IPS), consulting on asset allocation, recommending investment managers and monitoring performance. Under this model, the asset owner, in-house staff or investment committee make the ﬁnal decisions after the consultant provides information and makes recommendations.
Outsourced investment solutions provide institutional asset owners with flexibility and a wide range of options for delegating investment authority. The scope of outsourcing can vary significantly depending on the needs of the asset owner.
Advantages of Outsourced Investment Solutions
Outsourced investment solutions offer institutional asset owners a number of potential advantages.
1. Improved risk management and fiduciary oversight.
Seasoned OCIO providers have developed sophisticated tools to help manage portfolio risk and effectively deploy the client’s risk budget. In addition, outsourced investment firms have established exacting due diligence and monitoring systems to evaluate third-party managers and — if needed — remove and replace managers more efficiently. Outsourced solutions also provide institutional asset owners with a wide range of options for delegating discretionary investment authority, providing institutions with the ability to shift some of their fiduciary responsibilities.
2. Better allocation of resources.
Outsourced investment solutions enable institutional investors to allocate their resources optimally. Since an OCIO is responsible for decision-making within the scope of the delegated investment functions, the institutional asset owner can focus on higher- order investment policy matters and on overseeing overall performance, setting objectives and other key business priorities. As a result, investors can avoid allocating limited resources to functions that may be more effectively performed by outsourced investment providers.
3. Agile decision-making.
Since the outsourced investment model delegates authority for designated functions, the OCIO provider can make more timely decisions in response to changing conditions. The traditional consulting approach often involves providing information and recommendations to in-house staff or the investment committee, who are then responsible for making the final decisions. This process takes time, perhaps causing the institutional asset owner to miss opportunities that could have enabled them to optimize their portfolio structure. Outsourced investment providers, on the other hand, are able to make more timely decisions and move more quickly on implementation. Importantly, this enhanced agility that the OCIO model offers can help significantly reduce the costs associated with missed opportunities.
4. Opportunity for cost savings.
Because of scale efficiencies, outsourcing can provide investors with cost savings in implementing portfolio strategies. An OCIO firm has the opportunity to pool assets of several investors, thus enabling a single asset owner to gain access to managers and strategies that it otherwise might not be able to use because of account minimums. Pooling of investor assets also enables the OCIO firm to negotiate better terms with specialist managers as well as the ability to achieve less expensive executions because of larger transaction sizes.
5. More sophisticated investment strategies.
The challenging investment environment is causing institutional investors to explore increasingly sophisticated investment strategies. Evaluating the risk–return implications of these options can push staff and investment committees beyond the limits of their experience. An OCIO provider can provide the experience to implement multifaceted solutions to help enhance the potential of the asset owner’s portfolio.
6. Enhanced reporting.
Today’s complicated investment climate demands sophisticated communications and reporting. To be effective, information should be distilled and presented in a way that is responsive to institutional asset owners’ needs and customized to address the unique priorities of each. OCIO firms are able to combine a wide range of investment strategies into a reporting format and deliver meaningful, understandable insights. OCIO reporting also benefits institutional investors by freeing up internal resources that would be devoted to routine report preparation.
Implementing an OCIO Solution
Once an institutional investor decides that an outsourcing approach is appropriate for its portfolio, the next step is to define the framework within which an OCIO provider will be selected and then operate. While the specifics will vary depending on each institution’s needs, the following considerations are important elements in the initial stages of an OCIO relationship:
- Establish the level of delegation of functions being outsourced and the desired fiduciary accountability for each — essentially deciding the extent of outsourced solution being sought — full or hybrid approach
- Define accountability for all investment functions, including those that are retained by the asset owner
- Establish criteria for selecting an OCIO provider and compose due-diligence questions
- Work with the selected OCIO provider to document a new IPS that captures new guidelines and responsibilities, portfolio parameters, and other key areas of governance
Today’s institutional asset owners are choosing to outsource all or parts of their investment functions.
It is a challenging time to be an investment fiduciary for any organization. Asset owners must evaluate investment objectives, asset allocations, staffing and structure against a backdrop of market volatility, a wide array of investment choices, and increasingly complex and time-consuming due diligence requirements. The OCIO model provides investors with a compelling combination of specialized investment experience, cost effectiveness, nimble decision-making and the ability to take advantage of more sophisticated strategies — all while providing fiduciary relief.