“Outsourced CIO Model Carries Risks and Opportunities for Asset Managers,” released by Greenwich Associates, identifies several trends that will likely push an increasing number of institutions to consider the outsourced chief investment officer (OCIO) model in coming years. The steady increase in the share of assets invested by endowments and foundations in alternatives has made tasks such as allocating funds, performing manager due diligence and monitoring existing managers increasingly complex and time consuming.
The relatively large allocations to alternative asset classes only serve to compound the challenges facing all institutional investors in an era in which markets are becoming increasingly complicated, volatile and fast, and decisions must be made at a rapid pace. In addition, most investors expect investment returns in the next decade to fall short of those achieved in the years prior to the global financial crisis, and some are seeking external help in building portfolios for a low return environment.
These trends are posing a significant challenge to small and midsized institutions that often operate on a much smaller budget than that available to larger institutions, Greenwich says. Maintaining an experienced chief investment officer and investment staff equipped to handle new market challenges is expensive. In addition, many endowments and foundations have investment committees made up of volunteers who may or may not have extensive knowledge and experience in financial markets. The committees also might not meet regularly enough to provide robust oversight and quick decisionmaking.
Even among small and midsized institutions that maintain full-time investment staffs, many plan sponsors believe budgetary constraints and lack of compensation competitiveness limits their ability to hire and retain top-notch investment professionals. Some of these institutions welcome the opportunity to transfer discretionary control to sophisticated external providers through the OCIO model and also see the potential to realize cost-savings through outsourcing.
The most immediate risk to institutional asset managers ranking outside the industry’s top 100 in terms of assets under management is that virtually all new OCIO arrangements result in manager terminations. More generally, by aggregating the assets of small institutions, the OCIO will reduce the number of asset management mandates available from small and midsized institutions.
Some smaller asset management firms will be unable to accept the large mandates awarded by OCIO providers; others will be excluded from consideration by OCIO providers who mitigate risk by avoiding awarding mandates that would constitute a relatively large share of an individual manager’s total AUM.
Despite these risks, the proliferation of OCIO could present a significant new opportunity for smaller asset managers able to demonstrate their ability to consistently generate alpha.
“OCIO providers are always in need of new ideas and innovative solutions that can be applied to the portfolios of their many clients. As a result, asset managers who can position themselves as trusted advisers could gain an invaluable advantage,” said Greenwich Associates consultant Andrew McCollum.