The Markets November 17, 2016

Larger Institutional Clients Embracing OCIO Service

Outsourced chief investment officer assets managed with discretion have more than doubled to nearly $1.3 trillion over the past five years, according to Cerulli Associates. 
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A new report from Cerulli Associates, “U.S. Outsourced CIO Function 2016: Opportunities for Providers to Support Institutions Across Client Segments,” highlights the very strong growth experienced by outsourced chief investment officer (OCIO) providers in recent years.

The informative publication is actually Cerulli’s “first report focused on the OCIO market,” a fact that in itself suggests change in the OCIO landscape, including in market sizing, forces of growth, and demand and needs across client segments. In particular, Cerulli finds the segment of the market in which the OCIO provider actually takes discretion over client assets—as oppposed to just offering advice—has grown impressively, with such mandates doubling in volume to reach nearly $1.3 trillion over the past five years.

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“The growth of the outsourcing market stems from increasingly complex and volatile capital markets, regulatory changes, resource constraints, and demand for improved governance,” Cerulli explains. “As a result, institutions seek timelier decision-making, deeper manager due diligence, and greater oversight of portfolio risks.”

According to Cerulli Associates, the vast majority (85%) of OCIO providers surveyed expect significant new business opportunities from institutions looking to move from an advice-only advisory relationship to a more discretionary OCIO solution.

NEXT: Much wider use of OCIO

“Institutions of all size cohorts are using the OCIO model,” adds Michele Giuditta, associate director at Cerulli. “To date, smaller investors with less than $250 million in assets have been the most frequent adopters of an OCIO solution; however, several OCIO providers indicated there is a trend of outsourcing mandates moving upmarket.”

In fact, Cerulli says some providers believe that this is partly due to new client segments, such as defined contribution (DC) plans and healthcare institutions showing greater interest in OCIO services.

“Others have cited an increase in demand from nonprofits with greater than $100 million in assets," Giuditta explains. “Cerulli's propriety survey data also identified a greater use of the OCIO model by larger institutions.”

Compared to last year's survey results, OCIOs have increased their proportion of clients with greater than $1 billion in assets under management, the Cerulli data shows. While corporate defined benefit (DB) plans and nonprofit institutions have been the greatest users of the outsourcing thus far, the OCIO service arrangement clearly has a lot to offer other groups of clients as well.

“It can work for nearly any pool of assets,” Giuditta concludes. “Healthcare institutions, for example, are grappling with many challenges and relying more heavily on investment performance to meet their goals … Anticipated outsourcing growth for DC plans is also high, primarily due to the expected implementation of the Department of Labor (DOL) Conflict of Interest Rule in 2017; the 'DB-ization' or institutionalization of DC plans; and the prominence of 401(k) fee-related lawsuits in recent years.”

Additional information on obtaining Cerulli research reports is available here.  

Client Service November 17, 2016

DB Plan Sponsors Feeling Pressure to Reduce Costs

A new survey by Vanguard found that cutting costs and minimizing risk were the top two concerns for corporate pension plan sponsors.

 

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Curbing plan costs is becoming an increasingly difficult task for many corporate pension plan sponsors especially in light of challenging market and regulatory environments including low interest rates, longer life expectancies, and rising premiums, according to new research by Vanguard.

The firm’s latest survey of Defined Benefit Plan Sponsors found that plan costs were the No.1 concern among the more than 175 pension managers questioned. It was closely followed by funded status risk.

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Furthermore, the study found that sponsors are under mounting pressure to ensure their plans meet funding requirements either through cash contributions or return-generating asset allocations in the portfolio—the latter of which can expose the pension to increased funding volatility, Vanguard reports.  

“Our research has continued to point to a trend of cost reduction and risk management across the pension industry,” says Kimberly Stockton, an analyst in Vanguard Investment Strategy Group. “Yet, there’s a continued disconnect between these crucial objectives and existing portfolio construction. There is an opportunity for plan sponsors to implement strategic asset allocations to better protect themselves from unexpected costs and risk.”

Vanguard’s analysis of survey responses point to three persistent trends.

First, asset allocation has remained static since 2012 despite plan-design changes. And despite a growing number of frozen plans, the average asset allocation reported in 2015 was almost identical to 2012: 48% equities, 39% bonds, 2% cash, and 11% alternatives. The 2015 DB survey respondents with frozen plans reported an average funded status of 84%, likely influencing the outsized equity allocations. However, 32% of frozen plans also signaled a planned termination in the next several years, suggesting that portfolios might still be assuming too much risk, the firm notes.

Second, Vanguard reports that fixed-income allocations aren’t liability-hedged.

“While the average allocation to fixed income was unchanged, the types of fixed income products that plan sponsors are utilizing shifted slightly toward longer-duration products that better match plan liabilities,” read a company statement. “Despite this emerging trend, there is room for improvement. For plans with larger return-seeking allocations, Vanguard believes that the fixed income allocation—the liability-hedging allocation—should be at least duration-matched.”

Finally, the firm points out that investment strategies might not align with risk tolerances.

The majority of surveyed sponsors reported that only a 1-10% variance in plan-funding ratio is acceptable. However, Vanguard’s analysis found that the average asset allocation was well beyond the 10% variability threshold, suggesting that investment strategies are not appropriately aligned with risk tolerances.

Vanguard says its report reflects a long-term industry trend of declining open and active plans, with the number of frozen plans nearly doubling in the past five years. However, the firm also found a meaningful portion of plan sponsors committed to offering a pension over the long-term. Of the 30% of plan sponsors who reported having open, active plans, 86% said they continue to value the plan as a recruiting and retention tool.

Despite different end goals and approaches to investment management, cost concerns were universal across both the closed and active sponsor segments.

“Regardless of plan design phase, we are hearing from plan sponsors that there is a great need for guidance in today’s challenging world of pension management,” says Christopher Philips, head of Vanguard Institutional Advisory Services, which serves defined benefit plans and other institutional investors. “Portfolios need to be risk-appropriate, designed to achieve and maintain full funding, and aligned with your overall strategy—all with an eye toward costs. In an unpredictable market environment, we encourage plan sponsors to focus on the areas within their control: The fees they pay for their plans’ investment products and the fees they pay for advice.”

Vanguard’s survey can be accessed at Vanguard.com.

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