Outsourced CIO: is it more compelling than ever for institutional investors?
According to research conducted by Chestnut Advisory Group*, the respected asset management consultancy, global assets under advisory for Outsourced CIO (OCIO) models surpassed US$2.4 trillion in 2021. In just three years time from now, that number is projected to have stretched to more than US$4 trillion, indicating exponential growth in this sector.
So why is OCIO, the investment model where larger asset owners outsource elements of the management of their portfolio while retaining control on the investment strategy, growing at such a pace?
What is driving the transformational shift in investment governance?
The data is clear; the move to OCIO models is accelerating. However, in what may traditionally be perceived as a proposition just for small and mid-sized institutions, our experience also evidences that growth is occurring across a variety of clients, especially large asset owners. DB and DC pension funds, insurance companies, wealth investors and family offices are all seeking to reap the benefits.
In our view, this shift has four key drivers:
- Increasing regulatory requirements – The ever-changing level and complexity of regulatory requirements, is placing higher demands on institutional investors for compliance, disclosure and reporting. For example, with the regulatory focus firmly fixed on ESG, climate change and net zero, expert and specialist knowledge is required to evolve the investment portfolio and meet regulatory and reporting obligations.
- Improved resilience – Deploying deeper and greater resources through an OCIO arrangement provides institutional robustness and improved business resilience and continuity to an organisation. Additionally, access to subject matter experts, investment and risk management technology and succession planning can all be enhanced from a correctly-executed outsourcing arrangement. The ‘great resignation’** has revealed the extent of key person risk within in-house investment teams and the potential for the loss of knowledge as board committee members leave the workforce. Underpinning this is the difficulty in creating a compelling career structure with the right incentives under the existing in-house investment team model.
- Value creation - OCIO models offer enhanced scale to institutional portfolios. This can drive value and reduce headline costs as resources can be deployed more efficiently from a larger team, and savings are made through established processes and cost efficiencies.
- Complexity of investment strategy - Required returns have become increasingly difficult to generate. This has exposed limitations in portfolio construction and the level of dynamic decision-making available in those traditional investment governance approaches based on in-house management and consultant-supported models.
Furthermore the range of public and private asset classes, portfolio construction techniques, liquidity management and sustainability and impact integration required to meet desired outcomes has become increasingly complex and requires specialist expertise. For example, volatility associated with the onset of Covid-19 followed by high inflation in 2022 exposed a broader range of risks and required a deeper level of knowledge of individual asset classes and the ability to move rapidly is hastening the growth of OCIO.
The different models of Outsourced CIO solutions
OCIO can offer a solution to the variety of governance and investment challenges faced by nearly all larger institutional investors. A key question for the senior governance board is ‘who is best placed to execute my overall mission for me and how should I hold them to account?’ Where OCIO is unique in providing an answer to this question is in the bespoke delegation of decisions and operational structures. The most common examples of this bespoke delegation are below:
- “horizontal” assistance in the sense that components of management of the entire portfolio are delegated – e.g. risk and controls, investment strategy and portfolio management, reporting.
“vertical” assistance in a particular asset class (e.g. private markets or risk and FX management) with clear accountability for integrating the asset class cashflows, liquidity and risk into the overall portfolio management.
Each of the above help to provide a solution where there is limited specialist resource internally (eg no in-house team), or where there are challenges with the existing in-house team, for the latter the team can also be transferred to the OCIO partner as part of the OCIO arrangement. As an example, a change in investment strategy is not just an investment challenge – it can also become a human resources challenge as the needs of the portfolio are mismatched with the skills in the team. An OCIO solution provides an elegant outcome in such cases, which can potentially offer enhanced career prospects for valued members of an in-house investment team.
What to look for in an OCIO partner
The most important characteristic of a successful Outsourced CIO partnership is cultural fit. The use of an OCIO involves such a close and trusted partnership that the relationship should be viewed as an extension of an asset owner’s own business. Everything flows from finding a partner with the right institutional culture that puts client interests first at all times.
When considering an OCIO arrangement, the below should act as a useful guide to identifying the right partner, with the critical components required for achieving success. Ask your potential OCIO partner, do they offer…?
- All the elements required to deliver an investment programme on a modular basis. For example strategic advice, portfolio construction, asset class expertise, macro-economic input, fund management, open architecture.
- Demonstrable specialist knowledge and experience across a broad range of asset classes, developed through managing those assets classes directly.
- A dedicated OCIO team that includes individuals who have previously been the clients themselves. This is critical to deliver superior, experience-based insight into the challenges faced by clients.
- The willingness to adopt and improve existing reporting and processes for the benefit of the client and have deep experience in working with other providers, e.g. custodians.
- The desire to be held accountable for decision-making and to provide transparent information and reporting.
- A fee structure that is aligned to the interests of the client and results in a business model that serves the client’s best interests.
- An industry leadership position in current and future investment and regulatory considerations. For example, in sustainable investing and climate change – look out for the extent to which financially material ESG factors are integrated into decision making and impact (e.g. in encouraging de-carbonisation through engagement and voting).
The bottom line
As markets become more volatile, institutional investors are recognising that they need more support to help them manage their risks appropriately, allowing them to focus on what really matters for their organisation in a cost-effective way. The drivers for change are unique to each investor but include; risk management; key-person risk and evolution in strategic goals.
We manage in excess of £100 billion in Outsourced CIO partnerships, entrusted by many high profile and sophisticated clients across insurance companies and DB and DC pension schemes. In 2020 Schroders Solutions was appointed as the trusted partner for the largest ever investment outsourcing arrangement undertaken in Europe.
If you would like to learn more about how an OCIO arrangement could benefit you, please contact our OCIO team.
*Chestnut Advisory Group, The Widespread Impact of OCIO Growth, 2022
**The ‘Great Resignation’ refers to the ongoing economic trend of workers either voluntarily leaving the workforce or swapping jobs, exacerbated by the Covid-19 global pandemic.