The outsourced chief investment officer business is having a renaissance. OCIOs were once mainly the domain of sleepy corporate pension plans looking to offload the hassles of portfolio management. Now, outsourcers are running money across the institutional gamut. No in-house CIO running less than a few billion dollars is safe.
Asset management research firm Cerulli Associates is calling the era “OCIO 2.0” – a time when the market is generally accepted among institutions, with its influence reverberating across the finance industry more broadly. Asset management firms are changing the way they sell investment products to accommodate a new crop of clients with a huge amount of assets under management, while search firms are popping up to help institutions choose the right OCIO for them.
The OCIO market as it currently stands is big – and growing, according to Cerulli data. Assets under full or partial discretion by an OCIO firm grew to $1.56 trillion in 2017, with U.S.-based assets alone accounting for more than $1 trillion. Cerulli is projecting that U.S. OCIO assets will increase by $671 billion over the next five years – and that’s a conservative estimate, according to senior analyst Laura Levesque, who said OCIO growth would likely be slowed down by rising interest rates and market volatility.
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More institutional investors and larger corporate defined benefit plans have entered the market as OCIO clients in recent years. Going forward, Rich Joseph, an OCIO executive at Mercer, predicted that health care systems, hospitals, and insurance plans will look to outsourced-CIO providers as an investment solution.
“For typical, less than $1 billion, not-for-profits or family offices, it’s difficult to invest on your own,” said Larry Kochard, chief investment officer at OCIO firm Makena Capital Management. “You could keep it really simple and could go passive, but the returns from doing that have been very muted over a long period and probably will continue to be.”
The ever-increasing amount of OCIO assets has made outsourced CIO firms a growing source of business for asset management firms, Cerulli’s data show. Ninety-five percent of asset management survey respondents reported that they had won business through an OCIO mandate. In the past year, managers said 14 percent of their new business came from OCIO firms on average.
“Asset managers that are looking to partner with OCIO providers are starting to see the business as an underlying sales driver,” Levesque said.
In an effort to win OCIO business, these managers are hiring staff and investing in resources to specifically target that market, Levesque said. And they’re sweetening the deal by offering risk management tools, providing speakers for OCIO firm events, and sharing research, according to Jim Dunn, chief investment officer and chief executive at Verger Capital, an outsourced-CIO firm that spun out of Wake Forest University in 2014.
“They’ve changed their offerings to not think just about what they can bring to us, but also, how they fit into our portfolio,” Dunn said.
The rapid growth of the OCIO market has not just forced asset managers to change. It’s also created demand for a “cottage industry of consultants that will help institutions through their search” for an outsourced-CIO provider, Kochard said. Forty-seven percent of the OCIO firms surveyed by Cerulli reported that they won a mandate through a search consulting firm in 2018.
According to Dunn, demand for search consultants has been fueled by the board members of endowments and foundations, who often lack the knowledge or resources to making hiring decisions on their own.
“They’re all volunteers, they’re transient, and they have a real fiduciary responsibility,” he said. In these situations, he added, a search consultant can help fiduciaries determine what exactly they need from an OCIO – at a price. “The institutions have to consider the cost,” said Dunn, who noted that the price of search consultants range from a flat fee to asset-based fees to tier pricing. “For some of the smaller institutions, it may be difficult for them to amortize the cost themselves.”
There’s also the cost of the OCIO firms themselves to consider. Although Levesque expects fees to become standardized over the years to come, Cerulli’s data show that fees charged by OCIO firms are currently all over the map, with basis-point fees, fixed fees, and performance-based fees being used alone or in tandem across the industry.
Dunn said that Verger charges a flat fee for services, while Makena similarly charges a standard fee for the capital invested in its own investment vehicles, according to Kochard. Clients are not charged a double-layer of fees for the assets that Makena invests in liquid strategies, or those legacy assets that it manages for endowments and foundations, he added.
For Mercer, an assets-under-management-based approach is the right one, according to Joseph, who leads the consulting firm’s U.S. OCIO division. “That puts us on the right side of the client,” he said. “When we talk to them about fees, it’s not only our fees, it’s the buying power we can bring to money managers. Often an OCIO relationship can be cheaper than an advice relationship.”
For clients of firms like Mercer, which offer both consulting and OCIO services, Joseph said switching to the outsourced-CIO model might just be the more cost-effective option.
