Author: Jacobi – jacobistrategies.com
Aaron Smith, Head of Business Development – Jacobi
The phenomenon of outsourced investment services has exploded in recent years. Once a niche offering from firms founded by ex-nonprofit CIO’s, nearly everyone has gotten into the game over the last two decades. And, as is usually the case when an emerging playbook is proven successful, the “bigs” have taken notice. Of the roughly $2.5 trillion in discretionary OCIO assets worldwide, six global firms control almost half of the market.
During this same period, the full spectrum of owners—including corporate and public pensions, endowments, and foundations—have grown increasingly dependent on OCIO and consultants’ asset allocation and liability expertise to ensure they’re delivering on fund objectives. The common mandate issued by all these asset owner investment teams is simple: full or partial investment discretion within the boundaries of an investment policy statement, guided by their OCIO’s unique views on asset class returns and volatility, risk factor frameworks, and proprietary economic scenario analysis.
Outsourcing’s growing popularity is not without its challenges, however. The asset owner space has evolved in relation to markets, with many funds increasing allocations to private and illiquid assets. Similarly, many OCIO’s have launched their own managed-funds to compliment their discretionary services, making the delivery of bespoke OCIO solutions increasingly more complex. According to Charles Skorina of Charles Skorina & Company, “When asked why no independent OCIO firm has broken through the hundred-billion-dollar barrier they answer: the business can’t scale, our service quality will deteriorate and, if we grow or merge we will lose our unique firm culture.” More often than not, these barriers are related to insufficient technologies that support the OCIO’s core workflows and processes. The future of the outsourcing space will be defined by how these and other challenges are addressed.
“After the dust has settled, there is still one certainty: customization is not going away. If anything, the unprecedented events of COVID spotlighted the fact that institutional clients have come to expect a deeper level of involvement in portfolio construction decisions from their outsourced providers.”
A Shock to the “System”
Just a decade after the Great Recession, investment consultants and outsourced chief investment offices (OCIO’s) were met with yet another global economic shock. The early days of the pandemic forced both investment and client-facing teams to operate reactively, but improving conditions have created an environment more conducive to proactivity and reflection. What were the most valuable lessons learned throughout this prolonged COVID nightmare, and what do they mean for a growing outsourced investment community? More importantly, how are OCIO’s and consultants incorporating those learnings into concrete action plans to better serve their clients in the future?
Even during periods of relative “stability”, the deceptive straightforwardness of outsourced investment approaches are undeniable. “In designing investment solutions for clients, our emphasis has always been firmly on the client’s objective and expected outcome, and to follow a total portfolio approach that views portfolio quality through multiple lenses,” notes Chris Mansi, Global Chief Investment Officer for Delegated Investment Services at Willis Towers Watson. Yet when markets and conditions change rapidly, as evidenced by the wild asset swings of March 2020, investment teams can be challenged by the need to balance those strategic, objectives-driven views with knowing exactly when and where tactical moves are required.
Anyone on an investment team or in the direct line of client fire during the initial COVID selloff can attest to this reality. Almost instantaneously, asset owners began to exert intense pressure on their OCIO’s and consultants for updated capital market assumptions and greater insight into their portfolio positioning. Firms who lacked tools for connecting their investment IP to live client portfolio allocations struggled mightily, and the inevitable delays in client communications did little to assuage fears that we were experiencing an industry-wide 2008-like unpreparedness. With the benefit of hindsight, this didn’t have to be the case.
“It’s a simple equation, really: additional client AUM = more complexity; and historically, investment teams have compensated by throwing additional analysts at the problem. With subpar technology, OCIO’s and consultants will continue to struggle to break through that $20bn ceiling.”
For OCIO’s and consultants alike, the most critical learning from the pandemic was the need for a stronger real-time portfolio management and monitoring infrastructure. Trillions of dollars are managed on spreadsheets in the asset management industry, and for good reason: Excel is the “original” entirely customizable no-code technology. But given the fact that outsourced investment teams faced little adversity between the end of GFC and the COVID-19 outbreak, there was little incentive to move beyond the status quo of extremely manual, time-consuming, and error-prone work performed by armies of analysts.
March 2020 turned the tables on this laissez-faire approach and the outsourced game was changed overnight. Time was now of the essence, and technology was no longer a nice-to-have. We know the core value an OCIO or investment consultant brings to its clients is its uniquely developed investment IP. But while there are similarities, no two pension, endowment, or foundation clients have the same fund objectives or are governed by the same philosophies. There’s a marked difference between linking a single asset owner’s long-term objectives with all aspects of their investment process and performing that same exercise across dozens of unique client portfolios. It can be likened to the distinction between a game of paintball and dodging live rounds of ammunition.
OCIO and investment clients were suddenly forced to grapple with this challenge in real-time, without the luxury of extended preparation periods between monthly or quarterly meetings with their clients’ investment teams, boards and trustees. In the era of Zoom meetings and near-ubiquitous remote-work environments, there was a new expectation that hypothetical portfolio analysis should be performed on the spot, without “stepping away” to review. After all, we’re already in front of our computers, right?
In order to meet these increasing demands for transparency, OCIO and Consulting investment teams needed to rapidly reassess their technology stacks. Where deficiencies were identified, this often resulted in a shortening of the historically-lengthy buying cycles in order to get needed tools into the hands of investment and client-facing teams. If there has been a silver lining for long-time investment practitioners stymied by budgeting and endless approval processes, this has certainly been one.
In summary, most OCIO and Investment Consultants found they needed better tools in a few key areas as a result of COVID-19. Firstly, the Excel-heavy models of the past precluded faster iteration on scenario analysis – for example, exploring different V-shaped v. W-shaped recoveries across a large number of complex portfolios with widely varying objectives – as well as making quick comparisons to peers and other reference portfolios. This ultimately helped them understand when to stay true to clients’ investment policy statements and when to introduce tactical decision-making. Secondly, teams quickly realized that disconnected systems for public and private assets dramatically reduced their ability to view liquidity at a whole of portfolio-level. Lastly, the realization that a system that integrated their live portfolio allocations with their forward-looking models empowered them to better engage with clients dynamically and keep them better informed, without increasing manual reporting processes.
Growth Amidst Hardship
Despite unprecedented challenges presented by the COVID-19 pandemic, the trend towards outsourcing doesn’t appear to be disappearing. Over the five-year period ended March 31, OCIO assets under management with full or partial discretion was up 51.1% worldwide (source: Pensions & Investments Online). Further, outsourced portfolio management continues to be one of the strongest trends to emerge among endowments, foundations and families. Outsourced assets in the United States are expected to grow by $700 billion over the next five years (source: NACUBO).
These numbers are deceptive, however. While total OCIO assets have been growing, only a select few firms have reaped the rewards. According to Charles Skorina (Skorina and Company), “Growing a discretionary asset management or investment advisor business is tough. We have yet to see an independent Outsourced Chief Investment Officer firm reach $100 Billion AUM through organic growth. Most of them will never even reach $20 Billion.” While some might argue this reality is attributed to smaller OCIO’s / Consultants lacking the heft to grow by acquisition, it can just as easily be explained by insufficient investment technology to help these firms scale the complex processes across portfolio construction, management, monitoring, and client reporting. It’s a simple equation, really: additional client AUM = more complexity; and historically, investment teams have compensated by throwing additional analysts at the problem. With subpar technology, OCIO’s and consultants will continue to struggle to break through that $20bn ceiling.
With such massive consolidation at the top of the OCIO/Consulting food chain, smaller firms also stand little chance to differentiate themselves without better tools to amplify their value add. And with a general trend of smaller endowments and foundations actually “insourcing” their portfolio management functions, we could actually see a contraction of AUM in the OCIO/Consulting space for firms under that $20bn mark. As we discussed in section II. above, a common pain point in most investment processes is how portfolio analysis and recommendations get communicated to stakeholders. This is just as critical when engaging with existing clients than it is when seeking new ones.
The Future of the OCIO/Consultant
As OCIO’s and consultants continue to review their performance during COVID, all eyes have shifted to the next potential Black Swan event. “Being nimble is certainly very important,” said Rob Cittadini, managing director for institutional sales, Americas, at Russell Investments. “An OCIO partner needs the latitude to dynamically manage a portfolio, to manage risk or to seek opportunities, depending on the client’s perspective and objectives.” But at the same time, there is no longer any question as to whether technology can be the enabler of this deftness, giving small and large firms alike the ability to more efficiently respond to future market shocks.
After the dust has settled, there is still one certainty: customization is not going away. If anything, the unprecedented events of COVID has spotlighted the fact that institutional clients have come to expect a deeper level of involvement in portfolio construction decisions from their outsourced providers. For investment teams faced with the difficulty of scaling their processes, there is greater optionality than at any point in recent history. The OCIO / consultants who continue to foster greater transparency through digitalization may just be the ultimate beneficiaries of the increased demand for outsourced investment services.