The Three Pillars of Success for OCIOs

Institutional investors have faced a challenging investment environment over the last two decades.  Since the market peak of 2000, US equities have experienced two major bear markets. In addition, future expectations for many asset classes have been lowered. This environment has forced institutional investors to embrace a wide range of alternative investment strategies to achieve their performance objectives.

While these alternative strategies, which include private equity and hedge funds, have often served as drivers of higher risk adjusted returns and increased diversification, they have also dramatically increased the complexity of managing an institutional investor’s portfolio.  Tasks like establishing the asset allocation, selecting investment managers and implementing portfolio decisions have become increasingly complex and time consuming.  At the same time, markets are becoming increasingly complicated and the need for well informed and timely portfolio management decisions has increased. This dichotomy has been particularly challenging for investors who may lack sufficient resources and economies of scale to access and manage the information and structures needed to generate the investment returns that they are tasked with pursuing.

These dynamics have led a growing number of institutions to consider Outsourced Chief Investment Officer (“OCIO”) platforms as an alternative to establishing and maintaining the in-house investment expertise and operational infrastructure necessary to run a successful  investment  program in today’s market environment.  OCIOs allow institutions to outsource some or all of the investment functions that are typically performed by investment committees and investment teams.  Activities including portfolio rebalancing as well as selection, oversight and monitoring of complex strategies may be delegated to these specialised third party advisors who have extensive experience across a broad range of alternative investment  strategies  and their utilisation in institutional investment portfolios.

For these reasons, the OCIO market has rapidly expanded in recent years.  A recent Pensions & Investments article noted that worldwide OCIO assets grew 36.3 percent in 2018.  This rapid expansion of OCIO mandates is, however, creating its own challenges in the industry.  Historically, the outsourcing of the investment management function was generally limited to small and mid-sized institutions that lacked the size and resources needed to effectively manage their investment portfolios, but now larger plans are also utilising OCIOs.

Demands from these larger investment programs regarding transparency, a growing client base and increasing competition from new entrants has pushed leading OCIOs to find innovative ways to better serve their clients, differentiate  themselves  from competitors, and effectively scale their businesses.  Facilitating this growth often requires a robust platform that facilitates streamlined operations, allowing OCIOs to focus on investment oversight and decision making.  Solutions in the key areas of structuring, operations and technology that enable OCIOs to monitor, allocate and report on a broad range of asset classes, strategies and structures have arguably become the cornerstones of their success.

Pillar 1: Structuring

OCIOs are increasingly seeking optimal investment structures to facilitate portfolio rebalancing, maximise alignment of interest with underlying investment managers, and improve transparency, liquidity and control.  Optimal investment structures may generate structural alpha through increased control of fees and expenses and by providing greater transparency into portfolio holdings  for  improved  portfolio allocation and rebalancing decisions.  Bespoke solutions such as fund of ones or managed accounts can assist OCIOs in differentiating themselves from their peers who may only invest through commingled funds.

As OCIOs direct more of their alternative investments into customised vehicles they enable their investors to work with multiple managers while maintaining ownership and control over the underlying assets.  This allows for greater cost efficiencies, improved liquidity and enhanced portfolio transparency.  However, establishing and supporting managed account  relationships  requires  additional infrastructure and coordination between stakeholders, including managers, OCIOs and service providers. As a result, OCIOs must ensure that they have the robust technological  infrastructure and expert  support needed to maximise “structural alpha.”

OCIOs are also recognising the benefits of managed custody accounts (“MCAs”) which introduce an innovative  way of redefining the traditional relationship between asset allocators and managers and can play a significant role in enabling outperformance. MCAs seek to create a governance structure that allows the OCIO to work more efficiently with an asset manager, reduces contracting time and cost for both parties, and enhances alignment of interest through a fee netting agreement which increases compensation  for the manager based on the success of the overall relationship rather than individual strategies or investments. The MCA structure requires specific operational and reporting solutions to optimise its benefit and ensure appropriate governance. Best practices recommend the use of a third party administrator that can address the operational nuances inherent to MCAs to ensure data integrity and accuracy in the verification and reconciliation of assets and valuations, performance monitoring, fee netting calculations and consolidated reporting.

Pillar 2: Operations

Similar to optimising investment structures, establishing effective operations has become more and more difficult for OCIOs.  With investment programs, client requirements and reporting needs becoming ever more demanding, OCIOs must ensure they have the resources, expertise and infrastructure necessary to deliver.  Key areas of focus include:

• Data Management: OCIOs typically have broad informational requirements which necessitate aggregating, processing and interpreting large amounts of data from a multitude of data formats and a wide array of data sources.  Robust operational processes to manage this data are critical to ensuring that information is enriched with additional data attributes aggregated from third parties and clients, that source data is correctly captured through automated reconciliations, and that a detailed review of all output is conducted to ensure accuracy.
• Portfolio Accounting: Experienced accounting professionals along with robust processes and systems are necessary to address the varying portfolio accounting requirements of OCIOs and
  their clients, as well as the idiosyncrasies of individual asset classes, client fee agreements and investment structures.
• Portfolio Reporting and Analytics: Operational platforms should be able to aggregate data from a diverse array of third parties into contextualised and intuitive reports.  These reports should include accompanying analytics that provide insight into portfolio exposures, performance and risk to support investment decision-making and client reporting.

Outsourcing certain functions  can  improve operational efficiency and allows OCIOs to focus on engaging with their underlying clients and asset managers to drive performance and build better portfolios. In addition, this serves as a valuable way of introducing an added layer of independence that can supplement governance practices and enhance stakeholder reporting.

Pillar 3: Technology

Superior information delivery systems and the ability to make data useful is a necessity in today’s environment.  For OCIOs in particular, the reporting and level of oversight that underlying clients demand is typically quite complex and, as a result, the systems used must be extremely sophisticated.  Fulfilling operational  requirements demands the optimisation of existing processes through a single robust yet scalable technology platform.  Conversely, sub­ optimal technology solutions create a myriad of challenges for OCIOs which can propagate to reduce an OCIOs ability to make effective and timely investment decisions or to reduce the accuracy and integrity of their portfolio accounting and client reporting.

Given increased complexity and competition across the industry, OCIOs are unquestionably under more pressure than ever before.  The capabilities of an OCIO are determined by their ability to provide services tailored to the individual needs of a wide range of clients. This is something that can only be accomplished by a significant investment in resources and systems.  With this in mind, many OCIOs find it useful to outsource specific processes and engage third party experts who provide proven operational and technological solutions.

As investors are turning to OCIOs to manage their increasingly complex investments, OCIOs in turn need partners who can support the nuances of their businesses. Recognising each OCIO’s unique needs and the individual nuances of their business processes, the Maples Group provides expert support and dynamic solutions customised to meet the structural, operational and technology needs of their clients. These bespoke offerings are scalable and designed to evolve to meet future requirements while delivering optimal solutions for the current environment.