The challenges of the outsourced chief investment officer model
BY Kelsey Rolfe | October 26, 2020
Over the last 20 years, managing a pension plan has looked a little like riding a roller coaster — with the 2001 technology bubble, 2008/09 financial crisis and the recent coronavirus market volatility providing sudden, gut-wrenching drops that can draw a scream from even the heartiest of souls.
The pandemic is spurring increased interest in outsourced chief investment officers, but the model isn’t without its challenges
“From an investment standpoint, we’ve been in an extremely volatile market with three major corrections [in two decades],” says Colin Ripsman, president of Elegant Investment Solutions Inc. “In 2008 and 2020, we had governments around the world coordinating to lower interest rates. While assets were dropping significantly because of the equity and credit markets, plan liabilities increased as long-term interest rates fell. Together, all of a sudden, it’s hugely eroded the solvency position of a lot of [pension] plans and created a crisis.”
Indeed, the pandemic and previous market corrections have highlighted the inherent risk in managing a defined benefit pension plan. And for some plan sponsors, the most recent crisis is making a strong case for hiring an outsourced chief investment officer to take on the day-to-day management of their plans.
However, the model isn’t without its challenges, including potential conflicts of interest as many consulting firms add the service to their rosters.
While Canada’s OCIO market is relatively young, it’s experiencing “explosive growth,” according to Brad Rowe, principal in Eckler Ltd.’s investment consulting practice.
His own research on the market found the country’s top OCIO firms saw a roughly 60 per cent growth in assets under management over the five-year period that ended in 2018 and activity continued to grow in 2019.
Part of that growth has been due to consulting firms opening up OCIO businesses and converting many of their existing plan sponsor clients, says Rowe, noting his research found about a quarter of pension plan assets that converted to OCIO did so through an open tender, while the remainder were consultants changing their relationships with existing clients.
He argues this conversion presents a conflict of interest. “If I have a 25-year consulting relationship with a client and decide to offer OCIO, I’m coming [to the plan sponsor] from a super position of trust. I can say to my client, ‘You should convert’ and they will trust me and I can charge whatever I want. There’s no competition happening where the consumer is getting the advantage of a competitive process.”
Denise Kehler, head of delegated portfolio management for Canada at Willis Towers Watson, which has its own OCIO business, says many of the firm’s early OCIO clients were conversions, but doesn’t consider it a conflict because the organization doesn’t think of its advisory and delegated solutions as separate lines of business. “Clients can engage with us, or not, in the various ways that we offer them service. . . . For us, that is actually really aligned with providing them support rather than a conflict.”
Similarly, Aon has converted some existing consulting-side plan sponsor clients, says Federico Cervantes, a global partner and head of investment for central Canada. The firm approaches plan sponsors through educational conversations with plan committees or boards about what the service gives them and how the responsibilities break down. “Once we go through that, in some instances, the clients want to go through . . . and do a request-for-proposal type of exercise [and] we fully support those.”
Plan sponsors choosing to use their consulting firm’s delegated solutions should consider hiring an independent consultant to oversee the OCIO’s performance, suggests Jordan Fremont, a partner on the pensions and benefits team at Bennett Jones LLP. “Who in that case is reviewing the OCIO provider if it was the same party that was providing you independent consultant advice before? I would argue that, in order to get an independent view on that OCIO provider, you ought to consider obtaining a different consultant that is truly independent, because the old consultant now is arguably no longer independent.”
Ripsman also highlights potential conflicts in OCIOs’ portfolio constructions, particularly those that use their own investment solution and may be making choices that benefit their own business rather than the best interests of plan sponsor clients. Similarly, he notes relationships with particular fund managers may lead to a bias toward offering more of their products to plan sponsors because the OCIO can negotiate better fees.
Rowe says OCIO platforms may also prevent plan sponsors from accessing the industry’s most sought-after managers that wouldn’t be willing to offer their full capacity to the platform. “The question becomes, what’s the pool of managers that are left for an OCIO to select from if all of the highly in-demand managers don’t want to be there? I’ve seen OCIO platforms; there are pretty good managers there, but I can see that becoming an issue in public markets.”
Conflicts were a prime area of concern for George Weston Ltd. when it looked into the OCIO model about five years ago, says Roman Kosarenko, the organization’s senior director of pensions. It eventually opted not to use the service because of its plans’ sizes and pricing power, as well as its own in-house pension expertise.
“The OCIO model is prone to conflicts of interest, particularly related to self-dealing. . . . This is most apparent when consultants are offering OCIO services,” he says. “Currently, I don’t see any evidence of proper Chinese walls preventing a flow of information or cross-subsidizing of those businesses. . . . We don’t see good governance there.”
Digging for data
While money managers are required by regulators to disclose everything from their performance and assets under management to team turnover and succession plans, OCIOs are not, which makes it challenging for plan sponsors to compare options.
Over the past couple of years, Rowe has been trying to convince Canadian OCIO providers to become more transparent. At the end of the year, he’ll publish a paper on OCIO performance, trends in the space and reactions to the coronavirus pandemic. While he’s received many commitments from OCIOs that are willing to share more data on performance and assets under management, he hopes Canadian regulators will also get involved to require more disclosure.
“Clients that have moved to an OCIO model want to answer the question, ‘How are we doing relative to other fiduciary managers?’ If that’s asked relative to money managers, there’s a universe we can look at. I personally would like to get the OCIO market there as well.”
Willis Towers Watson supports full transparency, notes Kehler, but she says a true apples-to-apples comparison may be difficult even with a surfeit of data. Each OCIO firm comes with a different approach, such as a focus on mitigating risk or generating excess returns, and plan sponsors have varied needs.
The way OCIOs will ultimately demonstrate their value is by comparing their portfolio’s performance against the plan sponsor’s benchmark — but, asks Rowe, how will smaller plan sponsors know if their benchmark is high quality?
Many small plan sponsors that chose to delegate portfolio management started in a typical equity and fixed income portfolio, but working with an OCIO means building a new benchmark that incorporates alternative asset classes they may not have otherwise accessed. “The question I’d want to see asked is, ‘Is my benchmark better than my old one? Did I build a better policy first?’” he says. “My fear is the evolution of the benchmark and policy will get lost.”
OCIO in the time of pandemic
Despite its challenges, the OCIO model has been gaining popularity since the 2008 financial crisis and it’s poised to grow again, according to a July 2020 survey by Cerulli Associates.
It found 67 per cent of asset management professionals specializing in requests for proposals expect to see a growth in RFP volume for OCIO mandates. Another 2020 report, by Chestnut Advisory Group, found 50 per cent of consultants and OCIOs have higher expectations for growth in OCIO uptake in the next two years than they did before the pandemic began. “This crisis is a poster child for the OCIO business,” said David Eisenberg, managing director of Cambridge Associates, in the Chestnut report.
Willis Towers Watson has witnessed this shift firsthand. “We saw that, for prospects we were talking to before [the pandemic] that weren’t sure, a lot of them, when the lockdown struck and they felt the stresses in their own business, . . . it was almost like a lightbulb went off and they understood,” says Kehler. “We saw a tremendous amount of interest early on to say, ‘Can we talk again? Because now we think we get it. There’s so much to manage in our own business and we don’t have the capacity to look after this right now.’”
Opening the door for DC
While OCIO has traditionally been the domain of DB plans, providers are beginning to make services available to defined contribution plan sponsors as well.
But the equation is a little different, says Ripsman. “In a DB plan, . . . even if you choose the worst fund manager and use the worst performing funds, the reality is, over time, as long as the company is solvent, you’ll do an evaluation every three years and fund at slightly higher levels. . . . In the DC world, it’s different; if you offer funds that are underperforming and you’re not monitoring them properly, anytime you make a suboptimal decision, your employees have less money than they otherwise would. That may erode some of the value of an OCIO provider. It’s hard to let go and let a third party do everything.”
Cervantes believes this could actually make the model more appealing for DC plan sponsors. “In addition to having limited resources [to manage the plan], there’s an extra layer of governance required because you’re managing the employees’ money and you have a responsibility to meet capital accumulation plan guidelines.”
As well, DC plan sponsors tend to focus more on the accumulation than the decumulation phase, he says, noting OCIOs can provide the scale to negotiate lower fees that will provide a better long-term outcome for plan members.
This article originally appeared on CIR’s companion site, Benefitscanada.com. Read the full story here.