The process of hiring another person or firm to manage an investment portfolio is referred to as investment management outsourcing.
In the past, institutional investors, high-net-worth individuals, and families were the employers of this approach. Today, however, investment outsourcing is finding traction among mainstream investors as well.
The trend initiated among smaller institutions that preferred not to craft their own investment teams. In so doing, they could delegate the task of investing to a third, presumably more experienced party, while maintaining a degree of control of the overall strategy and allocation of assets being employed.
This way, these organizations could retain an element of the fiduciary responsibility, while entrusting fiduciary responsibilities to the investment manager, or Outsourced Chief Investment Officer (OCIO).
Partnering in this fashion, investors can fulfill a scope of aims, including fiduciary requirements, heightened governance, improved funded status, diminished volatility, decreased risk, and reduced costs.
What is an OCIO? In most cases, an Outsourced Chief Investment Officer (OCIO) manages an investment management outsourcing approach. All decision making, including asset allocation, manager selection, and monitoring, is handled by the OCIO. This entity reports to the client, but responsibility for the performance of the outsourced portfolio falls to the OCIO.
This model serves to alleviate some of the shortcomings of the traditional governance model large-scale investors can encounter. The typical approach finds institutional investors, companies and high-net-worth individuals reviewing investment policy and asset allocations on a quarterly basis—in meetings of an investment board or committee.
This can mean that a mere 16 hours are allocated to the consideration of high-impact investment decisions for corporate pension plans, defined contribution plans, and university endowments on an annual basis. Given the volatility of the marketplace, this is far from being an adequate amount of time to steer a large and complex investment strategy.
Jonathan Hirtle, chief executive officer for Hirtle, Callaghan & Co., and his partner David Callaghan, are credited with pioneering the OCIO strategy back in 2011. The intention was to serve family groups and organizations that did not employ fully staffed investment departments.
Hirtle is known as the “Oracle of Outsource,” in recognition of his OCIO innovations.
The OCIO model was developed in response to profound changes in the institutional investment environment over the last decade, which placed increasing pressure on the traditional nonprofit governance model.
As an example, one of the biggest drivers of growth in this area was the increased stringency of the regulatory environment that emerged after the 2008 financial crisis. These added complexities, along with heightened risk management concerns, fueled the expansion of the OCIO movement.
As an industry, OCIO is still in its embryonic stages. Still, a couple of different models have emerged in terms of the way the business is conducted. These include full outsourcing and collaborative outsourcing.
Under the full outsourcing model, the responsibilities for all decision making — including asset allocation, manager selection and monitoring — passes to the outsourced chief investment officer. This entity reports back to the client but the burden of decision-making is largely lifted from the client and placed on provider.
Within this model, there are variances, including manager-of-manager programs, funds-of-funds, and former CIOs offering diversified model portfolios. In each instance, the commonality is commingled funds or portfolios with which the OCIO can leverage economies of scale.
Within the collaborative approach, the OCIO works in conjunction with the investors, as opposed to supplanting them. In this manner, the OCIO works as more of a consultant to the in-house CIO (chief investment officer), providing access to complementary expertise and advice, as well as information about potential investment opportunities.
Fees for outsourced management are calculated in addition to investment management fees.
According to one study, the outsourcing provider “typically charges a fee as a percent of AUM that ranges from 30-100 basis points” (i.e., between 0.3 – 1.0 percent of assets under management). However, some managers charge only the investment management fee and impose no fees for the outsourcing service as such.
Some providers may charge an incentive fee in addition to their base fee, and for specific mandates—alternative strategies, for instance—some may charge a premium.
The benefits of pursuing this strategy include the optimization of management and oversight in an era of heightened investment portfolio complexities. Decision-making can be made in a more timely fashion, which improves agility and the ability to respond to changes in the marketplace.
Staff members who may have been tasked with these duties before can be freed to focus on the production of value in other areas. Similarly, trustees are better positioned to fulfill their fiduciary responsibilities as they have more time to focus on the crafting of policy and providing strategic oversight. And finally, the OCIO approach makes it easier to deal with ever-changing and increasingly rigorous regulatory concerns.
On the other hand, the OCIO approach does introduce an additional layer of fees, potential conflicts of interest, and the requirement to relinquish a degree of control.
By all accounts, providing OCIO services is a growing industry. Many renowned financial institutions are offering them, including Goldman Sachs, Morgan Stanley, Black Rock. Mercer and JPMorgan Chase. The largest OCIO firm of all, Russell Investments, has some $96 billion in assets under management.
Global spending on outsourced trading services was $275 million in 2019 and is expected to top $2.1 billion in 2023. This is according to data by the AITE group, which provides mission-critical insights on technology, regulations, strategy, and operations to banks and investment firms.
Moreover, a study by the Family Wealth Alliance found 40% of wealthy families are currently employing this approach. Some 89% of college endowments between $100 and $500 million also rely on OCIO services today.
One of the key principles OCIO managers observe is portfolio diversification. Key to the success of any investment portfolio, diversification avoids over exposure to any single aspect of the market. One of the ways this is achieved is with alternative investments in assets that function beyond the scope of the mainstream equity markets.
Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings.
Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk.
In some cases, this risk can be greater than that of traditional investments. This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million. These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform. However, that meant the potentially exceptional gains these investments presented were also limited to these groups.
To democratize these opportunities, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments.
Learn more about the ways Yieldstreet can help diversify and grow portfolios.
Outsourcing of investment management is a growing trend among institutional investors.
Investment outsourcing offers institutional investors and high-net-worth families an increasingly popular solution to navigate complex financial environments, optimize investment performance, and manage risks through various outsourcing models and services.
With a broad range of institutions using or exploring the OCIO model, portfolio size is no longer the determining factor driving the outsourcing decision. For all but the largest—those with deep staff and technology resources as well as wide-ranging investment expertise—outsourcing is increasingly an option meriting serious consideration.
All securities involve risk and may result in significant losses. Alternative investments involve specific risks that may be greater than those associated with traditional investments; are not suitable for all clients; and intended for experienced and sophisticated investors who meet specific suitability requirements and are willing to bear the high economic risks of the investment. Investments of this type may engage in speculative investment practices; carry additional risk of loss, including possibility of partial or total loss of invested capital, due to the nature and volatility of the underlying investments; and are generally considered to be illiquid due to restrictive repurchase procedures. These investments may also involve different regulatory and reporting requirements, complex tax structures, and delays in distributing important tax information.
Yieldstreet provides access to alternative investments previously reserved only for institutions and the ultra-wealthy. Our mission is to help millions of people generate $3 billion of income outside the traditional public markets by 2025. We are committed to making financial products more inclusive by creating a modern investment portfolio.