OCIO 101

Have you ever attended a networking event with people from different industries who all introduce themselves in industry jargon? “I’m a PLP at EMC in charge of implementing ERP solutions.” That’s usually a good cue to head off in another direction.

The investment industry is no different – we may even be the worst offenders. When Alpha Capital Management performs investment consultant searches or OCIO searches for our clients, we generally work directly with finance staff and investment committee members. It may sound obvious, but even in these circles, we’re not speaking directly to investment professionals on a daily basis. Diversity of thought is valuable to investment committees, and members without investment experience play an important role by asking questions, checking assumptions, and approaching decisions from different backgrounds. Studies show that 70% of the members on a typical volunteer non-profit investment committee have investment experience – so on average, at least 1-2 people in the room with us on any given engagement are not investment experts (nor do they play one on TV). We try our best not to use a lot of industry lingo, but we aren’t always successful.

Here’s a great example: OCIO. This is a term we use constantly – in fact, it is at the heart of many of our client engagements. The first decision that an investment committee needs to make is whether to “go OCIO” – that is, whether to outsource any of the investment decision-making functions that currently rest with the committee. But before a committee can make that decision, each of the members need to know what we mean when we use the acronym OCIO.

With that in mind, school is now in session. Welcome to OCIO 101.

What is OCIO?

“OCIO” is an acronym for Outsourced Chief Investment Officer.

Many large organizations, especially in the non-profit world, have Chief Investment Officers (often shorted to “CIOs”) who oversee their investments. A well-known example is David Swensen, who has been Chief Investment Officer of Yale University’s $30B Endowment since 1985. Organizations can also choose to outsource this job to an external firm, hence, an outsourced CIO or OCIO.

To understand what an OCIO does, it helps to first understand two things:

1. What its namesake, a Chief Investment Officer (CIO), does
2. What its predecessor, the investment consultant, does 

What does a Chief Investment Officer (CIO) do?

At Yale, CIO David Swensen’s ultimate job is to earn Yale strong returns on its investment portfolio. His and other CIO’s typical job responsibilities are a mix of portfolio management, people management, and investment operations. A university’s CIO might:

• decide how much of the portfolio can be illiquid versus how much must be available to send to the school annually to fund operations
• choose how to invest the portfolio across geographies and asset classes
• hire investment managers to manage certain asset classes
• make direct investments into property, businesses, or securities
• trade the portfolio
• recruit, hire, and manage a team of investment experts to assist with any of the above
• coordinate with outside experts (like accountants and auditors) and other departments at the University (like the development office)
• give regular performance updates to the Board of Directors or Investment Committee
• and plenty more!

Hospitals, corporations, and other non-profits like foundations are other examples of organizations that may have large pools of assets to manage (whether that is to give away, pay pension benefits, support the budget of an organization, or do something else entirely) and may therefore need a CIO to handle similar duties.

But not every institution is as big as Yale and can dedicate a salaried position (let alone several) to investments. Many institutions (especially those with less than $500M in assets) do not have a dedicated Chief Investment Officer and find ways to split up these duties across other staff members (the Chief Financial Officer is a common choice) and volunteer Investment Committee or Board members. Often, the Investment Committee will hire one or more experts to assist them. Enter the Investment Consultant.

What does an Investment Consultant do?

The most common arrangement in the industry, for a long time, looked like this:

(Investment Committee makes portfolio decisions with the help of Investment Consultant, an outside expert who provides advice. Execution is done by the Chief Financial Officer or other internal staff, often in the finance department)

Under this arrangement, everything rests on the shoulders of the volunteer Investment Committee. As we learned earlier, most Investment Committees are not comprised entirely of investment experts, nor do they have the time and resources to perform the heavy lifting on investment due diligence. These Committees need advice and analytical firepower to help them make the big decisions they are tasked with – namely, how to prudently invest the assets under their care so that those assets can meet the organization’s needs, and hopefully also grow over time. This is the role that the Investment Consultant plays – an outside firm hired by the Investment Committee to provide advice, do the heavy lifting on asset allocation studies and investment manager due diligence, and to help the Committee discharge its fiduciary duty.

Under this model, the Investment Committee makes portfolio decisions based on the advice of the Investment Consultant, and the Chief Financial Officer or other staff implemented those decisions by performing tasks such as signing documents and moving assets.

What does an OCIO do?

The traditional arrangement we described above still exists, but it can be a heavy burden for an Investment Committee, and it is becoming more so over time. As investment consulting firm Callan wrote in their 2019 paper, "Risky Business Update: Challenges Remain for Today's Investors,"  an institution could expect to earn an annualized 7.5% return in 1989 just by investing in bonds and cash. In 2019, to earn the same expected return requires a diversified portfolio with stocks, real estate, and even private equity. It has become harder for Investment Committees to oversee these portfolios as they grow in complexity.

It is no surprise, therefore, that OCIO (outsourced Chief Investment Officer) has taken off like a rocket in the past ten (really the past five) years. It shifts some of the Investment Committee responsibilities and some of the Chief Financial Officer responsibilities onto a new player, the OCIO, who replaces the old Consultant. Like this:

(Investment Committee oversees portfolio strategy. Many day-to-day  investment decisions are made by and executed by the OCIO. The CFO serves in a supporting role.

Under this model, the Investment Committee oversees portfolio strategy. The OCIO makes portfolio decisions based on the strategy the Investment Committee has outlined in its Investment Policy Statement. The OCIO is also empowered to implement many of those decisions, including signing documents and moving assets. The Chief Financial Officer or other staff serve in a supporting role.

What Kinds of Firms Act as OCIOs?

Based on what you've learned so far in this course, you may have already guessed that two of most popular types of OCIOs are:

• Former Chief Investment Officers who set up dedicated boutiques to work with multiple clients instead of just one
  
• Investment consultants who took on more discretion for the clients they worked with

After all, both of these groups were intimately involved in the investment process before OCIO was popularized. Both groups were well-placed to identify the new challenges facing Investment Committee members and had the right skill sets to offer strong solutions. That’s a powerful one-two punch.

These two groups aren’t the only ones with the right skill set to offer OCIO solutions to institutions. Other OCIO providers who have leveraged existing services to build discretionary solutions are:

• Asset managers, who were managing underlying asset class investments for these portfolios and were well-placed to either expand or begin multi-asset class investing
  
• Traditional banks and trust departments, who bring vast financial resources and experience managing perpetual portfolios for individuals and often have lending relationships with the institutions
  
• Registered investment advisors and broker-dealers, leveraging their experience with wealthy individuals and family offices to manage associated foundations and retirement plans

Are All OCIO Models the Same?

No!

Let us repeat, NO!

Just as OCIOs evolved from a variety of different firms, there are a wide number of potential OCIO models to choose from. Here are three main groups of OCIOs (noting that real life does not conform nicely to these groups, so there is plenty of variation. The value of a well-written OCIO RFP to suss out these nuances cannot be overstated):

1. One Fund OCIOs
2. Customized OCIOs
3. Hybrid OCIOs

Our next class, OCIO 102, will delve deeper into the different OCIO models available. For now, it is  important to understand that your organization has several choices even within the OCIO construct.

Final Exam

1. What does OCIO stand for?
2. What kind of firms can be hired to provide OCIO services?
3. Are all OCIO models the same?
   

Thanks for taking our class!