Challenge #1: Performance
With OCIO though, performance responsibility rests squarely on the consultant-turned-OCIO, good or bad. Take a look at this statistic from Cerulli’s most recent OCIO research study: 100% of non-profit respondents list investment performance as the #1 thing an OCIO must deliver.
We don’t believe that consultants have fully embraced responsibility for performance yet. When prospective clients ask for performance, a common refrain from consulting firms is, “we cannot show an OCIO track record because every client is different.” Clients may have different goals, but relative performance or composites of clients with similar goals should capture these. (As a side note, without an industry standard like Global Investment Performance Standards (GIPS) being used, even composite returns must be viewed with suspicion. But it is still a step in the right direction! For more on GIPS, see our 2018 blog post).
Institutions must be able to see a track record in order to judge whether an OCIO is likely to deliver their #1 expectation, investment performance. OCIOs must accept responsibility for investment performance.
Challenge #2: Operations
It also presents an interesting conundrum for consultants selling OCIO solutions to investment committees. Investment committees make the investment decisions, but they usually don’t know how the sausage is made. Operations staff handle portfolio implementation, but they don’t sit on investment committees. Consultants tie investment discretion and operational authority together into one OCIO package, but committees may view these as completely separate decisions. And committees may not want their consultant to sell them new and expensive investment solutions, which brings us to our third challenge.
Challenge #3: Conflicts of Interest
Offering OCIO services alongside non-discretionary services, however, opens the door to brand new, serious conflicts of interest that must be managed. Now consultants have something to sell non-discretionary clients, OCIO, that increases revenue. Consultants are building proprietary products in an attempt to scale OCIO solutions – another potential conflict. Consultants are held wholly responsible for OCIO track records but not for non-discretionary client performance, incentivizing them to allocate top quartile, limited capacity managers to OCIO clients in the hopes of improving their performance record. The fee differential between non-discretionary and OCIO clients incentivizes firms to allocate their best resources to the line of business with higher revenue potential. These are just a few examples.
The OCIO industry is just beginning to grapple with these serious conflicts. Consulting firms must find a way to offer OCIO services without breaking the trust of their clients. We encourage consulting firms to think carefully about the potential conflicts of interest inherent in offering OCIO alongside traditional non-discretionary services, and to proactively and transparently address those issues with well-designed policies. December performance woes may be forgotten by mid-January, but clients have a long memory for bad behavior. It is time for the OCIO industry to evolve.
This blog post is adapted from our research report, "Clients Give Consultants a Green Light for OCIO."