Outsourcing the chief investment officer position, a concept once embraced primarily by frozen corporate defined benefit plans, is becoming increasingly popular with a broad swath of asset owners. Chief Investment Officer spoke recently with Stephen Cummings, chief executive officer of Aon Hewitt Investment Consulting Inc., one of the fastest growing providers of outsourced chief investment officer solutions, to find out where and why demand is growing—and how new users of the OCIO model can make it work for them.
Q: Where are you seeing new demand for OCIO services?
Stephen Cummings: When the OCIO marketplace started gaining traction about a decade ago, demand was mostly from corporate sponsors of frozen defined benefit plans on a de-risking journey of some sort. Their plan was no longer an active employee benefit, and they wanted to minimize time and energy spent on it. Now growth is coming from all sorts of areas: active corporate defined benefit plans, smaller public retirement plans, endowments, foundations, and, most recently, participant-directed retirement plans—particularly 401(k)s.
Q: What’s driving this new interest?
Cummings: Typically, it’s a desire by certain plan sponsors to delegate responsibility. Many plan sponsors are not in the investment business, and the OCIO model lets them outsource that responsibility to a full-time investment advisor, which may provide better outcomes and allows them to focus on their area of specialization. A third driver is speed of decision-making. It’s not uncommon for institutional investors to meet quarterly and need three to nine months to discuss and implement a new investment idea. Under the OCIO model, investment ideas can be implemented very quickly by investment professionals who are thinking about those issues every day and have discretionary authority to act on the client’s behalf. Sometimes it’s economies of scale; often the cost of the investment program decreases. In the endowment and foundation space, I attribute growing use of the OCIO model to an increased awareness of the importance, and challenges, of investing in illiquid assets such as real estate and private equity, where you want the powerful economies of scale associated with commingled investments but have to be thoughtful about how and when liquidity is provided, such that the actions of one client don’t have an adverse impact on others.
Q: Are any external factors contributing to the interest in OCIO services?
Cummings: We’re living in an age of decreased return expectations. Any advantage you can get from speed of implementation or lowering of costs—even a small advantage—is just that much more valuable in a low-return environment. Couple that with the regulatory scrutiny that’s being applied to retirement plans, particularly in the 401(k) arena, where there have been a lot of class-action lawsuits about the cost and appropriateness of individual investments, and many plan sponsors are saying they don’t want to be their own investment officer. They want someone truly expert in the space.
Q: Is the OCIO product itself changing?
Cummings: In the early years, OCIO was an all or nothing proposition. Today it’s not. One of our oldest and longest-standing OCIO clients uses OCIO for alternative investments, for example, but retains decision-making for publicly traded stocks and bonds.
Q: How can institutions know when outsourcing the CIO function makes sense for them?
Cummings: There’s no single triggering event, but one common sign is that the sponsor is feeling less confident about the decision-making process for the investment program they’re responsible for overseeing. We have observed a tendency, particularly in times of lower investment expectations and high uncertainty, for plan sponsors to question whether this continues to be something they should be doing on their own.
Q: Defined contribution plans have different needs and objectives than defined benefit plans. What do the former need to think about when outsourcing the CIO function?
Cummings: In a defined benefit program, investment decisions are fairly isolated from the beneficiary’s experience. In the participant-directed space, participants select how their money is invested, or have transparency into how somebody is advising them on that. Defined contribution plans want to work with an OCIO who understands they’re not making investment decisions in isolation—that those decisions must be appropriate, understandable and desirable from the participant perspective. A focus on behavioral risks and participant outcomes requires a more robust set of capabilities.
Q: What about endowments and foundations?
Cummings: In this space you often have unpredictable or no additional sources of funds and a requirement to grow in perpetuity while spending a certain amount each year, so the financial dynamics of how to structure an investment program are different if you want to be sustainable over as many years as possible. Many boards face the challenge of wanting to make certain strategic decisions around their funds, but lack the access to investment leadership in order to deliver. Engaging an OCIO provides an extension of the staff to implement decisions based on strategic objectives. Also, there is often a desire among boards to incorporate responsible investing sensibilities into the investment program. These add layers of nuance to how you evaluate an OCIO solution.
Q: How have OCIO providers—Aon Hewitt Investment Consulting included—had to bolster their capabilities to serve this broadening market properly?
Cummings: Those of us who entered the business from the investment consulting world have had to build out our money management capabilities, and that has required quite an investment. Even if you’re not buying individual securities, you still have to have much of the same infrastructure and regulatory rigor that a traditional investment management organization has always had. In our own case, we’ve made a big investment in our middle and back office functions.
Q: What distinguishes your OCIO offering from the product offered by your competitors?
Cummings: We think there is a clear advantage to using an OCIO provider from the consulting space, because consulting organizations don’t have their own investment products to sell. We have no financial incentive to include or exclude any particular investment manager. Scale is important, too. To be successful in this space, you need a broad and deep infrastructure. Our distinctive differentiator is our independent business model. Most large OCIO providers from the investment consulting space charge a bundled fee to clients, whereby they compensate the underlying investment managers and retain the remainder of the fee. In some cases, the fee arrangement between the provider and manager is obfuscated. We have always charged a separate, standalone fee that is not commingled with the fee paid to the underlying investment manager. As our OCIO solution has grown in popularity, those underlying investment management fees have gone down as various breakpoints have been hit, and that savings has passed 100 percent through to our clients. At Aon, we are also focused on appropriately managing the risks our clients face. We view risk management as the intentional assumption of compensated risks for outsized rewards, while avoiding uncompensated risks. We believe strongly in meeting our clients where they are and providing custom solutions to address their unique goals and objectives.
Q: How distinct are your traditional investment consulting practice and your OCIO business?
Cummings: They are separate businesses, but we find them incredibly complementary. How we think about manager research and capital markets on the advisory side is fundamental to the way we think about our OCIO solution. Our advisory clients are some of the largest, most sophisticated institutional investors on the planet, always challenging us and allowing us to explore new ideas. We’re able to take the thinking we develop in that business and apply it to our OCIO solution. The two businesses are just different ways for clients to access what we believe is our best thinking.
Q: For any asset owner new to outsourcing the CIO function, what are some keys to a successful OCIO relationship?
Cummings: Remember that outsourcing is not the same as abdicating. Hiring us doesn’t mean you disappear and don’t know what’s going on with the investment program. Get periodic reports on how things are going and what changes have been made, and inspect the results of your decision to use an OCIO. Also, maintain frequent reporting relationships and touch points, and share news—good, bad or indifferent—in a very open and collaborative way.
Aon Hewitt Investment Consulting, Inc. (“AHIC”) is a federally registered investment advisor with the U.S. Securities and Exchange Commission. AHIC is also registered with the Commodity Futures Trading Commission as a commodity pool operator and a commodity trading advisor and is a member of the National Futures Association. AHIC provides investment advisory services to clients located in the U.S. Investment advisory services to clients outside of the U.S. are provided by Aon Hewitt affiliates. The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. The information contained herein is for informational purposes only and should not be considered investment advice.