Implementation Matters. Is Your OCIO Built to Execute?

Key takeaways:

  • A successful implementation process is critical to achieving investment success. Well-designed strategies often fail without strong execution capabilities in trading, overlays and transition management. 
  • Effective portfolio implementation utilizes three key methods: Manager changes, manager weight adjustments and precise positioning strategies using tools like derivatives.
  • An experienced OCIO provider is well-equipped to handle these types of complex assignments.

You’re ready to make changes to your portfolio. Your OCIO has decided on the asset class shifts and the revised underlying asset-class structures. They’ve researched specific investment manager products and selected the actual managers. If your OCIO has done all this well, you have a best-laid plan, right? What could go awry?

Here’s the blunt truth: Many great investment strategies fail because of poor implementation. Robust capabilities in trading, transition management, overlays and currencies are critical to executing a strategy. And there are three primary methods for putting a strategy into action, ranging from broad to precise:

  1. Replacing money managers
  2. Adjusting manager allocations
  3. Implementing precise positioning strategies

A skilled OCIO provider will be equipped with the tools and have in-depth expertise in handling each of these changes.

Expertise Please

Let’s say that a money manager assigned to a portfolio needs to be replaced. Perhaps they are not executing their investment process as expected, or there has been turnover on the investment team that concerns you, or you simply have to make room for a higher conviction manager. 

Once the hard work to identify the replacement has been completed, real-world considerations of how to actually transition assets come into focus. This can be a complex process depending on the country domiciles, regulatory environment, currency considerations and liquidity associated with the incoming and outgoing managers. For an OCIO without the right capabilities, this process can be fraught with opportunities for inefficiency, unwanted tax events and loss of market exposure.

Doing this well requires transition management expertise. An OCIO provider with these attributes can make the process highly efficient and minimize opportunity cost. But how do you know if the provider has your best interests in mind? At a minimum, make sure your provider fully discloses their fees and provides complete transparency, particularly while the event is in process.

Trade Vitals

Replacing a manager is a significant action. Instead of swapping out a manager completely, an OCIO provider may recommend looking at moving exposures from one manager to another depending on the risks and tactical opportunities observed.

But whenever exposure changes are made, there are still inefficiencies to avoid. Trading expertise is vital. For maximum trade efficiencies, we believe trading expertise should be held to a high bar, with the following best-practice characteristics:

  • 24-hour staffing – When global markets are open, the trading desk should be open. Even with international exposure instruments that can be executed during U.S. trading hours, like futures and ETFs, large institutional investors need local market access to manage real time risk with minimal trading costs.
  • A pure agency model – The structure of an agency model removes potential conflicts of interest. The structure itself demands that the trading desk works on behalf of the client, not on behalf of the asset manager. By its nature, it eliminates conflicts associated with proprietary books.
  • Specialization – Markets are complex and understanding the nuances of individual asset classes is vital. We believe traders should be organized to specialize by asset class, including fixed income, equities, derivatives and foreign exchange transactions.
  • Risk management tools – Systems and technology that allow your manager to understand the risks involved in the implementation and minimize these risks in real time throughout the process.

Position Precision

When it comes to the fine-tuning of a portfolio, an OCIO may use internal positioning strategies separate from money managers. This allows for greater precision, speed and flexibility in achieving your dynamic preferred positioning. Positioning strategies may include derivative-based overlays or custom-built quantitative strategies. 

How can this work in a global equity portfolio? Consider a situation where more exposure to Japanese equity is desired relative to the existing country exposure in a portfolio. However, active managers are typically chronically underweight Japanese equities. In this case, an OCIO may use a positioning strategy, such as a futures overlay, to bring the entire portfolio’s exposure to Japan in line with their preferred positioning. Additionally, depending on the hedging strategy desired in the portfolio, a positioning strategy can also include currency forward contracts to disentangle the Japan equity exposure from the Yen currency exposure. 

Taken all together, positioning strategies are designed to ensure that a portfolio’s position is fine-tuned to improve both the risk and return profile of a portfolio, often with a focus on reducing downside risk. But to do this well, we believe expertise in trading both physical securities and derivatives in real time is a requirement.

The Bottom Line

Without the right tools in place to execute, even the most genius of investment strategies can fail. Make sure you have access to a powerful lineup of implementation tools with your OCIO provider.