I think I know what OCIO is … but what the heck is a strategic partnership?

Executive summary:

  • An investment program with dedicated but limited internal resources can extend its staff through a strategic partnership with an external investment solutions provider. 
  • Examples of assignments that can be transferred to an external provider include equitization, liquidity and rebalancing tasks, exposure management and LDI execution services.
  • The best OCIO providers make strong strategic partners, working side-by-side with resource-challenged internal investment staffs to achieve their desired goals.

I think I know what OCIO is … but what the heck is a strategic partnership? 

Here’s the punchline: It’s all about the interrelationship between productivity and resources that allows asset owners to do more with the same.

All asset owners understand that managing an institutional investment program requires resources to support a senior committee that makes policy decisions on behalf of the plan. But internal support for that fiduciary function ranges from virtually none to a broad and sophisticated team of experts. Those with plentiful internal resources may mainly do it themselves or use an investment consultant to augment their in-house capabilities. The OCIO industry at-large sprang up to service those on the sparse end of this spectrum.

But I believe there are many asset pools that are in between these two models. And this is where strategic partnerships fit it.

Investment programs that can benefit from these types of partnerships typically have dedicated but small internal staffs who are constantly looking for ways to harness external resources to enhance their productivity. In my days as a CIO at a large public utility company, I had a team of two to run multiple, large-dollar asset pools. I was constantly challenging my industry contacts to figure out how I could improve my team’s productivity by either:

  • Adding a turnkey strategy or service that improved my overall results
  • Upgrading the execution of an internal task that frees up bandwidth by transferring responsibility to an external provider

Both of these approaches were wins for my team. Looking back, I now realize that many of these strategic partners I used, like Russell Investments, were also in the OCIO business. In retrospect this should not have been surprising, as OCIO is all about assuming many of the functions of an asset owner. Some OCIO providers may take an all-or-nothing approach to accepting decision-making responsibilities. Other OCIO providers excel at a more nuanced approach. These OCIO firms that combine a complete service menu with flexibility for sponsors to select the key components that are right for them also make ideal candidates for these staff-extending assignments. By offering the bespoke mix of services that meets clients where they are, these firms can truly function as a true extension of an internal staff. And here’s an underappreciated benefit: An element of advice naturally comes as part of the upfront identification of the right product that fits within the client’s overall structure, and often continues as part of the ongoing service delivery. 

The graphic below illustrates this conceptually, highlighting a few ideas for the plans in the middle—those organizations that have dedicated but limited internal resourceswhere an external investment solutions provider can enhance productivity via a strategic partnership.

 Consulting  Strategic Partnerships  OCIO
Insourced - dedicated, well-resourced full-time staff Dedicated but limited internal resources Outsourced - no dedicated internal staff
  Overlay, risk and liquidity manager - cash equitization, rebalancing, currency hedging and LDI completion  
   Harness turnkey multi-manager implementation for specialized asset class  

Example A:  Overlay risk and liquidity manager

Every asset allocation needs to be rebalanced. Every investment pool needs to plan for liquidity to cover benefit payments, capital calls or operating budgets, and expenses need to be planned for. And over time, realization of the equity premium above cash is one of the most reliable bets you can find in investing. Yet the first two needs tend to be handled as administrative rather than investment functions, and the last one often is ignored completely, with cash often raised at the last minute based on stale market values. 

Fortunately, there’s an answer in an overlay strategic partnership. Use of an overlay transfers these functions from an internal team’s plate to that of a best-in-breed external provider. And we believe there’s every chance that execution improves along the way due to:

  • Decisions being made on current asset values
  • Use of an expanded toolkit that includes futures (and forwards, options, and swaps) to more efficiently manage exposures and equitize manager cash to capture market-risk premia and strategic FX (foreign exchange) hedging
  • Access to a team that:
    • Offers a robust, global around-the-clock trading platform across asset classes and covering cash and derivative instruments
    • Plans for liquidity months ahead and manages asset class exposures in the interim
    • Routinely monitors integrity of custodian accounting

Result: Reallocation of scarce internal resources to more value-added activities, potentially higher returns from equitization, and more effective control over asset allocation. Win? I’d say so.

Example B:  Access to turnkey asset structures

Here’s the reality: Resource constraints mean CIOs need to constantly prioritize between the things they have to do and the things they should or would like to do. This can mean sacrificing excess returns by implementing asset classes passively that have reasonably high reliability of alpha but have small allocations. An example of this is an allocation to small cap or emerging market equities. This can also mean taking a pass on diversifying into private markets at all due to lack of bandwidth, expertise or access. Achieving a well-structured exposure in these areas can definitely require a lot of work. 

But once again, a do-it-internally or not-at-all approach is a false choice. Fortunately, there’s an answer in turnkey multi-manager structures. Selectively outsourcing these exposures to an institutional, commingled fund can make tons of sense for a resource-challenged internal team. Advantages here include:

  • One-stop manager diversification
  • Improving asset class diversification by moving beyond public markets
  • Harnessing the strategic partner’s scale to achieve lower underlying management fees
  • Gaining access to otherwise asset-constrained strategies
  • Moving legal, cash flow management, accounting, and auditing responsibilities off your plate

Result: Reduced impact on internal resources, better diversification and potentially improved returns for the plan. Win? Sure sounds like it.

Example C: LDI risk manager

As corporate plan funded status improves, the importance of risk management grows and drives the need for consolidation of accountability and coordination across multiple fixed income managers. Hedge ratio and key rate duration management becomes important. Planning for a partial or total risk transfer enters the conversation. A fit-for-purpose risk management platform and expertise goes from nice-to-have to must-have … yet remains unattainable for many resource-constrained internal corporate plan management teams.

In this case, enlisting an external provider’s LDI management capabilities as a strategic partner is super important to:

  • Focus responsibility and accountability with an external organization that has the visibility in daily positions complemented with a toolkit and risk systems to meet total plan hedging objectives
  • Achieve transparent and consolidated reporting that allows the plan sponsor to sleep at night, knowing funded-status volatility is under control
  • Monitoring of funded status and asset allocation for implementing an LDI glidepath
  • Provide an unbiased assessment of potential risk transfer transactions, including consideration of the impact on the asset/liability structure post-PRT

Result: Reduced impact on internal resources, better risk control and more informed perspective on potential risk transfer transactions. Win? I’d sure say so.

The bottom line: There’s help out there

At Russell Investments, we believe the term extension of staff isn’t a phrase to be thrown around lightly. In our opinion, the best OCIO providers should be able to deliver as strategic partners, working side-by-side with an existing but perhaps resource-challenged internal staff.  They should be able to throw their full weight behind this phrase by taking on any task, no matter the difficulty or ease, and complement it with comprehensive training and support.

Ultimately, the right OCIO provider can be a strategic partner that will blend in seamlessly with your team, moving your organization one step closer to achieving its investment goals. Let us know if we can assist you on this journey.