The big DB plan questions for 2017, #4: Do we need to think about outsourcing?

It’s a tough time to be running a corporate pension plan, with low interest rates frustrating many sponsors' attempts to close the funding gap in the post-PPA world. For many plans, outsourcing can offer a compelling and robust way to enhance organizational focus and boost return seeking portfolio performance.

The small-staff-plus-consultant approach is tough

Many years of running a corporate pension plan investment program gave me a ringside seat to the challenges of the "small internal staff plus consultant" model of actively managing return seeking asset classes. Those challenges include:

  • Manager selection authority that is typically placed at the governing fiduciary committee level—yet the committee’s members often operate with negligible primary information and don’t have the bandwidth to develop it;
  • A quarterly review cycle that is both out of synch with the market’s daily cycle and can be overly focused on market benchmarks and short-term results, to the detriment of plan objectives;
  • A lack of visibility into, much less management of, multi-manager exposures because Manager A and Manager B operate independently and consultants can’t always see or aggregate daily holdings.

These real challenges often impede generation of after-fee active management returns that can reduce the funding gap. But is there a better way? Outsourcing certain investment responsibilities can help to generate more reliable excess returns. That’s because outsourcing brings at least four benefits to the investment process:

Outsourcing means a specialist organizational focus:
Trust asset management is typically staffed by a small team that resides within the Treasury organization of a larger corporation whose core business often has little to do with managing investment managers.

Could delegating this function to an organization dedicated to multi-manager investing result in more effective decisions?
Outsourcing means daily oversight:
Securities markets change daily yet most plan sponsors’ fiduciary processes typically operate on a quarterly tempo.

Could delegating the management of investment managers to an organization that operates on a daily cycle help to deliver better returns from the portfolio? This doesn’t mean that changes are executed daily…only that the possibility is evaluated each day as markets move.
Outsourcing means access to the systems and expertise needed to monitor and manage portfolio structure:

We’re long past the days when the art of putting money managers together consisted of aiming for a high level balance between value and growth exposures and hoping for the best. In todays’ world of smart beta and detailed factor exposure analysis, effective management of portfolio structure demands a risk management system that shows aggregated portfolio exposures across multiple managers. It demands a view of how exposures are likely to affect return patterns, both risks and rewards. And it demands tools that can accurately and promptly reshape aggregate exposures to conform with current market dynamics.

Could delegating the management of the return seeking portfolio to an organization that has made the required investment lead to a better structure?
Outsourcing means economies of scale:
We all know that there is an inverse relationship between asset management costs and portfolio size…and in closing funding gaps, reducing costs is just as valuable as increasing returns. By aggregating buying power, outsourcers may be able to pass along cost efficiencies that are unachievable when a plan negotiates independently.

Could outsourcing deliver a higher quality investment process at a lower cost?
Continued growth in 2017
Plan sponsors have “outsourced” building portfolios of individual securities to investment managers for years. As we move into 2017, a growing trend is to expand this outsourcing to also include multi-manager oversight.

When we peel the onion just a little bit the reason becomes clear: outsourcing can offer a means of enhancing organizational focus, conceivably boosting excess returns with potentially lower fees—and anything that helps to reduce the funding gap in the post-PPA world is worth considering.