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The Big Challenge for the Booming OCIO Industry: Solving the Black Box

The unprecedented growth of the OCIO industry in recent years has led to heightened demands for transparency from asset owners.

As the outsourced chief investment officer industry continues to grow, demands for transparency are amplifying. 

Institutional investors who hire OCIOs to select managers and perform other investment functions are demanding increased transparency into the OCIO process, according to Sanjoy Chatterjee, chief strategy officer at Investment Metrics, a global provider of portfolio analytics, reporting, and data for institutional investors and advisors.

These OCIO clients are particularly focused on the connection between the fees OCIOs charge for the services and the returns they generate. This space, Chatterjee said, is often a “black box” for asset owners. 

“If you have a direct separate account manager, an asset owner has an idea of what the fees look like to get the absolute return,” Chatterjee told Institutional Investor. “But in an OCIO portfolio, technically what’s happening is the consultant or the asset allocator is negotiating with multiple managers to have a favorable fee arrangement.” 

This structure makes the process more opaque for asset owners, Chatterjee said. 

Additionally, asset owners hiring OCIOs are starting to demand greater insight into the manager selection process. With increased focus on environmental, social, and governance strategies in the institutional space, Chatterjee said asset owners will extend the pressure of these mandates to the OCIOs they work with. 

“ESG brings in another layer of analytical requirements,” Chatterjee said.

In order for OCIOs to keep up with industry norms, Chatterjee said they will need to provide their clients with “annual report cards,” outlining information on manager selection, performance relative to benchmarks, research-based rationale for decisions, and current trends they’re taking into consideration. 

The catalyst for this heightened demand for transparency is the unprecedented growth of the OCIO industry in recent years. In fact, in September, Cerulli Associates, a research and consulting firm, predicted the OCIO market would grow at an annual rate of 5 percent over the next three years — faster than the broader institutional market, II previously reported

Brad Alford, founder of OCIO search firm Alpha Capital, described the market as growing at “break-neck” pace. “It’s a goldmine for [OCIOs], and their fees are so much higher because they’re taking on so much fiduciary risk,” he said.

Chatterjee attributed the growth of the OCIO market to the increasing complexity of asset classes. Continued demand for alternative investments means asset owners require guidance when navigating “hard-to-manage” asset classes, Chatterjee said. 

“The reason this trend will continue is because harder asset classes are also coming into play,” Chatterjee said. “In the hard-to-manage asset classes where OCIOs have good research and information in terms of recommendations of various private equity and hedge fund managers, the allocation shift from public markets to this private alternative area will ultimately [uphold] that increase in the allocation [to OCIOs].” 

The move from public to private markets won’t diminish the push for transparency, Chatterjee said. In fact, it will strengthen it. As more alternative assets make their way into the hands of OCIOs, questions of due diligence and compliance will become even more relevant, he said. 

“As [OCIOs] become more mainstream, they will probably become mandated with more information on a daily basis,” Chatterjee said. “They’ll need to communicate with asset owners in terms of manager changes. There will be more compliance requirements.” 

Another reason for the increased demand for transparency, according to Alford, is concerns over conflicts of interests.

“This is the most conflict-inherent model I’ve ever seen as an OCIO,” he said. “I mean, we see some of the OCIOs own parts of money management firms. One of them just took money from a private equity fund-of-funds. It’s getting very incestuous.” 

In addition to increased transparency, Alford argued that there needs to be “a lot more” regulation of industry. 

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