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Is There Any OCIO Model That Is Conflict Free?
Even pure-play providers have some competing interests, argues Alpha Capital Management’s Brad Alford.
A pioneer in the outsourced chief investment officer business says it’s necessary to be both a pure-play provider — with no products to sell — and have scale. A large asset manager believes disclosing and managing potential conflicts is enough. A search consultant says no OCIO is truly free of competing interests.
These arguments represent the range of answers you’ll get when posing questions to people on the conflicts that are embedded in this business.
But it’s unclear what potential and perceived conflicts pose the biggest risks to or raise important issues for asset owners who employ one — and the answers depend on who you ask.
Jon Hirtle, co-founder of Hirtle Callaghan who was early to see the merits and opportunities of the OCIO business model, believes a hallmark is that the provider refrains from selling investment products and does not charge hidden fees.
It’s not surprising that OCIO firms, which among other things provide asset allocation advice and pick managers and investments for allocators, are growing in popularity. In 2021, the sector grew to $2.5 trillion in assets under supervision. Here’s just one example of the business case: a public pension may hire an OCIO because as a state agency, it may not have the freedom or a big enough budget to hire staffers with enough experience in the investment world. Instead, the pension can outsource the work to a firm that can then spread the costs of its expensive employees across many clients. But there are additional reasons behind the flourishing business.
Hirtle and his co-founder, Don Callaghan, began the firm in 1988 after working with a range of clients at Goldman Sachs. Hirtle recalled witnessing the big gap in performance between allocators that had independent and sophisticated investment offices — perhaps the best-known one is run by David Swensen at Yale University — and those that did not. He and Callaghan decided to try and replicate that independent office by using the collective power of multiple clients’ assets.
Hirtle believed it came down to the OCIO being independent and not having funds to sell the pension or endowment. In contrast, a traditional asset manager can choose its own products over those of competitors.
Hirtle Callaghan now is a $20 billion OCIO, but the idea, even if different versions of it, has caught on and the market is increasingly competitive. (Through a series of acquisitions, Hirtle's former employer, Goldman Sachs, now has an OCIO business as well.)
But the OCIO guru believes that 75 percent of the 103 OCIOs reviewed annually in a well-known annual report on the industry from Charles Skorina do not have a truly conflict-free, product-less structure with enough purchasing power to play successfully in the market.
“The banks don’t do that,” Hirtle said. “They can’t do that.”
Skorina is now in the process of pulling together his 2022 list of OCIOs, and said he has noticed a shift among those on it.
“What struck me is how the independent OCIO like Hirtle Callaghan is disappearing,” he said. “They’re being bought up.” High-profile deals like Focus Financial’s acquisition of Cornerstone Partners and KKR’s investment in Beacon Pointe Advisors are just a few recent deals Skorina pointed to.
“What are the implications of that?” Skorina asked. “Well, corporate or private equity firms have a certain timeline for a return... They need profits. How is that going to affect the delivery of OCIO services?”
Goldman Sachs has an answer for that.
“Any OCIO provider needs to ensure that they are managing perceptions of conflicts of interest issues,” said Mary Athridge, a spokesperson at Goldman Sachs Asset Management. “That is true of OCIO providers associated with asset managers who need to be rigorous about internal versus external manager selection for clients or a pure-play OCIO who considers allocations to capacity-constrained managers.”
According to Athridge, Goldman can negotiate fee savings for clients due to its massive size — the firm manages $240 billion in OCIO assets as of December 31, 2022.
“Manager selection is walled off and independent of other areas of Goldman Sachs and we restrict trading with the broker-dealer arm of the firm for both GSAM and outside managers where needed,” Athridge said.
Brad Alford, founder of OCIO search consulting firm Alpha Capital Management, stressed that even pure-play OCIO providers aren’t free of competing interests.
“We're seeing more OCIOs that are now starting to charge performance fees inside of their alternative vehicles,” said Alford.
In one instance, his team saw an OCIO provider charging 20 percent to clients hoping to access a co-investment. Traditionally, these vehicles are used by allocators to decrease the amount of fees paid in generally expensive alternative investments.
“The pure plays are becoming more conflicted with their alternative access vehicles,” Alford said. He added that the rationale for the products, and the resulting fees, is so the OCIO can tailor them for its client base. “They all want to have their own access vehicles for private equity. People want things that are more customized.”
Hirtle expects the industry to go through a restructuring.
“In business school, they teach you there’s a group of pioneers,” Hirtle said. “If it works, there’s a flurry of copycat activity. And then there’s a shakeout and a consolidation.”
But allocators need unbiased help more than ever, he argued.
“The governance model that most people are using is the same governance model they used 40 years ago,” Hirtle said of asset owners. “That's why OCIO is growing. The complexity has skyrocketed. The noise has skyrocketed. You need full-time experts who don’t have a conflict.”