OCIO Model Can Improve Outcomes for DB and DC Plans

The outsourced chief investment officer (OCIO) model is a shifting of responsibility in investment decision making—a discretionary investment manager shares fiduciary responsibility with a retirement plan sponsor related to the investment portfolio, explains T.J. Kistner, director for Segal Marco Advisors in Chicago.

Most of the time, the OCIO discussion is related to defined benefit (DB) plans. Together, DB plans and nonprofits continue to represent the majority of the assets under management (AUM) of OCIOs polled by Cerulli Associates (81.1%), and while the OCIO model was once limited to small or mid-sized institutions that felt they lacked the size and resources needed to effectively manage their investment portfolios, a recent report from Greenwich Associates, “Winning in the New World of Outsourced CIO,” finds that larger institutional investors are now embracing the model.

However, the OCIO model is akin to the 3(38) investment manager model for defined contribution (DC) plans, as Kistner says, “Any time responsibility for investment decisions is outsourced—whether for DB plans or DC plans—it can add value.”

Rich Joseph, leader of the OCIO business in the U.S. at Mercer based in Boston, says his firm has about $40 billion in DC OCIO assets today in the U.S., about the same as it has in DB OCIO assets. He says using an OCIO model allows both DC and DB plan sponsors to be more strategic.

“For DC plans, they can discuss with OCIOs why they offer the plan, their objective and the outcome they want for participants—how to ensure participants are retirement ready,” he notes. In addition, he points to the tremendous amount of legal action being taken against DC plans over investment menus, and suggests that focusing on participants is easier in the OCIO framework.

“On the DB side, many plans are headed to exit,” Joseph says. “The complexity in managing DB assets is extraordinary today. How should plans align with Trump tax reform? Is it the right time to accelerate contributions? With the whipsaw in the markets in the last two months, DB plan sponsors should consider whether they are managing the plan as effectively as they can. Historically DB plan sponsors were focused solely on performance, but now they are focusing on funded status and getting liability and assets in tandem to get the plan off their balance sheet.” For those not planning a DB plan exit, he says the focus is how to reduce the volatility of performance to reduce balance sheet risk.

The Greenwich Associates research confirms that funds change their asset allocation considerably when turning to OCIOs. This presents an opportunity for managers who are able to bring greater sophistication to the table.

In comparing the allocation decisions of current OCIO users to more independent, like-sized peers with under $500 million in assets, there are several notable differences. For one, OCIO users show a shift away from the most liquid asset classes—average active U.S. equity allocations for OCIO funds are 27%, compared to 32% for peers of similar size. Likewise, OCIO funds are reallocating these assets up the risk-return spectrum, as evidenced by their more globalized portfolios. The research shows that mean active international equity and fixed-income allocations within OCIO portfolios sit near 25%, while like-sized institutions average only 17%.

Kistner agrees that managing complexities of the investment program is one of the benefits of the OCIO model. “The sheer number of investment managers and strategies available to asset owners presents the challenge of identifying best-in-class investment ideas. An OCIO can relieve asset owners of some of these complexities by providing the decision-making framework and operational discipline necessary for managing a successful investment portfolio,” he says.

But, Kistner points to many other benefits of the OCIO model for plan sponsors. First, it allows them to focus on their core responsibilities to their plans. There is also great potential for fee and cost savings due to the scale of an OCIO’s platform. “OCIOs can combine a plan’s assets with a larger pool of assets under its platform to drive down fees, and plans that on their own couldn’t participate in certain investments due to required minimum amounts can do so with an OCIO’s platform,” he says.

“Some of these benefits taken together with others can lead to better risk-adjusted performance,” Kistner says. “A discretionary investment manager has the ability to react quickly and efficiently in today’s market.” In addition, Kistner points to an enhanced governance structure. “Utilizing the OCIO model can provide the governance and committee structure needed to ensure the portfolio is being managed and monitored frequently, as opposed to the typical meeting cycles of a board of trustees, investment committee or other governing body,” he says.

All these benefits trickle down to retirement plan participants. Joseph says DB plans will be better funded, and Kistner notes that cost savings impact DC plan participants’ fees and produce better returns.