OCIO - The Good, the Bad and the Ugly

I regularly get asked to talk about OCIO - what it is, where it is going, and the all important why. This article is a focus on the why and lessons learnt from the frontline but in order to do this, I first need to explain what I mean by OCIO. 

I often hear ... OCIO and fiduciary, they’re all versions of the same thing. There is some truth to that. But we do ourselves a disservice if we do not acknowledge a fundamental difference. There are two key providers in an OCIO arrangement and advice is separated from implementation. 

In my view, there are three models for pension scheme investing: 

1 .Traditional - investment advice provided by a consultant, implementation is the responsibility of trustees. 

2. Full Fiduciary - investment advice and implementation provided by a fiduciary manager.

3. OCIO - investment advice provided by a consultant, implementation is delegated to the OCIO.

The OCIO model is considered a “best of both worlds” approach. It offers a greater level of investment control. But it also seeks to extract the benefits of Full Fiduciary.

But does it always work smoothly? Well you probably know the answer given the title of this article. No, it doesn’t. But it can.

Firstly, the good. Lower costs through economies of scale are evident. Transparency tends to be better when compared to Full Fiduciary. And the burden of dealing with lots of paperwork is eased. I’m sure a number of trustees using the Traditional model would appreciate the last point given the volume of instructions they have dealt with in recent weeks.

But it can go bad if roles and responsibilities are not agreed from the outset and regularly reviewed. Confusion about this leads to a breakdown in who should be held accountable for certain investment decisions. And it can also increase costs if there is duplication of work. Most commonly I have seen this duplication happen with performance reporting where the consultant does a report which merely repeats the report provided by the OCIO. I have also seen consultants and OCIOs using their internal systems to track funding levels and the two not agreeing. This can be distracting and frustrating for trustees who just want a single source of truth. This can be easily fixed by agreeing who does what at the start of the arrangement. And putting in place objectives / key performance indicators with each party. 

The ugly of OCIO is less evident but recent market events have exposed what can go wrong. Liability hedging is a very relevant example of this. With OCIO, it is obvious the consultant is advising on hedging levels. But it is less obvious who is designing the liability hedge and choosing the funds the OCIO invests in. With some OCIO models, the consultant gets very involved in this. And when markets move the way they did, the model can break down. Information flows can become hindered and there can be a lot of friction between the consultant and the OCIO. What’s worse is when a loss is suffered. But for Full Fiduciary, there is only one provider who advised on the hedging level, designed the hedge, did the trades to put it in place and are responsible for monitoring it. It is similar for Traditional but whether consultants would see it in this way or blame LDI managers for information flows is a different story.

So the OCIO model is not a silver bullet. All investment models have their pros and cons. And the right model today is not necessarily the right one in future. There will be future innovation in the market given the funding level improvement a number of schemes have experienced of late. What is therefore important today is having a model which is well understood, properly governed and flexible.