More and more endowments and foundations are entering outsourced chief investment officer (OCIO) relationships as long-term mission-aligned investing becomes mired in the complexity of rapidly shifting market environments.
Despite increased market volatility (e.g., a historically good market year followed by a historically bad one from 2021 to 2022), institutions need to know they can serve their communities and continue to exist in perpetuity.
On top of that, the nonprofit sector—leadership specifically—has not been immune to staffing challenges and high rates of labor turnover. To best navigate these converging dynamics, organizations are turning to outsourced investing strategies, often transitioning from in-house investment management or a consulting relationship to a partially or fully outsourced investment office.
An OCIO relationship provides diverse capacities and resources that nonprofit institutions may not have in house, from rigorous asset allocation modeling to continuous risk assessment and analysis. In 2022, nearly half—46 percent—of higher education institutions outsourced, up from 43 percent in 20211. And the use of an OCIO is growing broadly across all asset owners; approximately 14 percent expect to begin using an OCIO relationship and 11 percent expect to expand the use of an OCIO, according to Cerulli Associates. Further, data from across the field indicate an increasing share of institutions seek to invest in private markets, which an outsourced investor can dedicate a full team of well-networked staff to managing.
The shifting roles and responsibilities that a board or investment committee has when transitioning to an OCIO are commonly misunderstood, and the process may not be transparent. That’s why Commonfund Institute is preparing an OCIO Transitions Toolkit to illuminate key governance, technical and operational, and strategic considerations when moving from one arrangement or provider to another. Here we outline some key high-level features and governance considerations and shifts in working with a new OCIO.
Governance Considerations for Transitioning to an OCIO
Perhaps most important to understand is that an institution may be handing over technical day-to-day investment operations, but a good governance framework must be in place to ensure fiduciary responsibilities are soundly maintained. The following responsibilities still apply to boards and investment committees while an OCIO provider handles portfolio management:
Setting an investment governance and operational framework. It is important to be intentional about determining who is responsible for what. That may require new positions within the board or investment committee, or it may require delegating existing responsibilities to the OCIO. A thorough assessment of the universe of governance and operational needs, and ensuring all are accounted for, is critical in any transitional phase. This also allows boards and investment committees to ensure they are setting up the right governance and investment practices to fulfill their fiduciary duties under the Uniform Prudent Management of Institutional Funds Act2.
Budget, finance, accounting, compliance, development, and other operational functions. Many times, the investment committee considers the portfolio, while the senior investment, finance, and development staff maintain broader responsibilities and considerations that should also be addressed. Your OCIO partner should understand the broader institutional responsibilities and effectively partner with finance, development, and other functions to ensure adequate oversight and management.
Investment policy statement (IPS). This document will be central to building shared accountability with your OCIO. Your OCIO partner should work with your institution to deeply understand your needs and provide council on how to best align goals and mission with asset allocation, risk management, performance targets, manager selection, and more. Reviewing the IPS annually, in the context of any arrangement from in-house to full OCIO, is a best governance practice that some research shows is correlated with higher investment performance.
Diligence framework. If manager selection is fully outsourced, there is still a shared responsibility to determine a diligence framework that aligns with the IPS as well as other goals such as inclusion of diverse managers or environmental, social, and governance considerations.
Liquidity needs assessment. Your board and investment committee will best understand the liquidity needs of the institution. Things such as spending policy and investments in illiquid assets in the IPS will dictate targets that the OCIO will be accountable for meeting, but the board and investment committee will also have to work with other staff across the institution to ensure the OCIO is understanding and serving the liquidity needs of the institution.
Monitoring other institutional changes. New goals, broader shifts in the operational, political, or community landscape, a large shift in assets, and new or prospective capital or liquidity needs all require effective communication and coordination with the OCIO for integration into the IPS or other strategic decision-making.
Understanding the transition time frame and its implications. All items described above take time. It is important to work with your provider to lay out a timeline that covers all these processes and understand potential financial impacts from rebalancing or being out of the market during a transition period.
Another feature of these types of transitions is shifting governance culture. Many times, depending on when and to which investment governance model your institution is moving, the investment committee and senior investment staff may need to develop a new approach for communicating and sharing information with the OCIO. For example, an investment committee and staff that traditionally have done more of the day-to-day work of managing the portfolio may need to be guided and supported as they shift their investment governance framework. Just as important as the technical and operational components, effectively communicating about the details of this new shift, clearly articulating what it means for the investment committee, and continuing to be clear about these new roles and responsibilities will be key.
In the forthcoming toolkit, Commonfund Institute will continue to explore and illuminate best practices throughout any type of transition. Be sure to sign up for the Insights Blog to be notified when this toolkit is available.
Editors note: Originally published on agb.org October 23, 2023.
1NACUBO-TIAA Study of Endowments, 2022.
2 Uniform Prudent Management of Institutional Funds Act, National Conference of Commissioners on Uniform State Laws, 2006.