Top 5 Ways OCIO Fees Mislead

April 5, 2021 |
4 minute read
|

Fees are frequently overemphasized by Investment Committees when evaluating an Outsourced Chief Investment Officer (“OCIO”). Committees often believe that fees are a quantifiable and tangible way to compare managers, when in fact, fees between managers are incredibly hard to compare. Due to a lack of transparency and consistency across the industry, the “sticker price” for an investment manager is often misleading, resulting in many investors not knowing what their actual “all in” costs are, much less if they are paying a reasonable rate for each underlying component.

Most investors know their total cost can vary widely based on the total amount invested, asset allocation, performance, allocation within selected funds, and extras such as reporting on outside managers and a broad range of other costs and service choice options. It’s less known that while the underlying components of costs are consistent, the way each of those components is reported is frustratingly inconsistent among managers. Management fees may show up in RFPs and presentations as bundled, a la carte/unbundled, layered, or flat—or they may not show up at all! Embedded and hidden fees are common and by design, easily overlooked.

It is essential to understand how managers package and present their fees. Hidden fees negatively impact performance and can create the potential fee-related conflicts of interest. 

Here are five eye-openers regarding OCIO fees: 

1. Passive Fund Management Doesn’t Always Mean Lower Cost

Typically, active managers offer passive funds, and passive managers offer active funds. Shockingly, passive funds offered by traditionally passive managers are not necessarily priced less than similar funds offered by their active manager competitors. Bottom line: when implementing a portfolio with both active and passive funds, the fee difference between partnering with an active manager vs. a passive manager is often negligible.

 
2. Look for Hidden Layers in Fees 

The “advisory fee” is the amount you are most often quoted. It is the direct fee paid to your OCIO provider for their advice, oversight, diligence, manager selection and implementation on your behalf. It may also be called a consulting fee, a retainer fee or a wrap fee. Typically, the advisory fee is set as a percentage of your total AUM. In most instances, the higher the level of discretion a manager retains, the higher the fee. However, the advisory fee may really be a relatively modest portion of your total cost! Look out for managers that point you to their advisory fee, without providing full transparency on additional indirect fees, such as: 

  • Underlying investment manager fees, performance fees, fund-of-fund fees 
  • Transaction fees for redemption, trading, custody and securities lending 
  • Fund servicing fees for legal, audit and administration 
  • Special fees for reporting on outside assets, customized reporting and client service models 

Hidden fees are dangerous because they falsely inflate historical performance and in doing so, increase the burden of due diligence on investors. 

3. “No Cost” Solutions Always Have a Catch

The “No Cost” approach is your formal invitation to play the game of “Find the Fees”. They are buried somewhere. The first place to look is at the fund level fees. If the manager is using proprietary funds, there is often a fee baked in which goes directly to the management company. Worse, it is not unheard of for an OCIO or an allocator to receive a kick-back for including a particular manager’s fund in its allocation model or on its platform. These incentives can be monetary in the form of a rebate, or a soft dollar arrangement which provides free services or benefits to the OCIO. Further, no cost or very low-cost solutions can create conflicts of interest and increase your diligence burden.

4. Bundled Fees Require Transparency 

Bundled or flat fees sound enticingly simple—but without complete transparency, they can turn into a bundle of trouble. How much of the fee is going directly to the OCIO? How much is allocated to indirect managers and services? Bundling fees has the potential to create a conflict of interest if the OCIO favors lower-cost managers to increase their own margin over higher-cost managers who may provide you with better performance. 

5. Watch Out for the Redemption Fee Trap

Starting a new OCIO partnership brings optimists and pessimists together over a clean slate. The group focuses on the next steps of onboarding, feeling this will be a smoother relationship with better long-term potential than the one they left. Rarely is anyone thinking the Investment Committee may have to fire this new manager at some point down the road. Unfortunately, some managers take advantage of this honeymoon period and fail to clearly point out their stiff redemption, or back-end fee clause. These fees can be onerous and can significantly reduce your historical performance. Attempting to avoid this fee hit, Investment Committees sometimes choose to stay with the underperforming manager for too long. Redemption fees inevitably create an unfair lose-lose situation for the investor. 

So, while fees are part of your manager evaluation process, they should not be the deciding factor. Your future success will be strongly influenced by a potential manager’s experience in working with similar clients, the manager’s willingness to gain a deep understanding of your organization’s operating environmentalong with their ability to partner with your constituents and to evolve with you and the markets over time. A high-quality manager provides meaningful guidance, prepares your Investment Committee for market events, and helps improve governance. In the long run, these skills outweigh the line-item fee.  

Without standardization in reporting fees, Investment Committees are forced to dig deep to uncover multiple layers of fees if they are to know their total cost of investment management. Only when they know the total cost can a manager’s performance be measured fairly. If you’re considering issuing an RFP or changing OCIO providerswe have a number of additional blogs that you may find helpful.

Commonfund is dedicated to promoting transparency in investment management and governance throughout the industry. We believe it is essential to provide full transparency on both fees and performance, arming investors with the data they need to perform their due diligence, analyze, and evaluate our results. As always, we welcome the opportunity to connect with you on this topic or any others that may be helpful. 

 

Paige Rabalais

Author

Paige Rabalais

Managing Director

Disclaimer

Certain information contained herein has been obtained from or is based on third-party sources and, although believed to be reliable, has not been independently verified. Such information is as of the date indicated, if indicated, may not be complete, is subject to change and has not necessarily been updated. No representation or warranty, express or implied, is or will be given by The Common Fund for Nonprofit Organizations, any of its affiliates or any of its or their affiliates, trustees, directors, officers, employees or advisers (collectively referred to herein as “Commonfund”) or any other person as to the accuracy or completeness of the information in any third-party materials. Accordingly, Commonfund shall not be liable for any direct, indirect or consequential loss or damage suffered by any person as a result of relying on any statement in, or omission from, such third-party materials, and any such liability is expressly disclaimed.

All rights to the trademarks, copyrights, logos and other intellectual property listed herein belong to their respective owners and the use of such logos hereof does not imply an affiliation with, or endorsement by, the owners of such trademarks, copyrights, logos and other intellectual property.

To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated herein. Forecasts of experts inevitably differ. Views attributed to third-parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Market and investment views of third-parties presented herein do not necessarily reflect the views of Commonfund, any manager retained by Commonfund to manage any investments for Commonfund (each, a “Manager”) or any fund managed by any Commonfund entity (each, a “Fund”). Accordingly, the views presented herein may not be relied upon as an indication of trading intent on behalf of Commonfund, any Manager or any Fund.

Statements concerning Commonfund’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Fund. Such statements are also not intended as recommendations by any Commonfund entity or any Commonfund employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information or statements. Past performance is not indicative of future results. For more information please refer to Important Disclosures.

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Disclaimer

Certain information contained herein has been obtained from or is based on third-party sources and, although believed to be reliable, has not been independently verified. Such information is as of the date indicated, if indicated, may not be complete, is subject to change and has not necessarily been updated. No representation or warranty, express or implied, is or will be given by The Common Fund for Nonprofit Organizations, any of its affiliates or any of its or their affiliates, trustees, directors, officers, employees or advisers (collectively referred to herein as “Commonfund”) or any other person as to the accuracy or completeness of the information in any third-party materials. Accordingly, Commonfund shall not be liable for any direct, indirect or consequential loss or damage suffered by any person as a result of relying on any statement in, or omission from, such third-party materials, and any such liability is expressly disclaimed.

All rights to the trademarks, copyrights, logos and other intellectual property listed herein belong to their respective owners and the use of such logos hereof does not imply an affiliation with, or endorsement by, the owners of such trademarks, copyrights, logos and other intellectual property.

To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated herein. Forecasts of experts inevitably differ. Views attributed to third-parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Market and investment views of third-parties presented herein do not necessarily reflect the views of Commonfund, any manager retained by Commonfund to manage any investments for Commonfund (each, a “Manager”) or any fund managed by any Commonfund entity (each, a “Fund”). Accordingly, the views presented herein may not be relied upon as an indication of trading intent on behalf of Commonfund, any Manager or any Fund.

Statements concerning Commonfund’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Fund. Such statements are also not intended as recommendations by any Commonfund entity or any Commonfund employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information or statements. Past performance is not indicative of future results. For more information please refer to Important Disclosures.