Governance requirements, operational risks, and the need to manage funding are becoming greater. In response, some pension trustees are choosing to hire a delegated investment solution provider. So what does an ‘outsourced chief investment officer’ do, and should you get one?   
  

The difficulty starts with the term ‘OCIO’. Its interpretations vary – in the US, where it is thought to originate, OCIO encompasses fiduciary management as we know it in the UK. Here, ‘OCIO’ tends to be used specifically to describe arrangements where large schemes outsource their previously in-house investment function, although this might be changing, too. Some firms are also redefining their services as OCIO and describing it as a more flexible version of FM, according to Barnett Waddingham.  
  

For Sally Minchella, a director at trustee company LawDeb Pension Trustees, OCIO and fiduciary management describe similar arrangements. Whether under OCIO or FM, she maintains that in any case there is no ‘one size fits all’ way to delegate investment implementation to a manager, since no two pension schemes are alike.   
  
Apart from the investment strategy, which always remains with the trustees, it is up to the trustees and the manager to agree risk and return levels, how to implement the strategy and exactly what the degree of delegation should be in each individual arrangement, she says.   

   

As part of this, trustees can choose to have investment strategy advice from the manager, rather than a consultant. But even where this is the case, trustees might still have an external adviser – an evaluator – to check the OCIO is making “reasonable decisions” and offering good value, Minchella says.   

   

"That's still a really important sort of role for trustees, ensuring it isn't a ‘put it in place and forget about it’. It's very much a ‘put it in place and continue to monitor it with advice as appropriate’,” she stresses.   

   

   

About 900 pension funds – 17% of the defined benefit market – make use of fiduciary management, consultancy Hymans Robertson estimates. Whether or not to outsource investment implementation is a major decision, and a lot hinges on where schemes are on their endgame journey.   

   

“If schemes are very close to buyout or approaching the market and they're not already in the fiduciary space, then it might not necessarily make sense to move into that space at this point, because it's quite a big exercise,” Minchella says.   

   

While fiduciary managers can be helpful in the transition to buyout, she says schemes need to have enough time to get it in place and “get your money's worth out of it before the onward transition”.   

   

Where trustees opt for outsourcing and are faced with selecting a provider, she recommends looking at and comparing what portfolios the managers are suggesting as appropriate for the scheme, as this is important from a risk and return perspective.   

   

There is a further complication for large schemes that are dissolving an in-house investment team and moving it across to an OCIO, she notes – namely, how the team will fare in the new environment.    

   

“Often [the team] might be TUPEd across to the OCIO, but how are they going to be treated once they join the asset manager? Are they going to be earmarked for your scheme for a certain amount of time?” she says.   

   

A further consideration for trustees could be what happens if the OCIO or fiduciary misses their performance target. Over the five years to December 2023, only about half of FMs achieved their target, according to Barnett Waddingham, and there is high dispersion of returns across the FM market.   

   

Minchella says the first reaction to missed targets would be to monitor performance closely and work with the existing provider to improve it.

“While it is probably not that difficult to change the fiduciary manager or the OCIO in theory, the reality is they're often invested in a lot of their own funds, and the tricky bit can be in them moving the underlying funds and what the potential issues and costs are associated with that,” she says.    

   

If trustees do not want the delegated provider to invest in many of their own funds, this should be factored in when choosing the manager in the first place, she advises, because that will often be their first port of call and likely the most cost-efficient way of investing for them.   

   

The transition costs of moving to a new provider could also be significant, and schemes’ reluctance to move is borne out by the numbers. A 2023 report by FM oversight provider IC Select suggests 80% of schemes that retendered retained their incumbent fiduciary manager.   

   

Ultimately, schemes need to get good oversight advice, she stresses, to understand how the OCIO or fiduciary is performing relative to its peers and the market and manage conflicts like this. However, only a minority appear to do so; IC Select found just 9% of schemes that use fiduciary managers receive strategic advice from a third party.   

   

     

Managing conflicts of interest, such as with underlying funds, is important in outsourced solutions, agrees Tim Dougall, who heads up delegated solutions at Legal & General Investment Management.   
   

“I think the best way to manage conflicts of interest is really transparency, so that everyone's clear who's doing what and how those decisions are being made, and then in particular, what fees are being charged for that,” he says. “You want to make sure you've got a fee structure that aligns interests and that provides transparency for the clients.”   
  

OCIO has so far been the preserve of the largest schemes, but he believes there are now a growing number of mid-sized pension funds looking to outsource.    

   

Unlike the very large schemes, these mid-sized schemes have never had an in-house investment team, “but they're still looking for that service largely probably because of increasing governance demands”, he says.    

   

These new demands come on top of operational risks being exposed during the 2022 gilts crisis and increasing maturity, which demands closer management of the funding level. The fact more professional trustees now tend to sit on DB schemes could also play a role; more than half of schemes using FM have a professional trustee, Barnett Waddingham found.   

   

When choosing a provider, Dougall recommends meeting the team, because the relationship between OCIO and scheme will be a close one. In addition, “they want to make sure that the organisation has all of the requisite risk management and operational skills in place”.   
  

Beyond that, the investment beliefs of different trustees might decide who they pick. A scheme pursuing a high alpha, high fee strategy with a range of managers might choose an OCIO with a larger manager research function, while those more focussed on cash flow matching and managing the endgame might choose someone who is stronger in that area, he opines.   
  

With OCIOs, trustees can typically tailor which aspects of investments their outsourced provider should look after. Dougall says in practice, his team can handle almost any aspect of investments from managing operations and cash flows to research and funding level monitoring, with clients able to choose how many and which building blocks to use.  
   

   

As well as mid-sized schemes looking at OCIO, market activity might also have changed in other ways. There is a slowdown in pension funds moving to a full fiduciary management model for all of their assets, says Peter Daniels, head of FM evaluation at Barnett Waddingham. But where he does see increased delegation is in liability-driven investments and collateral management, ever since the ‘mini Budget’ of 2022 sent gilt markets into a downward spiral.    

   

In selecting a provider, Daniels agrees it is important to consider the strategic investment objectives and requirements of the pension scheme, as well as any investment beliefs and governance preferences of the trustee board.   

   

He highlights that there are big differences in the capabilities of different managers – and so, “depending on whether you need a high-octane growth-oriented strategy, or a low-risk portfolio tracking toward an insurance transaction, this could lead you to very different providers”.   

   

Despite the potential for underperformance, Daniels also advises trustees to think twice before changing FM or OCIO but says that “when underperformance is consistent or circumstances change materially, taking a mandate out to retender is likely to be the best option.”  

   

With outsourced mandates involving many moving parts and client-specific benchmarks, there is usually no publicly available metric against which to compare an OCIO or FM’s performance, and Daniels says performance evaluation cannot usefully be done by the manager itself.   
  
More schemes therefore choose to appoint an independent adviser alongside the outsourced provider, he says, to bolster trustees’ governance approach and in some cases provide strategic support.