The Outsourcer s Dilemma: OCIO Providers Strive to Simplify Complex Investing. By Elizabeth Baulch and Robert Dollard, BNY Mellon

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1 The Outsourcer s Dilemma: OCIO Providers Strive to Simplify Complex Investing By Elizabeth Baulch and Robert Dollard, BNY Mellon

2 Support service providers supply essential capabilities to OCIOs, including custody and accounting, reporting and administration, risk and capital markets solutions, and technology and cybersecurity.

3 For providers in the growing industry of outsourced CIO (OCIO), delivering superior investment returns to institutional clients might be the easy part. To succeed in this increasingly competitive market, providers must master a long list of complicated administrative, operational and IT functions. All these elements must be packaged into a seamless offering that hits investment return targets and meets institutional service expectations, while also standing out from competitors in a crowded field. To meet these tough standards, OCIO providers employ diverse teams of asset managers, custodians and other external vendors. These providers supply essential capabilities, including custody and accounting, reporting and administration, risk and capital markets solutions, and technology/cybersecurity. For some OCIO providers, these support service providers deliver another important benefit: partnering with external firms that have strong brands and established reputations in custody and other areas can create a halo effect that helps differentiate the OCIO s offering from those of competitors and provides a lift to sales efforts. TO SUCCEED IN THIS INCREASINGLY COMPETITIVE MARKET, OCIO PROVIDERS MUST MASTER A LONG LIST OF COMPLICATED ADMINISTRATIVE, OPERATIONAL AND IT FUNCTIONS. Integrating a long list of support service providers into a single platform and providing a unified client experience is, in itself, a formidable challenge. In this report, we explore the growth and development of the OCIO market, identify the biggest challenges OCIO providers face in fulfilling institutional mandates, and examine the role external support service providers play in helping OCIO firms meet client needs and grow their businesses. This analysis is based on the results of a Greenwich Associates study, sponsored by BNY Mellon. Between February and March 2018, Greenwich Associates interviewed 33 OCIO providers about their businesses, biggest challenges and support service providers. THE OUTSOURCER S DILEMMA: OCIO PROVIDERS STRIVE TO SIMPLIFY COMPLEX INVESTING 1

4 OCIO Industry Analysis Growing numbers of institutional investors are outsourcing the management of their investment functions. Over the past three years, assets invested through OCIOs have grown at an annualized rate of 15%, to a total of $1.7 trillion. 1 Initially, the OCIO model was adopted mainly by relatively small institutions with limited staffing. Outsourcing was seen as a way to obtain investment expertise, professionalized management and access to attractive investment opportunities previously unavailable, due to large minimum investment sizes or length of lockup. Over the past decade, markets have become increasingly complex, intensifying the challenges facing institutional investors of all sizes. As a result, larger institutions have begun to outsource, or at least investigate the pros and cons of the OCIO model. The ranks of OCIO clients now include several funds with more than $10 billion in plan assets. EXHIBIT 1 What proportion of your assets are in the following fund types? 4% 5% 10% 18% 30% 33% Endowments & foundations DB pensions High net worth / family office DC plans Healthcare pools Other For many institutions, investing is not a primary business function, but rather a necessary side business for ensuring future support and/or maintaining employee liabilities. Many have created separate departments and named CIOs with extensive experiences to oversee the plans, but not all groups have the luxury. Smaller organizations have had to lean on the expertise of external resources such as investment consultants and have not been able pursue certain investment opportunities due to large minimum investment sizes or length of lockup. Today, endowments and foundations represent the biggest source of assets for OCIO providers participating in the study, followed closely by defined benefit pensions. As shown in Exhibit 2, institutions invest in a mix of OCIO fund structures. Providers were split between offering pooled vehicles utilizing outside managers vs. pooled vehicles where the OCIO is responsible for security selection. Almost all OCIO providers offer separate accounts. Fee structures vary considerably across the industry, with OCIO providers offering clients a variety of options. Sliding, asset-based fees appear to be the most common, with a much smaller proportion offering performance-based fees.

5 EXHIBIT 2 What is your approach to investing clients assets? 100% 90% 94% 80% 70% 60% 50% 40% 55% 45% Pooled vehicles using outside managers Pooled vehicles using OCIO to select securities Separate accounts 30% 20% 10% 0 EXHIBIT 3 What type of fee structure do you use with clients? 100% 90% 80% 70% 73% 85% 60% 50% 40% 30% 27% Flat fees Sliding asset-based fees Performance-based fees 20% 10% 0 Adjusted for size of institution, the portfolios of OCIO clients differ meaningfully from those of their peers with OCIO portfolios demonstrating several characteristics more often found in the portfolios of much larger investors. One of the clear benefits of utilizing an OCIO is increased access to investment opportunities that were not available on a stand-alone basis, due to the size of the investment, the level of sophistication of the staff/board or some combination of both. Alternative investments such as private equity, real estate, hedge funds and, increasingly, infrastructure projects also present operational challenges that may drive smaller institutions to OCIO providers. Among institutions with less than $500 million in assets, OCIO users show a noteworthy shift away from U.S. domestic asset classes. Average active U.S. equity allocations for OCIO funds are 27%, compared to 32% for peers of similar size. OCIO funds are reallocating these assets up the risk-return spectrum, as evidenced by their more globalized portfolios. Average active international equity and fixed-income allocations within OCIO portfolios are approximately 25%, while like-sized institutions average only 17%. 2 THE OUTSOURCER S DILEMMA: OCIO PROVIDERS STRIVE TO SIMPLIFY COMPLEX INVESTING 3

6 As investors are turning to OCIO providers to manage the increasing complexity of their portfolios and to gain access to new asset classes, the OCIOs need partners who can support the nuances of these investment options. Elizabeth Baulch, Head of OCIO Strategy and Solutions, BNY Mellon Asset Servicing

7 What do institutions look for in an OCIO provider? When it comes to selecting an OCIO provider, institutions lean heavily on the reputations of the firms competing for their business. The reason: An OCIO relationship is, by definition, a comprehensive and long-term partnership. Going into this type of engagement, all levels of the institution including the investment committee and the organization s senior leadership must have full confidence in the provider s breadth of capabilities, commitment to the business and financial strength. EXHIBIT 4 How investors rate the following activities in terms of importance when selecting their OCIO provider: Global reach Firm reputation Service model Comprehensive solutions Capital Markets capabilities Client onboarding 0% 20% 40% 60% 80% 100% Very important Somewhat important Neutral Minimally important Not important Institutions seeking an OCIO solution want providers to deliver quantitative metrics that demonstrate prowess across a host of legal, compliance, administrative, service, and capital markets functions, and allow robust comparisons among competing providers. However, in many cases, the only thing that can truly satisfy institutions is a long and proven track record. [Potential clients] want to know our experience and our resources, says one OCIO provider. How many other OCIO relationships do we have? How long have you been doing this? What are your assets under management? Performance track record? THE OUTSOURCER S DILEMMA: OCIO PROVIDERS STRIVE TO SIMPLIFY COMPLEX INVESTING 5

8 Beyond Investments, OCIO Providers Face Major Challenges In meeting the expectations of institutional clients, OCIO providers must overcome a series of significant challenges, including: 1 Client Onboarding, including legal documentation, contract negotiation and KYC/ compliance. The manual nature of client onboarding represents a constant thorn in the side of OCIO providers. It s just a massive amount of paperwork, says one study participant. It s done internally, still on hard paper, signature required. It s the volume, the magnitude of opening account documentation. 2 Reporting, including accounting, performance and risk analytics. The pain point for us is the performance calculations. It is a very manual and cumbersome process, says one study participant. A lot of reporting is too complicated for the clients, adds another. It needs to be simplified. We d like it to be more automated. A third OCIO provider says the Holy Grail for his firm would be knowing we could just press a button, run a report for our client and then be able to send it to the client directly and not worry that the data is incorrect. 3 IT, including the online platform and user experience. There are so many programs and so many passwords; on a regular basis I have 48 and I have to learn how to navigate each one differently. Virtually all the OCIO providers in the study believe technology will be a major determinant of future success, including 40% of respondents who believe the technology platform will be an integral factor in institutions choice of an OCIO provider. 4 Trade Processing/Reconciliation. Trade data errors are a real challenge, says one study participant. They require just a ton of paper pushing. It s an internal issue with my people. 5 Capital Markets, including FX, trade execution and liquidity issues. As just one example of the challenges OCIO providers face in this area, one study participant cited the difficulty his firm faces processing dividend payments and income distributions, which come into the firm at different times and different ways, but must be reported back to clients in a timely manner. The client onboarding process, including contract negotiation, legal reviews and KYC/compliance activities, can be particularly challenging due to the manual information gathering involved. We work with OCIO providers to identify some of the legal issues and concerns from their clients, manage complex fee schedules, and ensure a smooth and seamless transition as part of the onboarding process. Elizabeth Baulch, Head of OCIO Strategy and Solutions, BNY Mellon Asset Servicing

9 Outsourcing Support Services To tackle these challenges, OCIO providers rely on external providers for a host of essential support services. More than half the OCIO firms participating in the study employ more than five external service providers in fulfilling client mandates, and about a third use more than 10. EXHIBIT 5 How many unique service providers do you currently employ to support your OCIO business? 9% 9% 24% 24% 30% 36% 36% % Integrating and managing these providers is one of the most important and difficult tasks for OCIO providers, whose core value proposition to clients rests on the ability to deliver a seamless, holistic offering. However, working with five or more service providers creates real operational challenges. Study participants say administrative issues are the biggest challenge, followed by reporting, data management, fees, and technology/cybersecurity. One respondent complains that the need to use multiple systems with unique programs and passwords from so many different providers makes even the most everyday work cumbersome. That s one reason some OCIO firms would prefer a single, comprehensive provider for all support services. When asked to list the characteristics of best-in-class support service providers, study participants first point to firms that offer modern, powerful technology. Second on that list are firms that offer comprehensive, end-to-end services. As one study participant explains, Our biggest frustration is multiple providers and making sure each system can talk to one another. Data harmony across portfolio management, trading, performance generation, custody, and reporting in one platform would be wonderful. THE OUTSOURCER S DILEMMA: OCIO PROVIDERS STRIVE TO SIMPLIFY COMPLEX INVESTING 7

10 EXHIBIT 6 What are the top 2 or 3 challenges you experience with regard to your interactions with service providers to your OCIO business today? Administrative Reporting Data management Fees Technology Cybersecurity Length of sales cycle Turnover While some study participants say they are concerned about putting all their eggs in one basket, or that they have not yet been approached by a single provider capable of taking on the quarterback role for all support services, OCIO firms that have consolidated these services with a comprehensive provider say their selection of that firm was driven by the provider s global reach, scale efficiencies, and ease and simplicity of reporting. We have a long relationship with a particular custodian, says one study participant. We are comfortable with them. We trust them. They have built up credibility. They provide a very high level of service at a reasonable cost. The best-in-class service providers are the ones who can anticipate the unique challenges of OCIO providers and tailor their solutions, particularly in the in areas of data aggregation, reporting and risk management. Bob Dollard, Public Funds Segment Manager, BNY Mellon Asset Servicing

11 The Third Phase of OCIO: Fierce Competition in a Maturing Market Although still relatively young, the OCIO industry is already in its third phase of development. In the first phase, institutions were getting comfortable with the concept of outsourcing fiduciary control of their investments to a third-party firm. Attention was focused on developing the legal, operational and investment frameworks to facilitate outsourcing. The second phase was one of growth. With the model firmly established, small endowments and foundations led he way in outsourcing. New opportunities attracted competitors to the market, including investment consultants, asset management firms and dedicated OCIO providers all of which built out their platforms and grew assets under management. Today, the market is in a third and more mature phase. With growth in assets and clients leveling off, OCIO providers are forced to compete aggressively for business. This requires that they differentiate their platforms from those of competitors and demonstrate to potential clients how their particular offering can create value. The OCIO providers participating in the study use a wide variety of strategies to differentiate their firms: Client Experience. We emphasize a very good client experience. We re very attentive to our clients, says one study participant. Another adds, We ll do everything, and we have very high-quality people who are long-term players in our field. Scale. We invest in a way that typical, large endowments invest, but for much smaller groups of people. We allow them to benefit from our scale. A smaller firm can t do what we can do. Our structure allows clients the benefits of a larger organization through pooled vehicles. Customization. A customized portfolio aligned with the proper risk-return tolerances, we provide a very comprehensive service soup to nuts, says one OCIO provider. Communications and Reporting. Proactively informing and educating our clients on an ongoing basis is key, says one study participant. The fact that we ll give them advance notice about all the things that we re planning on doing so that there s a pre-execution feedback loop. We emphasize that we don t ever want them to have a surprise in their relationship experience. THE OUTSOURCER S DILEMMA: OCIO PROVIDERS STRIVE TO SIMPLIFY COMPLEX INVESTING 9

12 EXHIBIT 7 Can OCIO support service providers serve as a beneficial differentiator during your sales process? Yes, we currently highlight our service providers Maybe, we would consider it if we were confident in our service providers No, we would not want to highlight underlying service providers to our clients 39% 21% 40% Many OCIO firms are using their relationships with respected support service providers as a way to enhance credibility, build trust and differentiate their firm from competitors. About two-thirds of OCIO providers say potential clients ask about support services, administrative functions, and the names and reputations of third-party custodian and/or administrative partners. Forty percent of the OCIO providers in the study say highlighting the identity and role of key support service providers is always a beneficial differentiator in the sales process.

13 Conclusion The pressure on institutional investors is not dissipating, it s building. Markets are getting faster and more complex. Pension funding levels are low, and additional cash contributions hard to come by. Tight budgets are constraining resources and staffing levels for plan sponsors of all types. In this environment, institutions will continue to seek external assistance, including the outsourcing of their investment functions to the growing ranks of OCIO providers offering investment expertise and the many benefits of professionalized management at scale. The opportunity to safely outsource will come as a welcome relief for many institutions that do not see investing as part of their core mission and never really wanted to be in the investment business at all. Over the next five years, the OCIO providers participating in the BNY Mellon -sponsored study expect demand for their services to be strongest among endowments and foundations. Over that same period, most OCIO providers expect midsize institutions ($250 million to $500 million) to be the biggest source of growth. However, a sizable share of respondents expect growth to come from larger institutions, including nearly 1 in 5 expecting institutions with more than $1 billion in AUM to be the biggest source of new assets over the next five years. EXHIBIT 8 Which fund type(s) do you believe will be the largest source of growth over the next 5 years? Other Healthcare operating assets 18% 27% Endowments and foundations 76% Defined contribution (DC) plans Defined benefit (DB) pensions 21% 27% 0% 20% 40% 60% 80% THE OUTSOURCER S DILEMMA: OCIO PROVIDERS STRIVE TO SIMPLIFY COMPLEX INVESTING 11

14 EXHIBIT 9 Which fund sizes(s) do you believe will be the largest source of growth over the next 5 years? Below $250mm 39% $250mm $500mm 58% $500mm $1B 39% Above $1B 18% 0% 20% 40% 60% 80% In order to win in this highly competitive market, OCIO providers are going to need to differentiate their offerings. Outlined below are five imperatives for success: 1. Tend to the Brand. Investors considering OCIO model want to work with firms they can trust and to know that their underlying service providers are reputable. 2. Evolve Investments. Continually evaluate and expand investment capabilities to meet changing client needs. 3. Manage Complexity. Collect and coordinate data in an efficient way to drive scale across the platform. 4. Simplify Reporting. Provide clients with clarity and insights on their portfolios and not simply transparency of positions. 5. Tailor the Approach. Develop capabilities designed to meet the needs of specific clients or groups of clients to demonstrate a keen understanding of their issues. NEARLY 1 IN 5 RESPONDENTS EXPECT INSTITUTIONS WITH MORE THAN $1 BILLION IN AUM TO BE THE BIGGEST SOURCE OF NEW ASSETS OVER THE NEXT FIVE YEARS. As OCIO providers are striving to become successful, they rely on support service partners who can help their clients gain access to more sophisticated expertise and service models. Many OCIO providers will adopt the same outsourcing philosophy they sell to clients: They will turn to specialized providers to secure and integrate the support services they need to meet client expectations for investment returns and service. As one OCIO provider remarked, In a perfect world, the support provider would offer a completely comprehensive service so it could really be a one-stop shop the one resource, the one single point of contact.

15 Elizabeth A. Baulch Head of OCIO Strategy and Solutions, BNY Mellon Americas Asset Servicing Robert Dollard Public Funds Segment Manager, Asset Servicing Liz has more than 25 years experience in the financial services industry in all areas of the investment lifecycle. Early last year, Liz assumed a leadership role in managing key strategic relationships in the rapidly expanding Outsourced CIO space. Prior to her current role, Liz filled a variety of staff and management roles within custody operations, client service and relationship management for BNY Mellon. Her experiences in these roles and in working with almost every type of institutional investor have made Liz a recognized subject matter expert related to trust and custody, merger and integration activity, Taft-Hartley and ERISA regulatory and compliance requirements, operational risk management, and best practices for sales and relationship management. In addition to representing BNY Mellon in a wide variety of community partnership activities in the U.S. and abroad, Liz is an active member of the firm s Women s Initiative Network (WIN) and IMPACT affinity groups through which she serves as a mentor in their formal programs, as well as for Year Up NYC, an external organization focused on providing urban young adults with the skills, experience and support needed to help them reach their potential through professional careers and higher education. Liz received a B.A. in Economics from Fordham University and has served on various committees and boards for St. Agnes Cathedral School, St. Agnes Cathedral Parish and Chaminade High School. Robert (Bob) Dollard is a Managing Director and Segment Head for the Public Fund business segment within Asset Servicing at BNY Mellon. Bob joined BNY Mellon in 1993 working in the Domestic Custody Operations department. He was promoted to Manager of the Global Custody Network Communications Group and subsequently joined Client Service as a Service Director in He then became a Relationship Executive responsible for maintaining the highest level of service for his clients. Through fostering relationship growth and effective client advocacy, Bob influenced product development and helped direct strategic priorities to promote and ensure long-term partnerships with our clients. In his current role as Segment Head for Public Funds he is responsible for leading teams of Relationship Executives and Service Directors in delivery of service to clients within the public fund segment across the U.S. Greenwich Associates is the leading provider of global market intelligence and advisory services to the financial services industry. They specialize in providing fact-based insights and practical recommendations to improve business results. BNY Mellon is a global investments company dedicated to helping its clients manage and service their financial assets throughout the investment lifecycle. Whether providing financial services for institutions, corporations or individual investors, BNY Mellon delivers informed investment management and investment services in 35 countries. As of March 31, 2018, BNY Mellon had $33.5 trillion in assets under custody and/or administration, and $1.9 trillion in assets under management. BNY Mellon can act as a single point of contact for clients looking to create, trade, hold, manage, service, distribute or restructure investments. BNY Mellon is the corporate brand of The Bank of New York Mellon Corporation (NYSE: BK). Additional information is available on com. Follow us on or visit our newsroom at for the latest company news. Prior to joining BNY Mellon, Bob worked in Private Banking and Trust Services for Fleet Investment Services, as well as in the Mortgage Division of the Bank of Boston. Bob majored in Business Administration with a concentration in Finance at Salem State College.

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