WHY ORGANIZATIONS ARE MOVING TO THE OCIO MODEL

Over the past decade, the outsourced chief investment officer model has seen a significant increase in adoption among nonprofit organizations. FEG Vice President, Matt Finke, sits down with Co-CIO and Head of OCIO, Alan Lenahan, to discuss why organizations are moving to the OCIO model. Their discussion includes committee governance, accountability, key benefits of the outsourced CIO model, some practical examples of how varying circumstances may impact portfolio management, as well as the qualities you should look for in an OCIO provider.

Transcript

Matt Finke (00:00):

Hi, I'm Matt Finke, vice-president with FEG Investment Advisors. I'm here today with Alan Lenahan, CIO and head of OCIO. Alan, a lot of people these days are looking at the OCIO governance model. What's attracting institutions to going towards that model?

Alan Lenahan (00:20):

Thanks, Matt. I think what's driving the majority of the interest is clear accountability and the traditional investment committee driven model for managing institutional portfolios. There's an investment committee that meets let's say four times a year, they have four opportunities really to make decisions. And then if those decisions have been driven by a consultant or advice or information provided to them, knowing who was truly at the end of the day responsible for the investment performance can get a little fuzzy. We believe that every client needs a CIO, whether that's an internal CIO or an external CIO that has very clear accountability for the results of the portfolio, as well as ensuring that the enterprise risk of an institution is managed well and factored into that portfolio construction.

Matt Finke (01:13):

You talk about accountability being a big factor. Tell me a little bit more about how implementation works and how that's different between an OCIO model and a traditional consulting model.

Alan Lenahan (01:22):

The OCIO model is very active, right? So investment committees without a true OCIO role are overseeing the portfolio on an irregular basis. The implementation for an OCIO should and does require constant oversight, constant monitoring, understanding the risk profile of that portfolio on a daily basis. And you need decision makers overseeing that portfolio to implement changes oftentimes very quickly.

Matt Finke (01:53):

Talk to me a little bit about in your experience as the head of OCIO at FEG, what you've seen over the past 18 years as long as you've been here and your tenure, how the OCIO model has changed and how governance has changed for institutions.

Alan Lenahan (02:08):

Sure. I do believe it starts with governance and institutions understanding their fiduciary role and responsibility in overseeing portfolios more specifically. Historically, it's been accepted that it's enough to have periodic or episodic meetings to oversee portfolios with feedback. I think it's become more and more expected, not just in asset management and managing institutional portfolios, but in many respects culturally to outsource those responsibilities, those exercises that an individual may not be an expert in. The day-to-day management, the commitment to daily and constant oversight has become a key expectation of institutions as well as their constituents. The constituents want to know that somebody is the CIO over that portfolio and has ultimate responsibility for performance and results.

Matt Finke (03:09):

So Alan, if you're a board member at a higher education institution thinking about moving to the OCIO model, we know that there's a lot of external factors outside of the investment committee that are challenges today to higher education, whether that's declining enrollments, operating changes due to the COVID-19 environment. What would you say would be great advice to a committee or a board thinking about moving to the OCIO model and how it helps them fulfill their fiduciary duty?

Alan Lenahan (03:36):

Sure. It should save them time and anxiety on worrying about oversight of portfolio management, worrying about who's making decisions when, how quickly, and worrying about are the enterprise considerations, especially in a year like 2020 with COVID and the effect on operating budgets, are those being incorporated? A good OCIO understands the operating environment for the institution and takes as much of that responsibility and understanding that, and then implementing changes to the portfolio possibly depending on spending rate and budget implications in managing the portfolio. So that should free up a board. It should free up their time to work on enrollment, work on fundraising, communicate confidently with constituents that the investment side of the house is taken care of and being managed very actively by their OCIO firm while they're focusing on the operational aspects.

Matt Finke (04:42):

So if you're a member of the investment committee and you hire an OCIO to help with the portfolio and manage your endowment or foundation, what are some of the key steps you need to take to get to that trust that you talked about earlier that you feel is important to a relationship?

Alan Lenahan (04:57):

Well, it's not on the investment committee to figure out the steps to go through, it should be on the OCIO firms. So we have built a very thorough enterprise risk process, a discovery process to make sure we understand the enterprise risk situation of the client, the many different variables, spending rate, budget, situation, enrollment. We have to factor that in and understand that. And that's on us to go through that process. So we take that off the hands of the committee to tell us and we ask for it and build a model of the institution that then helps us make much more informed investment decisions and portfolio design decisions.

Matt Finke (05:36):

So as a committee member just hiring an OCIO, shouldn't my focus be really on performance?

Alan Lenahan (05:42):

There is no one-size-fits-all portfolio. Our clients, which we understand through the discovery process, have differing levels of risk tolerance, illiquidity tolerance, a different understanding of how complex the portfolio can be, even active and passive exposures, not to mention ESG considerations and SRI considerations. All of those have to be understood at the beginning, then you set a framework for portfolio management and set expectations of where performance can lie. And then it's our job, our responsibility to exceed those expectations and provide performance to clients that delivers on our goals.

Matt Finke (06:24):

So I've heard you say that no two endowment foundations look exactly alike. Can you give me some examples of what some of those differences might be as we're going through the discovery process, changes we would make to the risk return profile for an organization?

Alan Lenahan (06:39):

Sure. So take, for example, an institution that is having a great time in fundraising. So we are seeing consistent inflows from a fundraising standpoint that are supporting the corpus of the portfolio and allowing the spending not to have to come from that corpus. That gives us a longer time horizon at the end of the day for managing that portfolio and being confident that liquidity needs are not going to negatively affect our portfolio management decisions. On the other hand, you have a client that let's say they have no fundraising. That is not part of their mission. No new flows are going to come into that portfolio and they have a very fixed required spending rate. In that situation, we have to be much more cognizant of the liquidity risk in the portfolio. If a portfolio, if we see a downturn and the portfolio has a significant amount of illiquidity, raising capital and raising cash in that portfolio could negatively affect the management of the pool. So those two situations result in very different model portfolio starting points.

Matt Finke (07:49):

I've heard of committees that used to get together on Sundays and pick stocks for institutional endowments. And now we've moved to a consultant model and now we may be transitioning towards an OCIO model. If you're thinking about making that transition for your institution, what are the qualities you should be looking for in an OCIO?

Alan Lenahan (08:06):

I think it's partnership and performance. Partnership goes to working with someone that you have trust and confidence in and that you're sure will do the work to understand the entire enterprise. Performance of course at the end of the day is the most important thing we deliver as an OCIO. A lot goes into generating performance and investors need to understand what to look for to have a high expectation of performance. It's depth of resources, having the ability to understand the global investment landscape and having a research and portfolio management engine that gives you confidence that they will navigate that well. It also goes with having decision makers.

Alan Lenahan (08:57):

Sometimes the traditional consultant model that then develops an OCIO capacity could fall prey to being staffed and managed by educators and advisors. And that is something that we've learned over our nearly 20 years of working in the OCIO space. There's a different skill set in a decision-maker and a portfolio manager than a research or an advisor role. We've developed and built those capabilities in-house. Brought people in that sat on the side of the table who were CIOs at institutions that have made those decisions before and know what goes into making them going forward.

Matt Finke (09:37):

Thank you, Alan. To continue the conversation or learn more about FEG, feel free to contact me at any time.