Should Nonprofits Consolidate Outsourced CIO Providers?
For a growing number of foundations and endowments, responsibilities that might normally be divided among board members, consultants and staff are delegated to an outsourced chief investment officer (OCIO) to oversee the organization’s investments and related functions. An OCIO is designed to help develop an investment policy statement, choose asset allocations, select managers, and track performance, among other functions — all in an effort to ensure that the organization’s investment decisions support its mission.
Some nonprofits split their endowments among two or more OCIOs, whether intentionally or by happenstance. At first glance, this approach would appear to offer benefits, providing additional diversification, while creating healthy competition among investment managers.
Nonetheless, there are potential drawbacks to this arrangement. “It can lead to a lack of consolidated oversight and accountability that make organizations choose an OCIO in the first place,” notes Bernard Reidy, National Endowment Foundation Executive, Bank of America Private Bank. “When multiple providers operate in their own silos, no one is really responsible for stewarding the entire portfolio.”
Challenges with multiple managers
Although an organization’s board and investment committee may feel that dividing its assets among multiple OCIOs demonstrates prudence in fulfilling their fiduciary duty, potential pitfalls can outweigh the benefits of this approach.
Administrative complexity. With more than one OCIO, someone at the nonprofit will need to manage multiple relationships with outside providers, organize meetings and coordinate schedules with the investment committee, and handle different reporting standards and timelines. “Having more than one relationship to track can also make it difficult to discern what’s going on in the portfolio and shifts the responsibility back to the staff and the investment committee,” Reidy says. “They need to reconcile reporting, track portfolio exposures and coordinate the risks. Not all organizations have the systems in place to do this effectively.”
An inefficient use of resources. Working with multiple providers can eat up staff time in other ways, too. Balancing the organization’s liquidity needs across two or more portfolios and managing distributions from the endowment can be particularly complicated. “How are the two cash positions being managed?” Reidy says. “Is there sufficient liquidity? Without a single point of contact, coordinating distributions between two OCIOs can mean double the work.” What’s more, the investment committee has the additional responsibility of comparing its own philosophy and preferences with those of multiple fiduciary partners. “It simply takes more time when you have to manage multiple OCIOs,” Reidy says.
A fractured investment vision. Separate OCIOs often miss the full picture — one OCIO might make decisions that are optimal for the assets it’s managing but are less than ideal for the overall portfolio. A OCIO handling a portion of an organization’s assets can find it very challenging to take into consideration — or even know — which risks, exposures or concentrations apply to assets being managed by other OCIOs.
When an organization gives, say, half of its endowment to each of two OCIOs to manage, there’s a good chance the arrangement could lead to overlapping holdings and unintended concentrations in individual sectors or securities. In one case that Reidy recalls, two OCIOs made decisions that led to the endowment having an inappropriately high concentration in large-cap technology stocks. In another, “One OCIO shifted to short-duration corporate bonds as its fixed income strategy, while another increased exposure to emerging market debt,” he says. “From a duration standpoint, the two positions were neutral, but the credit risk for the endowment’s fixed income holdings was now twice what it had been.”
Heightened risk. A primary role for an OCIO is to monitor and mitigate risk, a task that can be complicated by a second or third investment management provider. “An organization may consider multiple OCIOs because it wants a range of viewpoints and outlooks,” Reidy says. “And that can be valuable. But then, how do you reconcile those different points of views and translate them into decisions about the credit quality risk, sector risk and individual security risk of the overall portfolio?”
In addition, one motivation for using multiple OCIOs may be to spur healthy competition, “to see whose performance rises to the top,” says Reidy. But selecting multiple OCIOs to compete against each other may encourage them to make bold moves in an attempt to maximize performance. “In the process, they could take on excessive or unnecessary risks,” he adds.
Misalignment with your goals. There’s also a chance that one of the OCIOs will fail to align its investment decisions with the endowment or foundation’s overall investment strategy, risk tolerance and investment objectives. When that happens, the investment committee must start monitoring the holdings and ask the OCIOs to make adjustments — at which point any argument for efficiency is greatly weakened.
Higher costs. When a nonprofit consolidates all its assets with one provider, the size of the account can potentially earn discounts on management fees. At the same time, when multiple OCIOs are each responsible for a percentage of the overall assets, which are spread across a wider universe of managers, costs tend to increase.
Is a single OCIO always the best answer?
For all these caveats, in some situations it can make sense for a larger nonprofit to consider giving two OCIOs distinct roles in managing their endowment. “If you have a sizable component of your portfolio in alternative investments, for example,” says Reidy, “one manager could be responsible for that segment, while another manages the more liquid, traditional investments.” The OCIO handling the alternatives might be able to invest alongside a private equity firm in a particular project or take advantage of its experience and expertise in other ways.
In most cases, though, choosing a single OCIO provider remains a best practice, Reidy says. “That’s because a unified OCIO gives you clarity, control and cohesion,” he adds. “It also gives you a fiduciary partner to help you make the right decisions for your endowment while avoiding unintended consequences.”
