The solvency of Canadian pension plans has dropped to its lowest level since 2013, says a March 31, 2015, news release from Aon Hewitt. It reports the median solvency ratio fell for a third quarter in a row and dropped to 89% — a decline of two percentage points from the previous quarter and a six-point drop from a year ago.
However, plan sponsors that implemented de-risking strategies, such as using an outsourced chief investment officer, bucked the downward trend and saw solvency increase for the second quarter in a row, says Aon Hewitt.
Regrets … they’ve had a few
Joseph Gelly, managing director and head of institutional with Russell Investments Canada, says part of the reason the OCIO model is gaining significant traction in Canada is people still remember the 2008 global financial crisis.
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“I hate bringing up the fallout of 2008, since it happened so long ago, but it really is part of the impetus driving OCIO,” he explains. “People know that they can’t just buy and hold anymore — they can’t just assume it’s safe to take the traditional 60% equities and 40% fixed [income] formula and let it ride like they did 10 to 15 years ago.” In today’s economic environment, plan sponsors must make decisions in a more dynamic and timely way than in the past.
Gelly says, historically, the sweet spot for OCIO has been small to medium-size companies — typically those with less than $500 million in pension assets — that don’t have full-time resources dedicated to managing the plan daily. But over the last few years, he’s noticed larger companies showing more of an interest, too.
“Larger organizations typically have the staff, expertise and scale to manage their own plans. But they’re starting to ask themselves if they really want to spend their time managing what could be considered, at least in some cases, a legacy benefit,” explains Gelly, adding it takes a lot of effort in time, people and investment expertise to manage a complex portfolio.
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While Chris Kautzky, an associate partner with Aon Hewitt, notes the OCIO model is suited to plan sponsors of all sizes, he also sees larger sponsors recognizing the OCIO model as a viable alternative to constructing their own portfolio and using more of their governance budget toward implementing new investment strategies instead. For example, Kautzky is seeing larger pension plans issue mandates to their OCIO partners to implement and maintain more diversified alternative asset class portfolios, which might include real estate, infrastructure, hedge funds and private equity — something they might not have done themselves.
The reason, he says, is the OCIO model allows plans to invest in alternatives without needing to hire dedicated resources or consuming an inordinate amount of the pension trustees’ time, while still having access to economies of scale by investing in assets alongside like-minded investors through the OCIO partner.
Kautzky agrees de-risking continues to drive much of the interest in OCIO, although he’s also noticed an increase in demand from clients that are more interested in capitalizing on the expertise, time and cost savings that OCIO can offer. They can benefit from reduced investment management fees as a result of the increased buying power of the OCIO partner.
“The key question investors are asking is, ‘Where can I maximize my resources to generate the best risk-adjusted returns?’” he explains. “And, once the question is asked, OCIO often becomes part of the conversation now.”
Time on their side
The OCIO model is a natural fit with smaller to mid-size plan sponsors, which typically don’t have dedicated in-house investment staff, says Zev Frishman, executive vice-president and chief investment officer of Open Access, which provides OCIO to foundations and charities. “An organization with $400 million of assets in their pension plan might have a CEO or treasurer who oversees the plan, but these folks certainly don’t have the time—or sometimes even the [financial] expertise — to manage the plan on an ongoing basis,” he adds.
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As Frishman explains, time is typically the biggest challenge for smaller companies such as foundations. Although they typically have an investment committee — maybe even with top-notch experienced people — it often meets only quarterly or biannually. Add to that differing personalities, philosophies and healthy debate, and it creates an environment where more lucrative investment opportunities could be missed.
And that’s where the OCIO model has proven itself, says Frishman. In a typical implementation, the investment committee still has fiduciary responsibility to manage the plan — overseeing investment managers, and determining risk tolerances and acceptable investment ranges — but it delegates the day-to-day responsibility for managing the plan to the OCIO so the plan doesn’t sit dormant without any proactive management between meetings.
Frishman points to the Toronto Foundation as an example of a successful OCIO relationship. This foundation currently has more than 500 active funds, including endowments and total assets under administration, of more than $300 million. And its investment committee is stacked with members who have considerable financial investment experience — including Robert Bertram, who retired in 2008 as executive vicepresident and chief investment officer of the Ontario Teachers’ Pension Plan.
But in 2010, the foundation started to realize that its market-related benchmark strategy, while appropriate in the past, wouldn’t consistently meet the grant objectives of the fund holders in the future, says Frishman. The foundation was using an external advisor at the time, but the advisor did not have a true fiduciary relationship with the foundation, ultimately leaving important and timesensitive investment decisions to the board.
Recognizing the OCIO model best represented its needs, the foundation engaged in a lengthy research and interview process and then partnered with Open Access in July 2012. Since July 1, 2012, the Toronto Foundation’s annual average performance has exceeded previous benchmarks by 3.2% and the newly instituted benchmark of inflation (measured by the consumer price index) plus 5%, by 10.4%, Frishman adds.
Not all or nothing
While Kautzky maintains OCIO can be a good fit for companies of all sizes, because it can be tailored to the needs of the company, he concedes it may not be the best fit for investors that wish or need to retain a direct hands-on role in overseeing investment strategy, because there is still some degree of responsibility being outsourced.
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Still, an OCIO relationship doesn’t have to be an all-or-nothing deal. For example, Gelly points to a $200-million pension plan that outsourced all but one of the asset classes within its portfolio, because it was a specialized area for which the plan wanted to maintain control.
Contracting out only a portion of the plan is a way for companies to sample an OCIO relationship, he says. “I’d say a good 75% of OCIO partnerships are on a fully managed basis, but the other 25% involve a customized split in control. It might be to test the waters, or maybe it’s because the customer wants to maintain an existing relationship — at least in part — with another firm. Either way, the OCIO partnership can be tailored. It doesn’t have to be an all-or-nothing deal.”
Experts agree portfolio size may no longer be the determining factor in whether or not to outsource the investment function. And, because it doesn’t take a one-size-fits-all approach, capitalizing on the OCIO partner’s expertise, time and cost savings, and access to economies of scale makes it worth looking into.
Robert Bertram’s perspective on OCIO
In 2008, Robert Bertram retired as executive vice-president and chief investment officer of the Ontario Teachers’ Pension Plan. Now chair of the Toronto foundation’s investment committee, he explains why — despite the deep investment experience of the committee members — the foundation decided to move to an outsourced chief investment officer model.
What challenges was the Toronto Foundation facing?
The Toronto Foundation had been using a traditional management model of an external advisor who supervised the hiring of external managers and the implementation of the asset mix. The advisor did not have a true fiduciary relationship in those decisions and left the ultimate choice of managers to the board. This usually led to a relatively protracted process to hire or replace managers or to make any changes in the asset mix, since the committee met only every three months, and it usually took at least two or three meetings to work through a decision. It was a process that made it difficult to align the interests of the managers, the advisor and the fund. The outcome was that we typically underperformed market-related benchmarks and did not consistently meet the grant objectives of the fund holders.
How are decisions being made now, under the OCIO model?
The Toronto Foundation wanted to move to a model that made financial decisions in a much more efficient manner. Now, all of the day-to-day investment decision — including manager selection and asset mix changes within broad parameters — are left to the OCIO. The committee focus is now on measuring and supervising the outcome, deciding on broad asset-mix parameters and policies, and making sure there is a long-term strategic plan to meet the liability-related objectives of the foundation. The interests of all participants are better aligned to achieve the foundation’s goals.
What are the results?
The results have been better than our expectations, from two perspectives. First, the [OCIO] team has completely fulfilled [its] role so that when [it] reports to the committee, [it is] largely reporting on activities [it] has taken and results achieved, not looking for short-term investment decisions about manager selection or weighting. Second, the overall results are being measured against a real return objective, which [it has] exceeded during almost all measurement periods since inception. And, to help us with any lingering doubts about the new strategy, [its] performance has also generally been better than what we would have achieved with prior benchmarks.
What advice do you have for companies considering an OCIO model?
If you don’t have the scale to hire an internal CIO, then the sooner you can implement an OCIO structure, the better. OCIO provides a better alignment with — and fewer conflicts with — plan objectives than can be achieved using the advisory process, like we were using before.
Tony Palermo is a freelance writer based in Lombardy, Ont.
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