The field of outsourced chief investment officer (OCIO) services has evolved, says Debra Woida, head of North American delegated investment services at Towers Watson.

Back in the 1980s, companies chose to outsource primarily because they hoped to get fee concessions by aggregating their assets. Initially, they were satisfied if the fees were lower and the manager performed above the benchmark.

But plan sponsors started to want more assistance in managing their retirement plans, Woida says, and now OCIO means a bundle of services: “It’s investment advice, implementation, someone who can handle funding and day-to-day management of activities in an investment trust,” she tells PLANSPONSOR. Some of these daily tasks are asset allocation, hiring and firing of investment managers, negotiating investment manager fees, reviewing legal documentation, executing documentation, managing cash flow, monitoring investments and coordinating with the custodian.

Determining whether an OCIO arrangement is successful is not an immediate or easy process, she says, because not all these factors are easily measured quantitatively, the way an equity manager can be measured using a benchmark.

One key factor for success is having a shared understanding of objectives, which can take more time and more discussion. The OCIO provider needs to understand what the plan sponsor wants, Woida explains, and these objectives must then be translated to a meaningful timeline. This way, provider and plan sponsor can answer such questions as, “Are we moving the fund in the direction I need it to go?”

The ultimate objective might be pension plan termination, for example, Woida says. Using what Towers Watson calls a balanced scorecard approach, plan sponsor and OCIO provider agree on goals and strategy, and create a written agreement.

Even if short-term factors cause setbacks, she explains, the plan sponsor knows to take a broader view than simply focusing on any one factor. “You have to look at total trust and other longer-term objectives,” Woida says.

This approach requires evaluation as to whether the provider is moving you toward the ultimate goal, without getting sidetracked or overly upset over things like interest rates that cannot be controlled.

A critical part of the service is helping the plan sponsor to set achievable goals. Both sides must understand objectives and possible constraints. “If, over seven years, your goal is to fund the plan to 100% and then terminate, then the OCIO can do some things but not others,” Woida points out. “Setting the right strategy is going to have a bigger impact on the performance of your portfolio than any individual manager selection ever will.”

Modeling tools can help a plan sponsor get a preview of what changes in investment policy might look like. For example, the OCIO provider can model what an allocation that is 60% return-seeking and 40% defensive might look like over a longer-term horizon, and factor in potential constraints down the line. Perhaps the plan sponsor can anticipate that in year four or year five, there will be a contribution that can’t be funded. Predictive modeling can help reduce the likelihood of this happening by using different strategies and different asset allocations to avoid that position.

OCIO providers can help plan sponsors to connect the dots, Woida says. Perhaps a sponsor wants to fully fund a plan in seven years and put in a specific, limited amount of money. This would mean taking on a lot of risk for the plan sponsor, she explains, which will mean a lot of volatility. The DCIO provider can help the plan sponsor to “pre-experience” what those parameters will mean.

“You want to avoid surprises,” Woida says. “Document, and make sure people understand the objectives.” As an example of what not to do, she recalls that during the financial crisis, a number of managers were using leverage in portfolios that people did not understand, which led to a lot of upsetting surprises for clients.

A big gap that plan sponsors may need help with: thinking that investment returns make up some component of the gap in funded status. They make up some, but not all, Woida notes, so the funding policy can help to manage the plan sponsor’s expectations to see what is and what is not possible.

Strategies should not be and cannot be one-size-fits-all, Woida cautions. The individual plan sponsor’s goals and constraints can be incorporated into the process, which should be transparent. She recommends asking if the firm receives any other revenue from the investments in the plan. “It’s not necessarily a bad thing if they do, but it’s a potential conflict,” she says.

As well as transparency, the plan sponsor purchasing those services needs to understand the scope of the services they’re buying. “If it is truly a full scope of OCIO services, you want someone to handle as much as an external party can handle,” Woida says. “Understand the resources and tools they can bring on strategic advice as well as the manager selection. The driving indicator is how the strategy is built.” Choosing an OCIO provider is not a straightforward decision, Woida observes, so plan sponsors should expect to work with the investment committee or one of the plan fiduciaries to make it. “Go into it eyes wide open, and know what you’re buying,” she advises.

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