The Outsourced Chief Investment Officer Model of Management and the Principal–Agent Problem

Abstract

By convention, the responsibility for framing pension fund investment strategy lies with boards and their investment subcommittees, outsourcing the major part of the implementation of chosen investment strategies to various asset managers. In recent years, some pension funds have begun to outsource the investment strategy and implementation thereby locating authority and responsibility with external providers. In this paper, we focus upon the Outsourced Chief Investment Officer (OCIO) model of management emphasising the forces driving the adoption of this type of arrangement, its characteristics and what defines success. This model of management has the merit of replacing multiple providers with one contract on a fee-for-performance basis. For this model to be effective, it is shown that it must be well-governed. This includes clarity of mandate and delegation as noted in prior research on pension fund governance. In addition, any governance regime must address the principal-agent problem if the OCIO model is to realise clients' ambitions. This may require high-level Board competence, investment advisory services, and performance assessment processes that are sensitive to the unseen forces that influence success.

Small-sized asset owners’ OCIO selections and evaluations

“…Some studies attribute an OCIO's low return to the agency problem. An OCIO risks agency problems similar to those of other delegated asset managers because asset owners and managers are separated (Clark and Urwin, 2017). Yoon and Lee (2019) argue that a fee structure where a higher proportion of the total fee comes from operations rather than performance causes the OCIO agency problem.…”

Re-assessing the role of financial professionals in pension fund investment strategies

“…According to this research, financial professionals involved in pension fund capitalism such as asset managers, actuaries, and pension consultants exert an independent influence over pension fund investment strategies. Pension fund trustees increasingly take asset allocation decisions on the basis of advice from investment consultants (Jenkinson, Jones, & Martinez, 2016;Tonks, 2005), and there has been an increase in 'outsourced' asset management in which pension fund trustees or governing boards delegate not only the implementation of asset management, but also key aspects of investment strategy including high-level asset allocation decisions (Clark & Unwin, 2017;Tonks, 2005). Labour trustees in particular are increasingly likely to delegate investment decisions to financial professionals (Verma & Weststar, 2011).…”

Searching for and evaluating outsourced chief investment officers

“…Outsourced chief investment officer (OCIO) services are a type of delegated asset management. However, unlike traditional asset management approaches, OCIOs receive authority over strategic asset management from asset owners (Clark and Urwin, 2017). Asset allocation can be categorized into two types—namely, strategic and tactical asset allocation (Anson, 2004).…”