Creating an Investment Performance Monitoring Edge: The OCIO’s Perspective
OCIOs (Outsourced Chief Investment Officer) have emerged over the last decade as indispensable partners for investment professionals navigating an increasingly complex investment landscape. [1] The right OCIO firm can provide a comprehensive investment management service, allowing RIAs and financial planners to offer better investment options and freeing them from these specialized tasks.
Partnering with an OCIO can also bring transparency, analytics, focus, and accountability to performance measurement and monitoring.
Understanding Performance Metrics
OCIOs can help financial professionals improve investment performance and performance monitoring. Often, this is accomplished by refining the investment program so that it is better positioned to achieve client objectives. The starting point is high-quality, insightful information followed by smart oversight that turns insight into action.
Consider, key performance indicators (KPIs). An OCIO can bring robust monitoring to common KPIs like:
Returns and Income – Monitoring returns, including capital appreciation and income, as well as more sophisticated measures of excess returns and risk-adjusted returns based on factor models
Risk – Monitoring the risks of each investment and ensuring that actual investments remain within their respective risk mandates
Cost – Providing greater transparency into total investment costs, including management fees, transaction costs, other expenses and expected taxes, through analytics
Compliance – Ensuring regulatory compliance and consistency within the Investment Policy Statement (IPS)
These examples just scratch the surface of what an OCIO may assist with in regard to metrics and monitoring of investment portfolios.
Best Practices for Enhancing Transparency and Accountability
So, what does a holistic approach to measuring investment performance look like beyond KPI evaluation? Below we examine some of the ways investment professionals can build transparency and accountability into performance measurement.
Establishing Benchmarks
When it comes to assessing an investment’s performance, the first task for an OCIO is to establish useful benchmarks. This is often more difficult than it sounds because there is no perfect benchmark for a complex investment strategy or multi-asset model portfolio. Nevertheless, benchmarks serve as a yardstick for measuring performance and you want to align benchmarks not only with each investment strategy but also with your organization's unique value-proposition.
It’s worth taking a moment to characterize what someone means when they use the word ‘benchmark’, which means different things to different people. For a passive investment strategy, choosing a benchmark is often straightforward because the passive strategy is meant to track closely to a particular index. The index then is a good benchmark because we can literally compare how an actual investment compares to what it is meant to track. For example, how closely the SPY ETF matches the return of the S&P 500 Index is important and meaningful to the SPY investor because the investor literally wants to get the Index return with as little deviation as possible.
For any active strategy or for a model portfolio composed of multiple active or passive funds (the vast major of what people actually hold), no index exists that will match the performance of the portfolio. The choice of benchmark becomes subjective to some degree and this is where the expertise of an OCIO can be especially helpful.
Sometimes assigning a benchmark is easy, the S&P 500 can be a good benchmark for a US large-cap equity strategy for example. In most cases though more work and thoughtfulness are required because most portfolios contain a mix of asset classes (equities, bonds, commodities, alternatives, hedged or income investments, etc.).
To find a useful benchmark, OCIOs focus on the value proposition portfolios are meant to deliver and then measure actual performance against an index or hybrid index that closely matches the value proposition.
For example, if a portfolio’s value proposition is: over the long-term, deliver S&P 500 like returns but with less exposure to large drawdowns, then we want to identify or construct an index that matches that value proposition. We might find it useful to use two benchmarks. Use the S&P 500 Index to answer the investor’s question: ‘am I getting at least as good or better returns than index?’ And use an 80/20 (equity/bond) index to answer the question: ‘am I getting the downside performance I expected?’ Risk-adjusted return metrics like Alpha can provide an apples-to-apples risk-adjusted benchmark useful to advisors.
In the multi-asset portfolios that most people hold, OCIOs will often create multi-point benchmarks using a variety of risk, return, and risk-adjusted metrics, that can be used to communicate and educate advisor and client alike about the risks being taken and the compensation being received.
Emphasizing Regular Reporting
OCIOs often bring a regime of regular reporting and monitoring to investment organizations that help them better understand what is and isn’t working and why. This rigor is vital for organizations that want to provide a highly professional investment service to their clients. Reports ideally include rich insights about return attribution, risk-taking, costs, and significant changes or drift to the constituent funds. These insights in turn generate ideas about how to improve the invest service offering.
Conducting Regular Reviews
Often OCIOs bring enforced rigor to conducting regular reviews of the investment process. Regular reviews assess both quantitative and qualitative aspects of the investment process including: fund selection, strategic allocation, tactical allocation, and alignment with firm principles and objectives. These reviews can stimulate constant improvement and adherence to best investment practices.
The Role of the Board in Ensuring OCIO Compliance and Transparency
The board of directors serves as a pivotal line of defense in ensuring OCIO compliance and transparency.
As stewards of the organization's financial future, the board's oversight and governance are instrumental in maintaining the integrity of the OCIO relationship. This may include:
Setting clear expectations
Ensuring alignment with the organization's investment objectives
Implementing rigorous monitoring protocols
By conducting regular review sessions, due diligence checks, and establishing transparent communication lines, the BOD can foster a culture of accountability. Their engagement ensures that the OCIOs performance is not only aligned with expectations but also transparently reported, reinforcing trust and minimizing organizational and systematic risks.
Developing a Comprehensive Reporting Plan for Your OCIO
OCIOs can be valuable partners for RIA and financial planners navigating the many complexities involved in constructing, managing, monitoring and improving the investment services offered to clients. Key areas covered in this article include: a refined reporting strategy, establishment of useful benchmarks that support client communication, robust reporting and reviews, all tailored to the unique attributes of the organization.
Markin Asset Management provides OCIO services to financial professionals. We emphasize collaboration, transparency and systematic investment solutions tailored to the needs of each firm we work with.
To discover more, schedule a meeting with our financial professionals today.
Sources:
Institutional Investor. Nonprofits Are Flocking to OCIOs at a Higher Rate Than Ever. https://www.institutionalinvestor.com/article/2bstnzuzcpd77whmkr280/corner-office/nonprofits-are-flocking-to-ocios-at-a-higher-rate-than-ever