Can one OCIO monitor another?
With continued adoption by institutional plan sponsors of converting their non-discretionary 3(21) investment consultants to fully discretionary 3(38) investment consultants, entering uncharted water necessarily brings new challenges. One of those challenges is how institutional plan sponsors manage and monitor this new structure.
By converting to an OCIO (Outsourced Chief Investment Officer,) plan sponsors are not relieved of their fiduciary duty to know how their assets are invested. Further, they are no longer directly involved in decisions regarding asset allocation, rebalancing and manager selection. By design they have been removed from the change process for reasons of expediency and “leaving it to the experts.”
I previously wrote How Many OCIOs Should You Hire? to examine the question of whether to hire an OCIO and how many. This piece, however, examines how some institutional plan sponsors have chosen to manage the process once they have hired a lone OCIO.
Giving an OCIO complete discretion carries with it both benefits and drawbacks. One of the drawbacks is lack of real time oversight, monitoring and ensuring the OCIO does not go “rogue.” To this end, many institutional plan sponsors have hired another OCIO to give their imprimatur to suggested investment changes and serve as an extra set of eyes.
One of the contractual stipulations normally included is that this new “supervising OCIO” can never be hired to replace the “primary OCIO.” This is to eliminate the incentive to try to become the primary OCIO and therefore eliminate the incentive to be overly critical and thus be objective.
While it is good to eliminate such a conflict, there is actually a much worse conflict of interest that prevents the institutional plan sponsor from getting the mission critical information they should expect from the supervising OCIO.
There are two reasons incenting the supervising OCIO from not giving the best analysis to the plan sponsor.
First, the supervising OCIO must give their approval for the suggested asset allocation or manager change. Both OCIOs are now serving in the same fox hole. If the suggested change performs poorly, will the supervising OCIO report this fact and take the blame, or remain silent?
If the supervising OCIO does not approve a suggested change but then that suggested change performs well, will the supervising OCIO report this? Will the primary OCIO then report to the plan sponsor the mistake by the supervising OCIO? There is a reason why they both may remain silent.
The second reason the plan sponsor may not receive objective analysis from either OCIO is that they may already be supervising each other for a different client. All OCIOs play in the same sandbox and if they are not in role reversal for another mutual client, there is a chance they might in the future. This creates the incentive to always wear kid gloves.
This second reason creates a mutual admiration society such that they are hesitant to ever be critical of another member of their guild. This is like the Magician’s Code of never revealing how the trick is done or giving up the ghost. They maintain the status quo and their quarterly fees by not rocking the boat.
As a plan sponsor, would you rather have an OCIO be openly critical (knowing it is their job to do so,) or have an OCIO with an incentive to stay silent despite poor investment decisions occurring on their watch? The former is obviously superior to the latter.
The simple solution is to either hire multiple OCIOs in a competitive and comparative structure, or hire an independent advocate that is not in the business of providing investment consultant services.