Coach-up Your OCIO With Sports Analytics
Quick: Name a top athlete that is not coached. Not only does every top athlete have a coach, but they likely also have a trainer, nutritionist and sport psychologist. Now name a professional sports team that does not use statistics and analytics to craft game strategy.
Outsourced Chief Investment Officers (OCIOs) and non-discretionary investment consultants can also benefit from being coached-up. With simple and powerful analytics, plan sponsors can improve their OCIO's or investment consultant's performance.
Sports analytics were first famously used by the Oakland Athletics baseball team and chronicled in the book and movie Moneyball. The A’s were highly competitive year after year on a shoestring budget with sports analytics making the difference. In today’s world, no matter the endeavor, analytics are a must to succeed.
If you are not using similar analytics, you are falling behind. I will share a few examples so you too can coach-up your OCIO or investment consultant.
“Breaking Down the Tape”
When watching a post-game interview of Tom Brady, Drew Brees or Russell Wilson, regardless of a win or a loss, they are often asked about their next opponent and how they will prepare. A common refrain is they will review game tape to recognize patterns, fix mistakes and discover ways to improve. Your OCIO is your quarterback and needs their game tape.
Investing is indeed a lot like football. Both are team efforts, they face uncertainty, decisions are emotional, and the stakes are high. Most important, they are both a loser’s game. A loser’s game is a game whose outcome is largely determined by the mistakes of the loser. In other words, avoiding mistakes is key to winning. And reviewing game tape is the key to not repeating mistakes.
This phenomenon in football is seen in winning the “turnover battle.” The team that has the fewest turnovers is more often (78%) the winner. With investing and the concept of negative compounding, avoiding mistakes is the key to winning this loser’s game. After all, it takes a 100% gain to recover from a 50% loss.
Your OCIO’s 5 Coachable Skills
There are 5 skills an OCIO employs to create value. Therefore, there are 5 areas where a plan sponsor can discover analytics to coach-up. The skills are:
1. Strategic Asset Allocation
2. Tactical Asset Allocation
4. Manager Hiring
5. Manager Firing
The reason your OCIO can be coached-up in each of these skills is your OCIO likely does not report their value-add implementing these 5 skills. Therefore, they do not know where or how to improve and thus need game tape analytics.
Coachable Skill #1 - Strategic Asset Allocation
Long-term investment success is primarily driven by strategic asset allocation; determining which asset classes to own and in what proportions. But nearly every OCIO hides their ability to add value through strategic asset allocation. So, in order to coach-up your OCIO you will first need the missing data.
The missing data is the performance, timing and historical risk of their previous asset allocations. In my 10+ years of performing due diligence on investment consultants and OCIOs, not once have I seen one continue to report performance for their previous strategic asset allocations. The reason is obvious: they do not want to risk showing they “turned the ball over.”
But only by breaking down the tape can you discover behavioral finance patterns to improve future outcomes. Here are 3 examples from my past work on how this analysis can yield critical insights to improve future decisions and outcomes.
In one study an institutional investor increased their equity allocation at the end of 1999 and added a tech heavy equity manager. In 2002 they reduced equities and increased investment grade fixed income. In 2003 they took a 10% position in hedge funds. In 2007 they reduced fixed income and increased equities. The pattern was clear; the investment consultant had a recency bias. They were buying asset classes that had recent success hoping the trend would continue. Since this revelation, they are no longer chasing hot asset classes.
In another study an institutional investor had 13 different strategic asset allocations over the course of 19 years. Some of the changes even occurred in the same year. Strategic asset allocation is supposed to be long-term. Constant change suggests a lack of strategic thinking or long-term outlook. Had they made no changes; the returns would have been substantially higher. The two behavioral finance traps were the incentive to always “do something” and the over-confidence of believing their constant tinkering would add value. “Money flows to the patient investor.” ~ Warren Buffett
The last example involves timing and delays. In this study the consultant and client were indecisive and extensively deliberated every asset allocation change. Unlike the example above, they were not changing as frequently, but it sometimes took 12 months to fund changes. I measured the opportunity cost of the delays and it was costly with an average loss of 73 basis points. Further, their deliberation cost them as they were selling real estate following the 2008/2009 Global Financial Crisis and planned to reinvest in real estate once the downturn ceased. Once the real estate market stabilized, they did their asset allocation study, manager search and interviews, but by then there were long capital queues and they missed the strong recovery. They were not fully invested in real estate until late 2012. They learned the lesson and have become timelier and more decisive.
Plan sponsors must breakdown the tape of their strategic asset allocation history to learn if there are patterns, costly delays or behavioral finance lessons their OCIO can implement (and avoid.) Below is a simple example every plan sponsor should review regularly.
Coachable Skill #2 - Tactical Asset Allocation
Occasionally the financial markets present unique and limited opportunities to temporarily deviate from the strategic asset allocation. Recent examples include distressed credit and distressed real estate following the 2008/2009 Global Financial Crisis (GFC.) Such tactical opportunities are few and far between.
The keys to assessing a tactical asset allocation move are to determine, 1) a targeted rate of return, 2) a targeted time frame and, 3) an appropriate benchmark. Did you get your return in the anticipated time frame? If not, why not? Only by defining the goals in advance can your OCIO’s tactical asset allocation skill be measured.
In only one of my many studies was a tactical asset allocation made. Following the GFC they made a 5% allocation to distressed credit. The absolute return was quite good, especially when the investment consultant compared it to the Barclays Aggregate Bond Index. Compared to a high yield index, there was still excess value, but not as good when compared to investment grade bonds. So be sure to have an appropriate index, and not a “strawman” index that puffs up excess return.
Coachable Skill #3 - Rebalancing
Look back to the volatility in the markets over just the last few years. There have been several roundtrips in the global equity markets over 15% presenting rebalance opportunities to manage risk and capture incremental returns. Effective rebalancing is critical, but difficult to quantify due to the virtually infinite variety of rebalancing possibilities.
Never have I seen an OCIO present a written report on their rebalancing skill. Further, I have never seen an OCIO report they ever missed a rebalancing opportunity. Here are three tools to coach-up your OCIO's rebalancing skill.
First, your OCIO may follow written guidelines for rebalancing. These typically involve upper/lower ranges for asset classes and if such bounds are reached then rebalancing is triggered. Since this is normally a manual operation it is important to monitor if such bounds are reached and if a rebalance occurs. Demand your OCIO regularly report in writing if bounds were reached and if/when a rebalancing then occurred.
Second, sometimes there are not asset class ranges thus allowing the OCIO wide discretion to let an asset class run or fall hoping to maximize returns or minimize losses. After all, selling too soon is costly, and so is catching a falling knife. One of the reports I provide clients is my proprietary Drift Analysis. It measures the monthly difference between the actual asset allocation compared to the strategic asset allocation. The example below shows how the Drift Analysis was the impetus for changing the cash flow policy to improve asset allocation drift.
Third, analyze the timing by charting the history of your OCIO’s rebalancing. Does your OCIO have the tendency of being too early or too late? The graphs below are examples to see patterns in your OCIO’s rebalancing behavior and serve as the basis for improvement.
Coachable Skills #4 & #5 - Active Manager Hiring & Firing
I firmly believe an OCIO can hire and fire active managers better than a non-discretionary investment consultant requiring a plan sponsor vote. There are many reasons including fewer conflicts, fewer delays, lowered emotions and less defendable decision making.
Academic research from Jenkinson, Jones & Martinez and Goyal, Wahal & Yavuz document the great difficulty in hiring and firing active managers. Like the other skills, how many OCIOs or investment consultants report on the post-termination performance of fired managers? Are they firing too late, or too soon? Are there patterns to their hiring and firing decisions? Are there correlations between pre-hire and post-hire performance?
This is a simple table that requires no special skills to produce. It shows powerful insights into your OCIO’s active manager hiring and firing skills.
You can then breakdown the tape into finer detail with performance graphs seeking behavioral finance and timing patterns of your OCIO's hiring and firing history.
In-house or Outsourced... Just Do It!
The benefits of using statistical analysis to coach-up your OCIO or investment consultant are undeniable. Hiring an OCIO behooves you to undertake this additional oversight: especially if your OCIO does not provide metrics for their value-add in the 5 skills.
If your plan has the time, resources and expertise to do this in-house, by all means do it. If you prefer an independent and experienced professional, please consider my firm for a one-time or ongoing service by contacting me at admin@OCIOmonitor.com or visit OCIOmonitor.com.