The Letter “O” and the Art of Delegating

Family Office Alpha Report

By Phoebe Outerbridge & Keith Danko

February 27, 2017

This thought piece is brought to you by the letter “O,” which has become popular of late.

With the increasingly complex, fragmented, and costly investment landscape facing investors and asset managers, outsourcing has becoming an attractive option for firms of all types and sizes. The result is a proliferation of “O’s” preceding the familiar C-suite positions: CIO (chief investment officer), CFO (chief financial officer), CCO (chief compliance officer), chief marketing officer (CMO). Enter OCIO, OCFO, OCCO…

The logic is straightforward. Single-family offices and institutional firms alike are under pressure to keep costs down and performance up, all while balancing on the tightrope of a heightened regulatory environment and amidst an increasing overload of data and information. Outsourcing day-to-day functions of back office and even front-office support (beyond tax and legal advisory) can allow the investment committee or staff of a family office, institutional investor or manager to focus on its core capabilities. But is outsourcing for everyone?

Outsourced consultants have flourished and are now key industry fixtures: in 2016, the top 10 OCIO firms (fully discretionary) managed some $844 billion (All About Alpha, “Outsourced CIO Assets Grow to $1.3 Trillion,” 11/7/2016). Family offices also rely on outsourcing, with the acknowledgment from many of its original wealth creators that the next generation may not necessarily have the same level of interest in finance or investment oversight.

In the case of a CIO, the outsourcing model has thrived on the inefficiencies and drawbacks of the traditional structure of an in-house allocation team. In-house allocation teams, be they part of a family office or institution, have some key primary tasks: to properly align the investment strategy with the goals and mission of the investor, and to achieve the best risk/return balance possible. A seasoned allocation expert may be needed to best accomplish this, in addition to two or three competent analysts to perform thorough investment research.

Aside from managing the portfolio investment functions, a fully-staffed investment office also needs to maintain up-do-date systems, keep abreast of risk management, manage daily operations, monitor performance, conduct research, handle accounting and provide audit support. Part of the job description of a CIO is to ultimately negotiate the best fee structures to help minimize costs. All of this can add up to a sizeable chunk of staff time and of course cost.

Outsourcing the investment function is one alternative to assembling an in-house team, and can assume different meanings and be accomplished on various levels beyond the traditional OCIO. The traditional outsourced OCIO can range from an advisory role focused primarily on research and suggestions to a fully discretionary role whereby the OCIO is performing the entire scope of investment duties including asset allocation, manager research, investment recommendations, investment policy development, and due diligence.

The outsourcing of investment duties is not an all-or-nothing endeavor. Passive investing can be considered a form of outsourcing, given that an investor is essentially outsourcing its beta needs to the market.  The volume of investors now flocking to index funds and ETFs is a testament to the rise in this approach. Employing hedge fund funds-of-funds is another method of outsourcing the investment function, and at current fee levels offers comparable value to an outsourced CIO or the like.  On another level, affiliations of family offices (a.k.a. “club deals”) can have similar impact, the efficiencies of scale of the group and its research intelligence obviating the need for individual internal CIOs.

Outsourcing does have clear benefits if executed judiciously. For one, it can be a way to retain top talent. A small single family office looking to attract and retain an in-house staffer to manage its $150 million is competing against myriad larger firms looking for the same person. Second, an outsourced manager will be required to maintain a high level of professionalism and keep abreast of ever-changing regulations. Similarly, an outsourced firm or CIO will most likely be able to provide sophisticated technology and reporting.

In its delegation of duties, there can of course be inherent risks to outsourcing, above and beyond the fact that the outsourced entity is under a different roof, and very likely in a different state. Abdicating control allows the family office or manager to focus on other important tasks, but can also divert its focus from certain areas that need continual monitoring or sustaining, like relationship management. With an outsourced CIO for example the pressure to innovate and keep abreast of current trends, strategies or market indicators may be inadvertently alleviated. Proper communication and integration among all the constituents—outsourced and in-house—is key.

Outsourcing is hardly limited to the CIO function; any role can effectively be farmed out, whether CFO, CCO, CMO, business development consultant, or placement agent/third-party marketer. Nor is outsourcing limited to the investment industry. Outsourcing IT needs to subcontractors, for example, is a universal trend across industry platforms.

Outsourcing roles like CIO or CCO can bring efficiencies that ultimately save time and money for a family office, institution, or asset manager, and can allow members to tap into expertise that would otherwise be retained internally and at a meaningful expense. Given the sensitive nature of investing, however, transparency and communication, as well as confidentiality and privacy, must remain key considerations. So long as a firm can manage these ABC’s of investment management, adding a big “O” to the equation may be worth considering.