Moves by public pension funds this year to entrust outsourced chief investment officers (OCIOs) with discretionary oversight of substantial portions of their portfolios have industry insiders asking: Have OCIOs finally cracked the code to access public pension plan accounts?
In particular, news in the summer that the $18.4 billion Illinois State Board of Investment (ISBI) voted to retain BlackRock Financial Management as a strategic partner to manage on a non-discretionary basis approximately $9.3 billion, or 51%, of its passive portfolio, came as a surprise to industry pros. Additionally, BlackRock has discretionary oversight over a specified roster of active public market managers who handle approximately $2.7 billion, or nearly 15% of ISBI’s assets under management, according to Eric Herman, managing director at Kivvit, SBI’s public relations firm. The BlackRock partnership is ISBI’s fourth hiring of a strategic partner within the past year, however only one-third of the portfolio is under discretionary oversight, Herman added.
Discretionary oversight grants a manager or other third-party freedom to execute investment allocation changes and manager-roster changes on behalf of the asset owner without seeking permission in advance.
“Assets that pensions, endowments and other institutions are outsourcing are now growing between 10 percent and 15 percent per year—[outsourcing] is a very meaningful opportunity for BlackRock to help our clients,” said Jeffrey Saef, a managing director at the firm. BlackRock had $6.3 trillion in assets under management (AUM) as of June 30.
Assets that pensions, endowments and other institutions are outsourcing is now growing between 10 and 15% per year.
“The holy-grail pool of money for OCIO firms is public pension money,” declared Charles Skorina, principal of an eponymous executive recruitment firm that specializes in placing chief investment officers. “With $6 trillion in assets under management, BlackRock certainly has the scale to take public pension money as well as supervise a portfolio. The problem with public pensions like CalPERS is that they’re often run by political appointees who don’t want to relinquish control. This is an interesting move for Illinois, which is in terrible pension shape,” he added.
In a move similar to ISBI’s, in July 2017 Arizona State University Enterprise Partners retained BlackRock as its OCIO to oversee the roughly $1 billion ASU Foundation endowment. “We’ve seen clients looking for whole-portfolio OCIO solutions—they’re thinking about a range of investments from the role of indexed, factor-based, and alpha-seeking strategies, to liquid versus illiquid investments, to how they can think about gaining access to China,” said Sarah Melvin, managing director and head of the institutional client business for the U.S. and Canada at BlackRock. “Pensions, foundations and endowments are facing more regulations and compliance requirements, as well as cost and efficiency challenges.”
Since June 2013, asset manager Vanguard has managed 90% of the Montgomery County (Pa.) Employees’ Retirement System, and wealth manager SEI manages the remaining 10%. Currently, the pension assets stand at $522 million, said Steven Potynski, retirement manager at the Montgomery County fund. “Our experience with this model has been a positive one—it has helped us reduce investment management fees and we plan to continue with it in the future,” said Dean Dortone, CFO of the Montgomery County fund.
“We are seeing more organizations looking to a third-party to manage some or all of their legacy pension fund[s] both in the public and private space,” said Christopher Philips, head of Vanguard Institutional Advisory Services.
“The OCIO firms would love to have the public pension business, but most public pension boards are not ready to give up control,” Skorina said. “But it’s not just that, as you will find, if you dig into the San Diego pension’s attempt to outsource, there are many in the media and many public advocates who also attacked the idea. ‘Why should we pay outsiders?’ ‘How can we control what an OCIO firm might invest in, i.e., ESG [environmental, social and governance] stuff?’ ‘How can we influence an OCIO firm to invest in our favorite project?’”
In October 2009, the San Diego County Employees’ Retirement Association (SDCERA), outsourced management of its assets to an OCIO firm named Integrity Capital, headed by Lee Partridge, a former deputy CIO of the Teacher Retirement System of Texas. The specially tailored arrangement with Integrity began well but then hit turbulence amid disagreement by the fund’s board over the OCIO’s investment strategy. Under Partridge’s tutelage, the fund was heavily exposed to a risk-parity strategy. Intense local press criticism of the fund’s governance, and infighting at the fund’s board, culminated with the fund terminating the contract with Salient Partners. Integrity Capital was acquired by Houston-based Salient Partners in 2010, at which point Partridge relocated back to Texas, working for SDCERA remotely This turn of events generated more recriminations at the fund, which terminated the contract in June 2015 after it suffered downgrades by Standard and Poor’s and Moody’s Investors Service. Partridge departed Salient in 2016; the firm closed its OCIO business that year also. Salient is now a real asset and alternative investment firm. The rise and fall of the fund’s five-year experiment with an OCIO is viewed by many in the industry as a cautionary tale about the challenge in adopting and managing OCIO structures at public institutions, notwithstanding the fact that for the five years Partridge served as CIO the fund generated an 8.8% annualized net return, which represented a $4.1 billion gain.
If you dig into the San Diego pension’s attempt to outsource, there are many in the media and public advocates who attacked the idea. Why should we pay outsiders?
“By most accounts, the trend towards outsourcing will continue to increase,” Vanguard’s Phillips said. “In five-to-ten years, we think that we’ll see many more organizations, both large and small, using a third-party to manage their investment portfolios—but with two notable shifts,” he said. “First, while more organizations are entering the OCIO space, it’s very difficult for firms to differentiate themselves or articulate a unique value proposition. As a result, newer firms will likely find it difficult to grow and scale. One outcome of this will likely be a growing wave of M&A among OCIO providers. Second, as the needs and expectations of organizations looking to outsource increase, the era of providing asset allocation services and articulating out- or underperformance versus a bogey is over. If you are unable to measure and show risk attribution, return drivers, stress-testing and scenario analysis on multiple investment pools, you will be left behind,” Phillips predicted.
The OCIO business is seeing tremendous industry growth, as investors as seeking professionals to manage their institutional assets with a more hands-on approach, Timothy Ng, CIO at consultant Clearbrook, told IA. “The increased volatility and magnitude of price moves in the financial markets causes institutions to hire investment professionals with deep and seasoned asset management skills, who can make timing, strategic and tactical asset allocation decisions,” he added. “This has prompted institutions to fuel the growth of the OCIO business globally.”
BlackRock’s Services to ISBI
BlackRock will manage indexed and factor investments and provide discretionary portfolio oversight for ISBI, along with operations services and a risk and reporting platform.
“[ISBI] may wish to upgrade the pension management, and outside firms have more expertise,” said Skorina. “From a political standpoint, fund administrators don’t want to be last man standing when their plan collapses—if you outsource, at least you can say: ‘They were handling it, not us.’”
From a political standpoint, fund administrators don’t want to be last man standing when their plan collapses—if you outsource, at least you can say: ‘They were handling it, not us.’
ISBI also launched a $700 million allocation to factor-based investing that will also be managed by BlackRock using its Aladdin platform. The Aladdin platform (Asset, Liability, and Debt and Derivative Investment Network) is an operating system for investment managers that combines sophisticated risk analytics with comprehensive portfolio management, trading and operations tools on a single platform “BlackRock’s Aladdin platform allows us to stress-test client portfolios in different scenarios down to the manager and security level, and understand the impact on asset allocations and implications for potential portfolio drawdown and losses,” Saef said.
Goldman Sachs (GSAM), another mega asset manager with $1.5 trillion in total assets under management, will roll out a web-based investment dashboard to its clients later this year, as part of its OCIO services, confirmed Patrick Scanlan, v.p. of corporate communications at GSAM.
“While I am skeptical about anything that claims to predict future prices, the new technology platforms and investment insights do allow for the construction of multi-billion-dollar portfolios in more innovative and superior ways than in the past,” according to Vijoy Chattergy, the former chief investment officer of the $17 billion Honolulu-based Employees’ Retirement System of the State of Hawaii (HIERS). “A portfolio can be managed more holistically—it doesn’t really matter to an asset owner to have the best fixed-income or real estate portfolio in the world if the total portfolio misses its objectives.”
In the case of Illinois and BlackRock, the mandate appears to take advantage of BlackRock’s considerable resources and uniquely meets Illinois’ goals. For example, by BlackRock managing a sleeve of Illinois’ external fund managers, it can net trades and dynamically risk-manage factor exposures across asset classes in the portfolio. “There are few firms that can provide such
a comprehensive solution for large asset owners, and it will be interesting to see how this trend takes shape,” Chattergy said.
The move allows ISBI access to more resources while saving the fund money, Johara Farhadieh, ISBI Executive Director, stated in a press release. “There are several ways to play the OCIO game,” Skorina said. “As an alternative to active management, larger managers like BlackRock, Mercer, Vanguard and State Street do it the cheaper way—they put the money into index funds and ETFs and charge the client less. This is a way for OCIOs to take advantage of the current trend of low-cost investing.”
The Illinois Board issued an RFP in April and BlackRock was the sole finalist. Some observers noted that there are only some half a dozen firms like BlackRock, with the scale to take on a $30 to $300 billion mandate. “Most of the firms on my list do not have the staff or infrastructure to take on large pension funds,” Skorina said.
Other ISBI portfolio managers hired within the past year include Perella Weinberg Partners, Rock Creek Group, and Hamilton Lane. The latter had been ISBI’s real estate consultant and was given discretionary authority over $1.2 billion in private equity, $520 million in opportunistic credit and $400 million in non-core real estate.