Written by Paul Kelly
“Red hot.” This is how Michelle Seitz describes the current shift towards appointing external money managers rather than using in-house investment teams. The chief executive of asset manager Russell Investments believes our progressively unreliable investment environment is influencing large corporate and public pension funds, foundations and university endowments to hand over their reins. “There’s a lot of activity. It’s one of the fastest, if not the fastest growing spaces in the industry.”
Smaller organisations have traditionally delegated their entire investment functions to third-party specialists or ‘outsourced chief investment officers’ (OCIOs.) Lacking the scale, expertise and resources to profit most effectively from their own investment activities, they’ve relied on external professionals. Larger concerns have tended to outsource only their back- or middle-office tasks, retaining control of front-end dealing in-house. Accounting, compliance, analysis and administration duties were often contracted out. Now banks, OCIOs and money managers are all vying for mandates in the competitive arena.
Around $2tn of assets were under management by the end of March 2020 according to an annual Pension & Investments survey. That’s double 2013’s market and growth continues. Black Rock’s recently-won mandate to manage British Airways’ pension plan, with 85,000 members and worth $30bn, was the biggest UK deal on record. Black Rock’s chief executive, Larry Fink, commented, “More clients are looking to outsource their entire portfolio as regulations intensify, operating costs rise and investing grows more complex.”
Covid has also accelerated demand for wholly outsourced investment management services, including dealing. Changes in working practices and in the economy wrought by the pandemic have quickly forced the adjustment. Low interest rates and their effect on investment returns over the next decade have cast a shadow over the fulfilment of long-term liabilities. Based on long-term patterns, some are predicting a traditional portfolio split 60:40 between stocks and bonds is likely to return around only 2% after inflation annually over the next 5 to 10 years. Those with investment responsibilities are therefore more often choosing to instruct an expert so they can maximise opportunities. Outsourcing is also prudent mitigation against key person risk, especially in cases where one individual holds multiple roles, portfolio management and dealing for example.
Market volatility has also made delegation attractive. Rather than spending time juggling trades, asset managers have opted to partially offset their responsibilities and focus instead on their long-term asset strategies. Alternative working practices adopted during Covid were also influential. Enforced remote working proved trading could be done successfully from a distance. According to a report issued by Greenwich Associates, institutional investors are increasingly enthusiastic about outsourcing their trading desks, a move previously considered unthinkable. 32% of 84 traders polled saw it as a “good solution” for managing flow and achieving the best execution (up from 20% last year.)
And, it’s far from an all-or-nothing scenario. Much as hybrid working practices have been created in response to Covid, flexible outsourcing arrangements are being negotiated. Firms can choose to delegate only specific functions or limit outsourcing to individual countries. “It’s about flexibility and not every firm will want to outsource their entire trading stack. Instead they may look to outsource their overnight dealing function” says Gary Paulin, Northern Trust Capital Market’s global head of integrated trading solutions. International trading is the most common dealing activity contracted out, followed by forex trading, and delegated trading now covers fixed income and other assets as well as equities.
It’s estimated 76% of institutional investors with assets under $10bn have not yet outsourced their investment activities and, with competition intensifying and costs escalating, there is ample space and incentive for the market to expand.