Knowledge. Experience. Integrity.

IntroductionAs investors reach for returns in a sometimes bruising market, they are adding private equity, hedge funds,

and other alternatives, leading to increasingly sophisticated—and complicated—portfolio monitoring and

management. Heightened regulatory and compliance requirements have further increased the time and

resources required to meet fiduciary responsibilities. This has led some investors to consider delegating

investment oversight, monitoring, and management duties.

The industry press regularly reports on a large and rapidly growing outsourced chief investment officer

(OCIO) market, and some fund sponsors wonder if this model would serve them better than the traditional

consulting model. Funds managed through an OCIO are beholden to the same challenging market environ-

ment and regulatory atmosphere, but the burden of balancing these challenges can be largely shifted from

the investment committee to the OCIO provider. Some funds find this solution meets their needs.

CAllAn InveSTmenTS InSTITuTe

Research

May 2013

The Outsourced Chief Investment Officer Model

One Size Does not Fit All

In the outsourced chief investment officer (OCIO) model (also known as “implemented consulting,”

“discretionary consulting,” or “delegated consulting”), an institution shifts discretionary authority to an

advisory firm to manage some or all of the investment functions typically performed by the investment

committee. The precise definition of this model varies as much as the name, making the size and

scope of the marketplace difficult to pin down.

The increasing popularity of this model is in part a response to the frustration investment committees

have felt amid a shifting environment in which portfolio management requires more resources. While

an OCIO offers an elegant solution, it is not a panacea for all the issues facing institutional investors,

and relinquishing all fiduciary oversight is not an option.

In this paper we describe the OCIO market and Callan’s approach, which acknowledges that each

investor faces unique challenges that require custom solutions. We offer two case studies and a series

of questions that might assist fund sponsors in weighing the appropriateness of the OCIO model for

their fund.

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In this paper, we explain the OCIO model, describe its value, and provide a series of questions to help

fund sponsors contemplate whether outsourcing might be appropriate for them. We also compare Callan’s

traditional consulting model to our outsourcing approach.

OverviewDefinition and DemandIn the OCIO model (also known as “implemented consulting,” “discretionary consulting,” or “delegated

consulting”), an institution shifts discretionary authority to an advisory firm to manage some or all of the

investment process. These functions would normally be performed by the investment committee, poten-

tially with a consultant’s help.

The increasing popularity of this model is a response to the frustration investment committees have felt

amid a disconcertingly unfamiliar environment in which returns are hard to come by, risk is elevated, and

a glut of new investment vehicles have inundated the market. These elements have created an exception-

ally challenging landscape in which complications (unlike returns) are in ample supply.

For example, Exhibit 1 depicts the degree to which the task of realizing a 7.5% return has become sub-

stantially more problematic over the past 15 years. using capital market assumptions from 1996, we see

that a portfolio seeking a 7.5% return could allocate the vast majority of its assets to fixed income. Contrast

that with 2012, when a portfolio seeking the same return had to be far more diverse, with more than 80%

of assets allocated to riskier asset classes.

The modern-day investment backdrop has become more global and intricate. At the same time, the in-house

talent required to oversee these more complex portfolios, manage risk, and ensure compliance is becoming

more expensive, which is particularly daunting in light of the constraints being placed on institutional budgets.

Key factors that are driving institutional interest in the OCIO model include:

1. Highly unpredictable and multifaceted capital markets

2. Limited investor resources vs. rising costs associated with maintaining in-house resources

3. Little margin for error in a low-return environment

4. Demand for expertise in uncorrelated assets, particularly alternative investments

5. Difficulty gaining exposure to best-in-class managers

6. Heightened attention on liabilities (for defined benefit plans)

7. Challenges in fulfilling fiduciary obligations given the presence of greater scrutiny and regulation

8. The proliferation of new financial instruments that must be vetted for their applicability

Exhibit 1

Asset Allocations for Projected 7.5% Return

Broad U.S. Equity 18%

Non-U.S. Equity 3%

Real Estate 7%

Broad U.S.Fixed Income73%

Broad U.S. Equity 34%

Non-U.S. Equity 22%

Real Estate 11%

Private Equity 15%

Broad U.S.Fixed Income 18%

1996 Asset Allocation 2012 Asset Allocation

Source: Callan

3Knowledge. Experience. Integrity.

Interest in OCIO can be partially attributed to concerted marketing efforts deployed by actuarial and in-

vestment consulting firms, asset management firms, and start-ups (often created by former CIOs of large

institutional capital pools). All of these groups stand to benefit from the transfer of investment authority

from a diverse population of investment committees to a more concentrated group of professional entities

focused on the deployment of an OCIO business model.

Market Size and Scopeestimates as to the size of the OCIO market vary widely, in part because the industry has yet to consis-

tently define these relationships. Hence, identifying them is problematic. For example, strategic consulting

firm Casey Quirk recently estimated the 2012 OCIO market was $298 billion and projected it will grow to

$500 billion by 2016 (a compounded annual growth rate of 15%).1 Another firm, Spence Johnson, identi-

fied the market at $881 billion and projects growth to $1.5 trillion by 2015.2

It is difficult to say which of these figures is accurate, or if both are drastically overstated. Callan finds

that fund sponsors often decide to stay with traditional consulting when they learn certain functions

pertaining to fiduciary responsibility and liability cannot be delegated. Based on this, Callan feels the

ultimate adoption of OCIO may fall short of some industry analysts’ predictions.

Benefits of Outsourcing for Small-to-Mid-Sized Funds, Endowments, and Foundations

• A broader range of asset classes, managers,

and strategies become available. Access to

alternatives such as real assets, hedge funds,

and private equity increases. This may help

diversify and strengthen portfolios.

• The consulting firm’s staff can handle risk

management, research, due diligence, and

asset/liability modeling at levels smaller funds

typically cannot muster on their own.

• Rather than wait on an investment committee

that meets quarterly, an OCIO model allows

for rapid implementation of the OCIO’s

recommendations.

• Enhanced access can break through biases

smaller funds often have toward the home

country and broad equities.

• An OCIO potentially creates more leverage in

negotiating fee arrangements. many man-

agers offer outsourced clients commingled

accounts—or separately managed accounts

with certain asset classes commingled—giving

smaller funds access to new asset classes,

frequently at lower fees than they would

typically be charged. This includes emerging

markets, which have high custody costs that a

smaller fund could not typically afford.

1 Quirk, K. “The Outsourced CIO Movement,” Nov. 14, 2012.

2 Nauman, B. “OCIOs to Manage $1.5 Trillion by 2015: Study.” Jan. 8, 2013. http://www.fundfire.com/c/457451/51421

4

Small-to-mid-sized corporate defined benefit plans, other private funds, endowments, and foundations

are most likely to see the potential applicability of an OCIO model because these groups have fewer re-

sources and stand to benefit from the economies it brings to the table.

Some larger plans have also seen value from an OCIO model; however, Callan has experienced very

limited interest from this group to date. We attribute this to the simple fact that larger organizations tend to

have the resources necessary to manage complexity and compliance issues in-house.

While they cannot change a fund’s capital market expectations, OCIO providers are likely able to devote

more time, be more flexible, and move more quickly than an investment committee that meets intermit-

tently. Also, the OCIO provider may be more consistent than a committee, which can change portfolio

strategies along with membership seats. maintaining an arm’s length means the OCIO provider should

have the objectivity to move the portfolio only when there is a need to do so.

Fiduciary ResponsibilityAn OCIO firm may become a 3(38) fiduciary—a reference to eRISA section 3(38)—in that the fund sponsor

effectively delegates the significant fiduciary responsibilities and liabilities of investment selection, monitor-

ing, and replacement. When the OCIO organization has the discretion to make decisions for the fund, it also

takes over the legal culpability for those decisions from the fund sponsor, which can be attractive.

Giving discretionary authority to an OCIO firm that accepts fiduciary accountability for its investment deci-

sions relieves the investment committee of this responsibility. However, this does not release the commit-

tee from its fiduciary responsibility for selection and oversight of the OCIO firm. The fund sponsor must still

set goals and objectives for the fund, and clearly communicate them to the OCIO provider. These remain-

ing fiduciary responsibilities lead many fund sponsors to revisit the practicality of an OCIO arrangement.

Whereas in a traditional model the fund sponsor may focus on granular details, the responsibility changes

to strategic oversight and vendor management in an OCIO model. The role of the fund sponsor in an OCIO

arrangement does not disappear; rather, it simply changes to something different but equally essential.

Callan’s Approach to OCIOCallan is pleased to work with investors in either capacity—traditional or OCIO—depending on which is

more appropriate for their individual needs.

Callan’s OCIO methodology is an extension of our existing practices, with the same emphasis on custom-

ized, long-term, strategic approaches that have simple structures, favor proven investments, and do not

try to time the market or be overly tactical. As with our traditional model, our OCIO practice leans on evalu-

ation and implementation resources for support. each client’s existing portfolio remains the starting point

for all investment decisions. Our belief that there are no one-size-fits-all strategies applies universally.

5Knowledge. Experience. Integrity.

Callan’s traditional and OCIO processes are quite similar, save for a few subtleties as depicted in Exhibit 2.

In the example depicted in exhibit 2, Callan has been asked by the fund sponsor to take on all of the

investment committee’s decision-making responsibilities, including asset allocation, investment structure,

manager hiring and firing, and fee negotiations. We are also responsible for opening, funding, and rebal-

ancing accounts. (This is not indicative of all OCIO arrangements, as in certain circumstances Callan is

asked to assume only some of these responsibilities.)

The primary difference between the two models is the way in which decisions are made. In the OCIO

model, Callan actually serves as the client investment committee. At the outset, we form an in-house

investment committee on the client’s behalf. This committee consists of team members from our Fund

Sponsor Consulting and Trust Advisory Groups, as well as additional specialists when appropriate. The

committee is responsible for all aspects of the fiduciary process. It has full discretionary authority, meets

regularly, and votes formally on all investment decisions. Callan is responsible for implementing all deci-

sions made by the committee.

In exchange for a higher level of fiduciary and operational responsibility, we charge a higher fee for OCIO

consulting than our traditional model. However, this increase can often be offset for the investor through

fee reductions we negotiate with the investment managers, custodians, and recordkeepers employed in

the implementation of the asset allocation.

Exhibit 2

Sample Comparison of Traditional vs. OCIO Consulting

Traditional ConsultingCallan is extension of Staff

OCIO ConsultingCallan is Proxy for Staff

Non-Delegable

Plan’s Named Fiduciary Investment Committee/Board Callan and Investment Committee

Define Plan’s Objectives and Parameters Investment Committee/Board Investment Committee/Board

Investment Decisions

Determine Strategic Asset Allocation or Investment

StructureInvestment Committee/Board Callan and Investment Committee

Investment Structure; Manager Selection,

Monitoring, and TerminationInvestment Committee/Board Callan

Operational Actions/Implementation

Develop and Document Investment Process Staff Callan

Contract and Negotiate with Managers Staff Callan

Ongoing Operational Management (rebalancing, fee

payment, wire transfers, etc.)Staff Callan

Ongoing Support

Education and Research Callan Callan

Performance measurement Callan Callan

Source: Callan

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Investment portfolios created under the OCIO model may look slightly different than those of Callan’s

traditional consulting clients given the unique OCIO environment. To illustrate, we next present two case

studies revealing how OCIO implementation varies depending on the investor’s needs.

Case Study 1: Private FoundationThis small, family-run foundation has limited resources and investment expertise, and sought a more

comprehensive advisement solution to manage its $400 million pool, which was funded with cash. The

foundation’s long-term objective is to achieve a rate of return that will enable it to meet its 5% annual

spending requirement, outpace inflation, and allow for fund growth.

Callan recommended a broad asset allocation that the foundation approved (Exhibit 3). Its unique invest-

ment structure maintains a long-term, strategic approach with an emphasis on liquidity and reasonable fees.

For these purposes, we use more high conviction, concentrated managers than are typically found in other

client portfolios.

Investment Style Target Allocation

Fixed Income 30%Global Sovereign Debt 15.0%u.S. Investment Grade Credit 15.0%

Absolute Return 9%Hedge Fund-of-Funds 3.0%Global Risk Parity 3.0%GTAA 3.0%

Real Estate 10%Core Property 4.0%Income & Growth 3.0%Income 3.0%

U.S. Equity 25%large Cap High Conviction 5.0%Passive Russell 1000 Index 7.5%large Cap High Conviction 5.0%Small Cap Value 2.5%Small/mid Cap Core 2.5%Small Cap Growth 2.5%

Non-U.S. Equity 20%Active large Cap 8.0%High Conviction large Cap 6.0%Small Cap Developed 3.0%Small Cap Emerging 3.0%

Private Equity 6%Secondaries 6.0%Total 100%

Exhibit 3

Private Foundation Asset Allocation

7Knowledge. Experience. Integrity.

Case Study 2: Defined Contribution PlanThis defined contribution (DC) plan of $650 million was initially one of Callan’s traditional consulting clients.

When the firm acquired a company, it was unable to merge its DC plans due to a unique legal structure.

The prior plan fiduciaries sought an OCIO adviser to devote resources and expertise to address the new DC

plan. Callan has assumed the role of 3(38) fiduciary, and is responsible for all investment decisions. The fund

sponsor remains responsible for implementing these decisions, and we will assist staff in coordinating with

the recordkeeper and other service providers.

We conducted a fee study to evaluate existing administrative and investment fees and benchmark those

fees against peers. We negotiated recordkeeping fees and assisted the fund sponsor in evaluating the

most appropriate fee model (i.e., bundled vs. unbundled; fixed fees vs. asset-based fees). We also con-

ducted an investment structure review, taking into account the following considerations:

• Streamlining the investment lineup

• Considering multi-manager options in several asset classes

• Including a blend of active and passive options

• Evaluating the applicability of institutional vehicles

We evaluated the best investment options relative to the DC plan’s needs, then identified best-in-class

managers with reasonable fees for each asset class. The resulting three-tiered fund lineup is displayed

in Exhibit 4.

Tier I Asset Allocation Options

Tier II Core Options

Tier IIISpecialty Options

Capital PreservationMoney Market

Fixed IncomeActive Short-TermActive Core Plus

Real Assets/TIPSDiversified Real Return

Target Date Funds(Five-Year Increments)

large Cap Value EquityActive Large Cap Value

large Cap Core EquityPassive Large Cap Core

Large Cap Growth equityActive Large Cap Growth

International EquityActive International Equity

Small/mid Cap value equityActive Small/Mid Cap Equity

Self-Directed Brokerage Account (SDBA)

RIS

K S

PE

CTR

UM

Exhibit 4

DC Three-Tiered Fund Lineup Le

ssM

ore

8

Advantages and Disadvantageseach fund is different; however, there are some broadly accepted pros and cons to the OCIO model.

Advantages• Renewed mission focus: Allowing institutions to focus on their core interests is in line with a general

trend among organizations to outsource functions that are not viewed as core competencies.

• Enhanced oversight: OCIO advisers are likely able to devote more time to portfolio monitoring and

oversight than an investment committee that meets quarterly.

• Reduced opportunity costs: The OCIO model enables an advisor to develop an investment concept

and execute it quickly. This creates greater potential to capture more upside of an opportunity and

protect on the downside, as opposed to an investment committee that meets quarterly and acts slowly

over time—frequently too late to fully take advantage of an opportunity.

• More sophisticated portfolio designs: If the investor makes all portfolio decisions, the overall strategic

asset allocation may be less sophisticated than if the advisor is charged with day-to-day management

responsibilities.

• Expanded opportunity set: Outsourced portfolios tend to include more asset classes and tactical

adjustments, thus providing a broader array of return opportunities.

Disadvantages• Ceding control: most (if not all) decision-making power is delegated in an OCIO model, thus investors

do not have the opportunity to scrutinize advisor recommendations. many investors want more control

over their portfolios than is possible in an outsourced model.

• Increased costs: OCIO providers generally charge more for discretionary advice than traditional

consultants do to reflect the enhanced resources and the heightened fiduciary responsibilities they

assume in providing these services. Cost considerations can tip the scales in favor of a traditional

consulting model.

• Reduced investor education: While outsourced advisors offer educational services, there is no

doubt that investors can feel less informed in an OCIO model given their reduced proximity to the

inner-workings of the investment process.

• Risk of hiring a poor advisor: Turning the portfolio over to an advisor that is a poor match—or even

worse, an advisor that indulges in conflicts of interest—is an inherent risk of the OCIO model.

ConclusionOCIO involves the outsourcing of investment oversight, monitoring, and management to independent

experts. Institutional investors that cannot afford the substantial in-house resources required to manage

the modern portfolio might consider implementing the OCIO model. However, OCIO is not a one-size-

fits-all solution, nor a panacea for a challenging, low-return market environment.

9Knowledge. Experience. Integrity.

The OCIO market will grow in the coming years, though the magnitude of the expansion may not meet

the high expectations set by some in the industry. Callan has thus far seen the greatest interest in this

model from small-to-mid-sized private funds, endowments, and foundations. Funds that are looking to

outsource their investment process will have the most success if they pursue a customized, high-quality

approach with an OCIO provider that recognizes their fund’s unique characteristics and carefully incor-

porates them into implementation.

Is OCIO Right for Your Fund?Ten questions fiduciaries should ask themselves and their potential service providers as they contemplate an OCIO arrangement:

1. Do the fund’s governing documents allow for the shifting of investment authority?

2. To what extent will the OCIO advisor acknowledge in writing the degree to which it is acting as a

fiduciary? Once this is established, what is the investment committee’s remaining liability?

3. While some firms might have established track records as consultants or advisors, this does

not necessarily mean they are qualified to act as discretionary managers. What are their

qualifications?

4. If the fund needed the help of consultants in the past, is that need negated by the OCIO

arrangement?

5. In the event the traditional consultant is being displaced, is there a third party that can perform due

diligence on the OCIO advisor under consideration? What is the related cost?

6. If the fund’s traditional consultant stands to become its new OCIO advisor, what explanations can

the consultant give as to how the firm manages against potential conflicts of interest? Do they

have processes in place that consistently protect against these conflicts arising?

7. Will investment managers contract with the fund or the OCIO? What exclusions from liability will

managers seek from the fund for relying on the direction of the OCIO?

8. How will the investment committee evaluate the performance of the OCIO adviser? What

benchmarks or other indicators will they use?

9. Who will manage the fund’s investment policy? How must the fund’s existing investment policy

statement be amended to acknowledge the delegation of authority to the OCIO?

10. Given that the OCIO advisor will be assuming greater responsibility than a traditional consultant,

what new expenses will be associated with a switch to this model?

10

Certain information herein has been compiled by Callan and is based on information provided by a variety of sources believed to be reliable for which Callan has not necessarily verified the accuracy or completeness of or updated. This report is for informational pur-poses only and should not be construed as legal or tax advice on any matter. Any investment decision you make on the basis of this report is your sole responsibility. You should consult with legal and tax advisers before applying any of this information to your particular situation. Reference in this report to any product, service or entity should not be construed as a recommendation, approval, affiliation or endorsement of such product, service or entity by Callan. Past performance is no guarantee of future results. This report may consist of statements of opinion, which are made as of the date they are expressed and are not statements of fact. The Callan Investments Institute (the “Institute”) is, and will be, the sole owner and copyright holder of all material prepared or developed by the Institute. No party has the right to reproduce, revise, resell, disseminate externally, disseminate to subsidiaries or parents, or post on internal web sites any part of any material prepared or developed by the Institute, without the Institute’s permission. Institute clients only have the right to utilize such material internally in their business.

Authored by Callan Associates Inc.

If you have any questions or comments, please email institute@callan.com.

About Callan AssociatesFounded in 1973, Callan Associates Inc. is one of the largest independently owned investment consulting

firms in the country. Headquartered in San Francisco, California, the firm provides research, education,

decision support, and advice to a broad array of institutional investors through four distinct lines of busi-

ness: Fund Sponsor Consulting, Independent Adviser Group, Institutional Consulting Group, and the

Trust Advisory Group. Callan employs more than 170 people and maintains four regional offices located

in Denver, Chicago, Atlanta, and Summit, n.J. For more information, visit www.callan.com.

About the Callan Investments InstituteThe Callan Investments Institute, established in 1980, is a source of continuing education for those in

the institutional investment community. The Institute conducts conferences and workshops and provides

published research, surveys, and newsletters. The Institute strives to present the most timely and relevant

research and education available so our clients and our associates stay abreast of important trends in the

investments industry.

© 2013 Callan Associates Inc.

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