The outsourced CIO (OCIO) model has picked up mass adoption over the last few decades. The idea is a good one. Organizations like university endowments, foundations, and nonprofits, have the fiduciary duty to manage large pools of capital but may not have the organizational focus or desire to do so 'in-house'. OCIOs provide institutions like these the bandwidth to focus on their core non-financial responsibilities (nonprofit work, university education, etc.), while still maximizing investment returns and investing their capital responsibly for the future.
Most OCIO firms allocate money to external managers based on the individual investment risk profiles, liquidity needs, and time horizons of their clients. Hirtle Callaghan was an early pioneer in the space, and is one of several firms to credit for mass adoption of the model. The firm now manages in excess of $20BN on behalf of its clients.
Hirtle Callaghan recently hired its own CIO, Mark Hamilton. Mark Hamilton was formerly the Chief Investment Officer of Asset Allocation for OppenheimerFunds, where he managed $12 billion in global multi-asset solutions. Prior to OppenheimerFunds, he spent two decades at AllianceBernstein, where he rose from Portfolio Manager to Investment Director and Head of Dynamic Asset Allocation.
Upon joining the firm, Hamilton said "I'm proud to be joining a firm that is renowned for its client centricity and relentless innovation... I look forward to working closely with my talented colleagues to create even better outcomes so our clients can fulfill their aspirations and meet their critical missions".
SumZero sat down with Hamilton to discuss Hirtle Callaghan, manager selection, and the OCIO model.
Luke Schiefelbein, SumZero: What do you think is most misunderstood about the OCIO model? How do you approach these concerns as a value investor?
Mark Hamilton, CIO of Hirtle Callaghan: There are many nuances between the various OCIO models operating today, which can cause confusion. We pioneered an independent, conflict-free OCIO model 30 years ago and have stayed true to our roots. We have no investment products or agenda other than doing what is best for our clients. More recently, there have been many new entrants into the OCIO space, some of whom are owned by or affiliated with larger organizations such as banks, consultants and service providers. As a result, there is more confusion about whether OCIO is just another distribution channel for financial products. It is not a new distribution system. It is a fundamental change in fiduciary governance that gives investors more complete access to the capital markets. For this fiduciary governance system to work well, we believe it is critical for OCIOs to have a conflict free business structure that fully aligns incentives with client interests. Many investors don’t fully understand the differences between the various models and how an OCIO’s incentives and alignment can impact investment results.
Your question about being a value investor speaks to our experience as investment managers, although I would contrast value investing from valuation investing. I would not consider us a value investor in the traditional sense. It is true that a key component of our investment philosophy is that we seek to buy into asset classes when they are less expensive. However, maximizing breadth of opportunity is equally important to us. We seek out the best opportunities across global markets, in public and private markets and from passive and active sources. This differentiates us from OCIOs who are incentivized to use certain internal products or stick to a specific style. While we don’t want to overpay, we are completely agnostic as to where we source returns as long as they help our clients’ achieve their objectives.
Schiefelbein: What are the broader impacts of the shift from active to passive management? How have these impacted Hirtle Callaghan?
Hamilton: The indexing vs. active question is neither binary nor discrete; we view it as a continuum. As Chief Investment Officers, we are managing opportunity across three axes: all the different types of securities on one axis; all the different countries where these securities are issued on another axis, and the third axis is whether we can capture the returns via indexing or active. Successful investment programs require managing across all those axes. We are cost-sensitive because cost impacts returns, but we never want to be penny-wise and pound-foolish. We are happy to pay substantial active management fees to benefit from true manager skill.
One impact of the passive trend on Hirtle Callaghan is that it has set a higher bar for the active managers in which we invest. If the default is to get low cost exposure to an asset, then we want active managers to justify their fees by consistently demonstrating their skill. As part of our process, we dissect an active manager’s returns and risks to determine if their value is coming from market exposure or from true talent. We always want to avoid paying up for a return stream that we could access in a less expensive way.
A broader impact of the shift to passive management is, paradoxically, that active managers stand to potentially benefit. There are anomalies created as investors pour into certain stocks, driving up their market cap weighting and creating momentum that is not necessarily underpinned by company fundamentals. Good stock pickers will be able to take advantage of these opportunities.
Schiefelbein: In a recent article, Institutional Investor claimed that the OCIO business is an “industry under the gun”. What are your thoughts on the future of the OCIO model?
Hamilton: Our view is exactly the opposite. We’ve seen more and more families and institutions outsourcing, given the explosion in investment options and market “noise.” Thirty years ago when Hirtle Callaghan was founded, the choice was largely between stocks, bonds and cash, and we have moved a long way from that. We think the OCIO model is even more appealing today as more people recognize that they need help to navigate more complex global markets. What is true is that there is stiffer competition amongst OCIOs. It is a more crowded industry now with so many firms having entered the market in the past 10-15 years – banks, consultants and others. There are more players with quite different structures even though we are all lumped into OCIO. I believe that the independent, conflict-free OCIO model, which Hirtle Callaghan pioneered, will continue to thrive in the future as it puts us on the same side of the table as our clients.
Schiefelbein: Do you perceive OCIO's headwinds as an existential threat to the industry or a natural pressure that will ultimately improve the field of competitors?
Hamilton: As I said earlier we don’t perceive OCIO as having a headwind. It is one of the fastest growing segments in investment management. All new market segments begin with a group of pioneers who are followed by a flurry of new entrants and then a shakeout consolidation. That shake out is usually a function of two factors – 1) particular competitors gaining an edge and 2) consumers becoming more discerning about their choices. The more people understand the advantages of an independent investment office, the more these requirements become clear.
If there is any pressure, I view it as wholeheartedly positive for the industry. It forces everyone, including Hirtle Callaghan, to be introspective as we look to stay at the top of our game. The increased competition in the OCIO space, for example, has helped us become sharper in defining and communicating our unique value proposition. As I mentioned earlier, there is diversity among OCIO structures, and we view our transparent model as being a real differentiator. It was a pioneering model when we started in this business 30 years ago and it still distinguishes us, especially as many new players have entered the OCIO marketplace with dramatically dissimilar, and highly conflicted, models.
Schiefelbein: Natixis Investment Managers released a survey indicating 30% year on year growth in OCIO interest from institutional investors. What is causing this surge of interest? What role should an OCIO play in an institutional investor’s portfolio?
Hamilton: We see the surge in interest resulting from the increased complexity of the global marketplace, and an acknowledgement from institutional investors of just how hard it is to navigate a greater number of investment options. This is secular change, not a temporary trend. As more investors think it through the logic becomes more and more inescapable. Market complexity and noise have increased dramatically over the past 30 years, yet governance structures remain unchanged; the Investment Committee consists of well-intended volunteers meeting quarterly at best. It used to be easier for institutions to fulfill their fiduciary duty with a savvy Board and very limited internal staff. With the proliferation of choices – global vs. local, passive vs. active, traditional vs. alternative to name a few – there is greater recognition that it takes a team of experts, and that is expensive to do in house. The OCIO model replicates that benefit for those who choose not to pay for an internal department. We have always seen our role as a co-fiduciary, serving as our clients’ advocates in the marketplace and helping them fulfill their duties. As a conflict-free OCIO, we sit entirely on their side of the table and build investment solutions that solve their tough problems. By creating a model of a purely aligned firm, we set the bar high for how an OCIO can serve as a true fiduciary partner.
Schiefelbein: What are the biggest benefits for an institutional investor using an OCIO and what are the most salient drawbacks?
Hamilton: While the core fiduciary duties of an institutional investor do not change with the hiring of an OCIO, we believe that these duties are able to be performed better and at a more reasonable cost. Institutions are able to leverage the enhanced resources of an external team as opposed to having to hire and oversee additional staff. By broadening their resources, they are able to access a greater opportunity set of investments and increasing breadth has been proven to enhance returns. In addition, alleviating the hassle of day-to-day decision-making and execution allows institutional investors to focus on their higher-level responsibilities – setting strategic direction and overseeing the OCIO’s ability to achieve results. All of this creates greater peace of mind for internal staff and Board members of institutions.
One challenge for institutional investors is having the right governance structure to facilitate clear, smooth decision-making. Our extensive experience has given us insight into best practices in governance, and that makes us valuable partners to institutions. We work with our clients to clearly delineate their “governing” fiduciary responsibilities from our “managing” fiduciary responsibilities.
Schiefelbein: What are the biggest challenges facing OCIO firms like Hirtle Callaghan? How do you keep Hirtle Callaghan nimble with a $20B AUM?
Hamilton: As mentioned earlier, all OCIOs are increasingly challenged to differentiate ourselves as the number of OCIO firms grows. We believe that this is ultimately positive as it forces both us and our competitors to crystallize our unique value proposition.
With regard to size, we believe that one of Hirtle Callaghan’s advantages is that we are big enough to matter, but small enough to still be very nimble in the marketplace. At $20 billion, we have enough scale to gain access to specialist managers and negotiate reasonable fees, but we are not precluded from investing in smaller managers, even those under $1 billion. This combination is extremely powerful and a significant asset versus very large competitors who are too big to take advantage of niche investment opportunities.
We have been in business for 30 years and we view ourselves as a still very young institution. Our greatest challenge, which is also our greatest opportunity, is to identify, acquire, develop and retain talent within a team structure that remains famously client-centric and collaborative.
Schiefelbein: How large is Hirtle Callaghan’s multi-manager active strategy? What differentiates your investment process from other multi-managers?
Hamilton: Our entire program is multi-manager. Managing managers is an important task of an investment office, but it is only one task. We are constantly evaluating return sources across the globe in terms of risk-adjusted, net-of-fees opportunities. Some of those return sources are best acquired through indexing and others through active managers. Our job is to manage the entire breadth of the opportunity set on behalf of each client. Consequently, each client’s solution must be different and tailored to their needs. Most multi-manager solutions are one-size fits all. Our process is truly differentiated in that it is completely client-driven. Although virtually all of our clients will be diversified across multiple managers, the mix of strategies and managers is different for each client depending on their return profile and their tolerance for risk.
To figure out the right asset and manager mix for each client, we take them through a robust planning process at the onset of the relationship. Our goal is to get to the heart of what they are trying to achieve and determine how much risk they are able and willing to take. Then we create solutions with these specific goals and risk parameters in mind. As an independent, conflict-free OCIO, we can choose from broadest range of managers and styles, taking advantage of any available opportunities that fit with our client’s profile. We believe that our ability to tailor solutions, along with our ability to independently source managers, is truly unique in the industry.
Schiefelbein: What key traits do you look for when investing in a manager? What are the biggest red flags?
Hamilton: We view the people we partner with as integral to our success. We always look for managers who have a value system that is similar to ours, adhering to the highest ethical standards and consistently acting in a professional and fair manner. Recognizing that the investment business is hard, and no one gets it right every time, we look for managers who have humility. There is great value to openly acknowledging mistakes and learning from them. Great managers are also humble enough not to extrapolate their success in one area to an unrelated domain. We prefer managers who recognize their limitations and stick to their core competency. They are able to demonstrate a repeatable process, efficient decision-making and a disciplined approach to portfolio construction and monitoring. Finally, we seek out organizations that maximize their talents through thoughtful alignment and incentives. We look at the percentage and make-up of partner capital invested in the fund, the compensation structure, ownership structure, fees, terms and growth incentives.
Red flags are the converse of these traits: dishonest people, overreaching, overconfidence, extending beyond means, inconsistent investment process and poor alignment with investors.
Schiefelbein: What advice would you give a value manager looking to raise assets in the current bull climate?
Hamilton: We are currently not looking to raise assets for any particular strategy. The benefit of being a multi-asset manager is that we have a wide variety of opportunities and return sources available to us.
Schiefelbein: Has the internet changed how you select managers? Has it impacted how you do due diligence?
Hamilton: The internet has made information ubiquitous. There is much more ‘desktop’ research easily available to help us filter managers, including performance, holdings, regulatory filings and social networks. This makes it easier to analyze managers and weed out those who are simply riding the coattails of a strong market. However, on-site due diligence remains the paramount decision factor. There is no substitute for knowing the people who are making investment decisions and having confidence in their ability and the strength of their organization.
Schiefelbein: A common criticism of the OCIO industry has been the lack of transparency and public track records. How do you market yourself to prospective investors without relying on traditional data points like performance?
Hamilton: We pride ourselves on being radically transparent. This includes showing performance to prospective investors so that they have enough information to make an informed decision about choosing us as a partner. We feel that it is an important part of the process.
Our transparency goes well beyond performance and influences every part of our process. We prize openness, and work as close partners with our clients from day one to make sure that we have an asset allocation that reflects their goals and true ability to take risk. We create customized solutions, and educate clients about our portfolio positioning and views on the markets. We believe in having a truly interactive, collaborative process so that we can best serve our clients.