Building a successful OCIO partnership: an endowment’s perspective
Jeff Mindlin, CIO at Arizona State University Enterprise Partners, sat down with Mark McCombe, BlackRock’s Chief Client Officer, to discuss his experience using the outsourced chief investment officer model and to share his thoughts on how endowments can forge successful partnerships, why he believes portfolio construction and alternative assets are going to become increasingly important, and where he sees cause for optimism amid challenging market conditions.
Key takeaways
01
You can't outsource your strategy.
For a relationship to be successful over the long term, there needs to be a philosophical alignment between endowments and their OCIOs.
02
Portfolio construction and alternative assets are key.
With yields ultralow, hitting return targets is going to be challenging. To succeed, you’re going to need a smart, cost-efficient asset allocation and an innovative approach to alternative assets.
03
Sustainability is here to stay.
Sustainability and ESG strategies will increasingly become mainstream. Eventually, the line between sustainable and traditional investing will probably go away.
What are the key components that endowments and foundations should look for in an OCIO relationship?
-
Mark McCombe: I wonder if you could focus for a second on the thought process that an endowment or foundation like yours goes through in terms of, what are the key components of what it's looking for in that relationship, and what are some of the things that, in the concept of bringing a partner in, that you hope to achieve?
I guess with the follow-on question being, do you think those questions are even more pertinent today, given where we are with the state of the globe and the pandemic and some of the macro issues that endowments are facing?
Jeff Mindlin: When I came onboard, my first day I had a note on my desk from our president on a peer endowment performance report that said, "I don't expect to be on the top every year, but I'm sick of always being on the bottom. Welcome to ASU."
And I think with our committee, the real issue was that we found consultants at our OCIO really weren't focused on the portfolio construction side. They were maybe really focused on manager research. And I think one of the things we saw as an example of that was this major value bias in our portfolio that wasn't necessarily deliberate or even communicated to our committee.
That was I think really key to understanding things as we took on, I think. Overall with an OCIO model or that search, the importance of clearly defining the roles and responsibilities of staff, the committee, and the OCIO, are key.
We like to say that you can outsource implementation, but you can't outsource your strategy. And that was really clear when we were working together in a collaborative way -- staff, the investment committee, and BlackRock -- in defining our course and strategy for the endowment.
Also I think it's important for the stakeholders to really think about what is the role of the committee in an OCIO world where the OCIO has discretion. We definitely went through some growing pains with our old OCIO, and what do we want our investment committee to do given that they weren't supposed to be in the weeds and thinking about individual managers.
So I think ultimately, communication is key on a lot of these areas. It's been a common refrain in our meetings that we want to let Blackrock be Blackrock, and trust and confidence are certainly key in giving the OCIO enough leash, and I think that's earned through communication.
To begin, it is critical to clearly define the roles and responsibilities of the staff, the committee, and the OCIO. We like to say that you can outsource implementation, but you can't outsource your strategy. For the relationship to be successful long term, there needs to be a philosophical alignment between the endowment or foundation and the OCIO. For ASU and BlackRock, that philosophical alignment is based on innovation, sustainability, and a commitment to our communities.
Of course, performance is also critical. We had some real performance challenges with our original OCIO provider. A big issue was that the consultants at our OCIO weren't focused on portfolio construction; they were focused on manager research. This resulted in a major value bias in our portfolio that wasn't necessarily deliberate and wasn’t even communicated to our committee.
You can outsource implementation, but you can't outsource your strategy.
You mentioned sustainability as one of your core philosophical beliefs. Can you tell us a little about your journey there?
-
Mark McCombe: Jeff, thank you for that, a very thoughtful answer on a range of topics. You mentioned sustainable investing a little bit ago. I think one of the things we place a premium on is that when you go into one of these whole portfolio partnerships, it's so important to understand the whole enterprise. And certainly from the point of view of universities, clearly there are a lot of stakeholders who have very strong opinions and want those opinions to be heard, whether it's donors, a student body, faculty, and the board itself of course.
So, maybe you could talk a little bit about the journey you've been on from a sustainable point of view. I know there's been a lot of exciting development both from your side as well as working in partnership. And just how critical has the kind of insight into what the macro trends are in sustainable investing, how important has that been to you and the investment committee?
Jeff Mindlin: Yeah, I mean, I think it's probably one of the key areas that we've been working on for the last year or two, and I think BlackRock's really been critical to our journey. As a fiduciary investment committee, there's obviously this balance of trying to think about the desire to maximize risk-adjusted returns with the message from the university of how to best align the investments in a manner that's consistent with their leadership in this realm.
And I think sometimes that's a fine line to walk. And again, it's been really valuable to have you guys helping us think through that. In the early days, a lot of that was around again the analytic capabilities that BlackRock has through Aladdin, helping us understand what we owned across a multi-asset class portfolio, ultimately then helping educate our committee on what is meant by responsible investment.
I think there's a knee-jerk reaction to think about it in one of two areas, whether that be divestment or concessionary impact investments. And so, being able to educate the committee that that's not necessarily what we're talking about, and how it fits into the portfolio, was really key in their awareness and adoption.
And then, helping them understand how BlackRock at its core is using ESG as a lens in the manager research process. So even before we had explicit mandates and activities and objectives, those things were happening in the portfolio just by nature of our relationship already.
As a fiduciary investment committee, we have to balance the desire to maximize risk-adjusted returns with the desire of the university to align the investments in a manner that's consistent with its leadership in the sustainability realm. Sometimes that's a fine line to walk.
In the early days of our journey, we heavily leveraged the analytic capabilities that BlackRock has through Aladdin, to help us understand what we owned across a multi-asset portfolio, and to help our committee understand what responsible investment means. There’s often a knee-jerk reaction to the topic of sustainable investing: many people think that it has to mean either divestment or concessionary impact investments. The ability to show the committee that that’s not the case was really key in their awareness and adoption.
It was also critical to help the committee understand how BlackRock, at its core, is using ESG as a lens in the manager-research process. So even before we had explicit sustainable mandates and activities and objectives, we were already pursuing sustainable outcomes just by the nature of our relationship.
All of that helped pave the way for us to create a dedicated, mission-aligned portfolio this year. It’s an asset pool that is designed to deliver sustainable, responsible outcomes that are consistent with the mission of the university, without giving up return.
Beyond investment performance and philosophical alignment, what are some of the critical elements that you think make partnerships successful over the long term?
We don’t think about our service providers as just vendors, we really want to find ways to deepen our relationship in other areas. For example, as a large university, we have a lot of student-managed funds that are investing parts of the endowment, and these students have really benefited from the educational resources that BlackRock has provided.
We've also been able to work with BlackRock to host leadership forums for our team and many of our donors. These forums have been instrumental in providing insights to our constituents, and they really add additional value that you can’t get from just meeting four times a year to talk about your investment portfolio.
This has obviously been a very difficult year on so many fronts. As we head into 2021, where do you see challenges and what gives you cause for optimism?
-
Mark McCombe: As we end 2020 and head into 2021, what are you focused on, what are you optimistic about?
Jeff Mindlin: Yeah, this is tough, right? All asset classes are expensive right now. In the endowment world, we can't go to cash. As you alluded to, higher ed funding challenges are putting more pressure on endowments, so we can't look to cut the payout either. And at the same time, pre-COVID the prior 10 years were probably as good as it got -- you had stocks and bonds up with almost no volatility.
So, I think as we look forward, it's going to be challenging. You guys are going to definitely earn your keep in the next 10 years, I think. There's going to be more importance on portfolio construction, more importance to alternatives.
More allocators are adding to private equity, but again there's a lot of research that those returns maybe aren't all they're stacked up to be. So, this idea of just achieving median returns isn't going to be enough, and we need alpha, especially from that side.
And I think when we look at our portfolio, with yields where they are and hedge funds doing what they do, this idea that [needing] a 5 percent payout gets harder and harder when so much of your portfolio is probably lower than that.
So, I think it's going to be a challenge to hit those targets. I think thought leadership is important, portfolio construction becomes key. I think a smart allocation of assets in a cost-efficient manner, and using that fee budget where necessary is critically important. And looking for new and innovative ways to find alpha is going to be what really separates the pack, I think, in the next decade.
Let’s start with the challenges. All asset classes look expensive right now, and in the endowment world we can't go to cash. Higher education funding challenges are putting more pressure on endowments, so we can't look to cut the payout either. At the same time, pre-COVID, the prior 10 years were probably as good as it got for investors: stocks and bonds both posted impressive returns with low volatility. So, as we look forward, I think portfolio construction and alternative assets are going to be increasingly important.
Within alternatives, more allocators are adding to private equity, but there's a lot of research that suggests PE returns might not be all they're stacked up to. So, we believe that just achieving median returns isn't going to be enough, and we really need alpha, especially in private markets.
And with yields where they are, hitting return targets and achieving a five percent payout is going to be quite difficult. To succeed, you’re going to need a smart, cost-efficient asset allocation, and you’ll have to use your fee budget wisely. But what’s really going to separate the pack in the next decade is finding new and innovative ways to source alpha.
What’s really going to separate the pack in the next decade is finding new and innovative ways to source alpha.
That said, there are several things I’m optimistic about. Within alternatives, we feel good about the infrastructure we've set up with our custom hedge fund portfolio. We're also bullish on our approach to private equity. We think co-investments have a big role to play in the PE portfolio, and we’re looking at innovative strategies, such as long-term private equity.
Turning back to sustainability, we expect that it will become mainstream and that we’ll see increased use of ESG strategies. Eventually, that line between sustainable and traditional investing will probably go away, and I think that’s a cause for great optimism.
