For decades, non-discretionary investment management was the de facto standard for most foundations, endowments and nonprofit investment committees. With a cadre of sophisticated in-house investment talent, the largest of these organizations would only periodically turn to outside consultants for specialized asset allocation and/or manager selection recommendations. And despite far more limited in-house resources, their medium-sized and smaller counterparts tried to follow suit.
After the tech bubble of the early 2000s and the subsequent financial crisis of 2008, however, a growing number of nonprofits began to realize that they simply lacked the necessary internal investment resources to actively and effectively manage and rebalance their portfolios in a timely manner. Turning to their advisors for a more end-to-end outsourced solution, the discretionary investment management model experienced a major growth surge.
Rather than trying to internalize every function, the discretionary approach (often referred to as an outsourced CIO or OCIO model) provides the consultant with broader discretion over the selection of investment managers, implementation of investment strategy and ongoing portfolio rebalancing—with the investment committee providing essential oversight and monitoring.
Discretionary model continues to gain traction
In addition to limited in-house investment expertise, a number of other factors have steadily driven smaller organizations to outsource investment management.
- The discretionary model minimizes any lag between recommendation and implementation—a factor that can be pivotal to portfolio performance given the increased market volatility of recent years.
- It provides daily (rather than quarterly) oversight of assets, which enables greater responsiveness in a lower return environment.
- And it empowers organizations to add a greater variety of nontraditional asset classes with low correlations to traditional portfolio holdings, as well as expand the global scope of their investment opportunities.
Perhaps most importantly, because the investment committee’s role shifts under the discretionary model, much of the day-to-day fiduciary obligation is shifted onto the shoulders of the consultant/advisor.
Discretionary OCIO Growth 2013 – 2020
Cost and control
Typically, cost and control are the primary factors which often dissuade organizations from moving to a discretionary model. Understandably, most providers will charge more for discretionary investment management as opposed to non-discretionary investment recommendations. Therefore, if cost is the sole determinant, a non-discretionary relationship may be preferable. Keep in mind, however, that absolute costs should be weighed against both ancillary costs (e.g., the savings associated with outsourcing back-office responsibilities) as well as the opportunity costs associated with freeing up committee members to focus more on the organization’s mission and vision.
Investment Management Models
|Investment Policy Design||Yes||Yes|
|Capital Markets Assumptions||Yes||Yes|
|Asset Allocation - Strategic Targets||Yes||Yes|
|Asset Allocation - Tactical Shift Response Time||Greater response time due to the ability to make decisions outlined in the Investment Policy Statement||Limited response time due to the need to seek approval from the Investment Committee|
|Manager Research / Due Diligence||Yes||Yes|
|Manager Selection - Hire / Terminate||Greater ability to quickly select and implement managers best suited for designated asset class||Investment Committee is responsible for selecting managers presented by the consultant - Limits response time|
|Fiduciary Responsibility - Investment Provider||Higher as a result of increased decision making responsibilities||Lower due to increased role of Investment Committee|
|Fiduciary Responsibility - Investment Committee||Lower - Allows Investment Committee to focus more attention on policy and governance||Higher level of responsibility due to investment decision-making role|
|Fees (Explicit)||Higher as a result of increased decision making responsibilities||Lower due to increased role of Investment Committee|
For some investment committee members, meeting with investment managers can be the most intellectually stimulating, engaging and enjoyable part of their duties, and may be a principal reason why they volunteered for the role. There’s always a risk, therefore, that moving to a discretionary model could be viewed negatively by some investment committee members who are reluctant to relinquish that responsibility.
Choosing the right model for your organization
The world of investing offers few absolutes, and this decision is no exception. There’s no right or wrong approach when it comes to choosing a discretionary or non-discretionary investment model for your organization. Instead, a multitude of factors need to be carefully weighed to determine which side of the scales you most gravitate towards. How much time, expertise and resources are board members and staff willing to devote to investment management? How large and complex is the portfolio you’re overseeing? Which model best aligns to the structure, composition and dynamics of your committee? And what is your organization’s overall comfort level with each approach?
Regardless of which approach you use, you still retain a solemn fiduciary duty. The discretionary model simply shifts that duty to one of oversight and governance. In addition to a well-articulated Investment Policy Statement (IPS), it’s essential you retain full transparency into the manager selection, performance analysis, and replacement process, as well as detailed fee and liquidity analysis.
About Truist Foundations and Endowments Specialty Practice
Truist has more than a century of experience working with not-for-profit organizations. Fiduciary stewardship is the heart of our culture. We’re not just a provider, but an invested partner—sharing responsibility for prudent management of not-for-profit assets. Our client commitment, not-for-profit experience, and fiduciary culture are significant advantages for our clients and set us apart. The Foundations and Endowments Specialty Practice works exclusively with not-for- profit organizations. Our institutional teams include professionals with extensive not-for-profit expertise. These professionals are actively engaged in the not-for profit community and are able to share best practices that are meaningful to their clients. Team members offer guidance and advice tailored to the various subsets of the not-for-profit community, including trade associations and membership organizations. Our Practice delivers comprehensive investment advisory, administration, planned giving, custody, trust and fiduciary services to trade associations, educational institutions, foundations, endowments and other not-for profit clients across the country.
Interested in having a deeper conversation about discretionary versus non-discretionary investment management? Contact your Truist relationship manager or investment advisor or call us at 866-223-1499.