The Outsourced Chief Investment Officer Model of Management and the Principal–Agent Problem

By convention, the responsibility for framing pension fund investment strategy lies with boards and their investment subcommittees, outsourcing the major part of the implementation of chosen investment strategies to various asset managers. In recent years, some pension funds have begun to outsource both investment strategy and implementation, thereby locating authority and responsibility with external providers. In this article, we focus on the Outsourced Chief Investment Officer (OCIO) model of management, emphasizing the forces driving the adoption of this type of arrangement, its characteristics, and what defines success. This model of management has the merit of replacing multiple providers with one contract on a fee-for-performance basis. For this model to be effective, it is shown that it must be well governed. This requires clarity of mandate and delegation, as has been noted in prior research on pension fund governance. In addition, any governance regime must address the principal–agent problem if the OCIO model is to realize clients’ ambitions. This may require high-level board competence, investment advisory services, and performance assessment processes that are sensitive to the unseen forces that influence success