Outsourcing: the right move for your portfolio? "Should we outsource part or all of our investment management function?" That's a question on the minds of many leaders of not-for-profit healthcare organizations. And given the many nuances to be considered, there is no simple answer

Healthcare Financial Management, May, 2007 by Dennis Doody

In reality, outsourcing is a comparatively new label for an activity that existed since the dawn of commerce. Few organizations have ever been so vertically integrated that they supplied themselves with all the goods and services they need. In recent decades, organizations of all types and sizes have increasingly focused on their core competencies and contracted or partnered with specialized providers to buy needed goods and services outside their principal value stream. Outsourcing lowers costs, generates greater efficiencies, frees up resources, and usually results in better quality.

Outsourcing also is not new to the healthcare world. Healthcare providers often outsource environmental services, nutrition, IT, and even some clinical functions. But in the case of investment management, healthcare providers have seemed reticent to move ahead quickly.

What is it that providers have been hesitant to pursue? As defined here, outsourcing the investment function means assigning responsibility for day-to-day investment management to a qualified and competent external provider that manages a majority of a healthcare institution's investment funds. This idea is not completely new for healthcare providers. To various degrees, providers have long outsourced aspects of the investment management process, including the retention of outside investment managers. Indeed, providers commonly outsource the custody of portfolios to outside organizations. So the question remains: Why should healthcare providers consider moving forward on outsourcing the investment function?

Why Outsource Investment Management? The most obvious benefit of outsourcing investment management is the opportunity it affords for lower costs, greater efficiencies, and freed-up resources. But another important benefit is its salutary effect on investment management decision making.

For one thing, outsourcing investment management facilitates greater diversification. A truly diversified portfolio requires substantial staff and board time to manage effectively because of its wide range of asset classes, with diversification extending within each asset class. Yet healthcare organizations typically have small financial staffs that are spread thin, and their boards and investment committees often meet as infrequently as four times a year, making effective oversight of a diversified portfolio problematic.

Consider, as well, the shift toward investing in classes of assets called alternatives, a term that usually refers to assets that are not traditional, liquid, long-only equities, fixed income, and cash. Investments currently defined as alternatives include real estate, commodities, venture capital, private equity, natural resources, timber, distressed debt and hedge funds. Each of these categories involves its own intricate strategies. Thus, along with an increased number of asset classes and strategies to manage, there is a need for considerable specialized knowledge for informed decision making.

The Essential Challenges

The conundrum created by the growing complexity of investment management and limited human resources is, "How can trustees exercise their responsibilities in a manner consistent with that of a fiduciary? And how can a group of individuals focus limited resources to fully address all issues from high-level policy decisions to manager selection?"

A fairly consistent board-level response has been to focus energies on low-level decision making to the detriment of the high-level policy issues. This approach, while easy to fall into, does not fulfill the primary mandate of a trustee-level committee. Reporting on a recent study of the behavior of investment committees, Arnie Wood, founding partner of Boston-based Martingale Asset Management, observes, "When committee members were asked what their priorities were and how much time they spent on various topics, the answer was the opposite of what we expected. Planning issues, which take a lot of thought and a lot of discussion, were not things that they liked to spend time on. Instead they would rather spend time on tasks like talking to managers or thinking about the market. They appeared to spend more time on management than on governing."

Investment committees need to guard against these tendencies, because they have real work that is clearly critical. They play a key role in maintaining an institution's financial equilibrium, only part of which is responsibility for management of the investment portfolio.

What Can--and Cannot--Be Delegated?

The fiduciary responsibility of a trustee committee most certainly cannot be delegated. The board's investment committee, on behalf of the full board, must provide institutional leadership on matters of investment policy, investment objectives, asset allocation, and spending policy. And that, for a body composed of part-time members, is a full-time job.

To ease its burden, however, the committee may delegate certain tasks to qualified organizations--selected with appropriate care--and still fulfill its duty as guardian of the organization's financial well-being. Transferring daily management, administration, and reporting duties to the outsourcing partner strengthens trustees' ability to fulfill their fiduciary role, giving them more time to devote to critical long-term objectives.