As institutional investors seek to maximize returns and manage risks, outsourcing investment strategy development has become an increasingly popular option. By leveraging external expertise, investors can gain access to sophisticated investment strategy templates developed by specialists. However, blindly adopting an outsourced investment strategy without proper evaluation can lead to suboptimal outcomes. When considering outsourced investment strategies, investors should focus on alignment with organizational goals, risk management, fees and customizability. Comprehensive due diligence and ongoing monitoring are essential to ensure the strategy continues meeting its investment objectives.
Evaluate alignment of outsourced investment strategy templates with organizational goals
The investment strategy template provided by external managers may not fully align with an organization’s specific return objectives, risk tolerance, investment horizons and liquidity needs. Investors should assess how the investment strategy balances growth, income generation and capital preservation. It’s also important to analyze the portfolio’s composition across asset classes, geographies, sectors and security types compared to internal targets. Any mismatches with organizational investment policies and constraints need to be identified. Investors can then work with the external manager to adjust the template as needed to meet strategic asset allocation goals and other requirements.
Assess risk management approaches used in outsourced investment strategy templates
While outsourced strategies promise expertise, the ultimate fiduciary responsibility lies with the investor. Evaluating the investment manager’s risk management philosophy and processes is critical. Investors should review the portfolio’s level of diversification across securities, sectors, countries and asset classes. Risk mitigation strategies such as exposure limits, stop losses, hedging and liquidity management should also be analyzed. Stress testing the investment strategy under different market conditions can further gauge its risk and return characteristics. The goal is to ensure the outsourced strategy’s risk alignment and expected volatility are acceptable.
Scrutinize fees, incentives and potential conflicts of interest
While easy to overlook, fees can significantly erode net returns over time. Investors need to analyze management fees, performance fees, transaction costs and any other expenses associated with an outsourced investment strategy. It’s also prudent to evaluate how incentives and compensation for investment managers and any related parties may influence decision making. There could be motivations to take on excessive risk, complexity or illiquidity. Investors should proactively identify any potential conflicts of interest and misalignment with their best interests.
Evaluate customizability options for the outsourced investment strategy
Outsourced investment strategies are often rigid templates that may require modification to suit an investor’s unique requirements. Investors should assess to what degree they can customize or constrain the strategy’s composition, risk levels, tax considerations, liquidity requirements and other factors. If the manager is unwilling to provide adequate customization, the standardized template may be a poor fit. On the other hand, managers that allow excessive tailoring may lack expertise in implementing the strategy successfully. Finding the right balance is key.
Adopting outsourced investment strategy templates can provide valuable expertise. However, proper due diligence is vital to ensure the strategy aligns with organizational goals and risk tolerance. Fees, incentives and customization options should also be evaluated thoroughly. Ongoing monitoring and open communication will help realize the full benefits.