The Verger Way: An OCIO playbook in sourcing opportunities with a purpose

Named after a short story by W. Somerset Maugham, Verger Capital embraces change in an uncertain world, recognizes opportunity and takes initiative with humility and awareness.

The outsourced CIO (OCIO) spun out of the Wake Forest University Office of Investments in 2014 with the aim of exclusively serving non-profit organizations including endowments and foundations, most primarily focused on educational institutions, non-profit healthcare entities and community and cultural foundations.

Indeed, the firm is known for being an early adopter of ESG and diversity screening its external managers.

Jim Dunn, the CEO and CIO at Verger, is well known in investor circles from his time as Wake Forest’s endowment CIO. Prior to that, he was a managing director at Wilshire Associates and the CIO and portfolio manager for Wilshire Funds Management.  

Verger CEO and CIO Jim Dunn (provided)

Vailakis: A 2020 study by Chief Investment Officer magazine found that 37% of organizations surveyed were already outsourcing their investment program or were making plans to do so within the next few years. Speak to the dynamics you’re seeing around this increasing trend.

Dunn: It’s interesting, because while I think 2020 was a perfect storm, it also exposed a lot of underlying trends or concerns for investors and institutions. The market volatility that was born out of the global pandemic, the following recession, the racial inequity laid bare by the events in the past year and half, and a national leadership vacuum made institutions rethink a lot of things.

All of this coupled with trillions in bailouts and an uneven closing and re-opening of the global economy created unique challenges for investors and their clients. The number of endowments and foundations that are outsourcing, such as our clients, and those considering it or rethinking their strategies, has grown.

Many non-profits want to improve their investment processes. They want to have the confidence that this process is going to achieve their goals so they can focus on their organization’s mission. Often investment selection isn’t the highest and best use of their time.

During this period of economic volatility, social and political change around the world, and growing social needs, our work matters, more than ever. Many non-profits cannot afford to experience operational challenges and major declines in their investment portfolios simultaneously.

An example of what I’m talking about is an institution such as a hospital system that, during the height of the market volatility in 2020, received a multi-million dollar capital call from a private equity manager that they are invested in, but may not have been able to facilitate it as easily when revenues were down. The hospital couldn’t do more profitable elective surgery and had a building full of COVID patients and nervous nurses and doctors. This is not the best time for their investment adviser to come to them with a liquidity conversation. You add to that a low interest rate environment, or nearly no returns from classic fixed income, and what you find are investment divisions taking on more risk or illiquidity which might play out well in the long run, but it may not.

Investing isn’t a spectator sport, so many non-profits are intent on outsourcing to a true fiduciary partner that can help them surmount these challenges and more.

Vailakis: What distinguishes Verger from other outsourced CIO firms?

Dunn: I love this question. While there are a lot of ways I see Verger as unique in the space, I always lead with Verger’s endowment DNA as what really sets us apart and gives us an edge.

Our heritage is a rich history of endowment management and a unique understanding of the role these critical funds play in supporting an organization’s mission. Running an endowment is very contextual, it depends on the nature of the institution, its history, its ambitions, its financial resources, and the social context. Our roots in higher education, our sole focus on non-profits and our scale allows us access other institutions may not have.

Non-profit endowment and foundation management is all we do; we don’t have to worry about other lines of business or other stakeholders. Our clients know we are focused on one thing: protecting their portfolios, performing above spending and inflation to grow their assets, and providing liquidity when they need it most.

Being an OCIO means we are a true fiduciary for our clients, and we put them and their interests first. Consultants may offer sector or strategy buckets, but they may not be accountable for their manager selections, in some cases blaming the board for picking the wrong manager. Some questions I would pose to an institution looking to outsource are: How does a large consultant provide access to a limited capacity VC manager or co-investment? How does a consultant fire a manager for one client but not another? 

While an OCIO may not be the right fit for everyone, for non-profits that don’t have the time, investment management expertise, ability to do thorough research and risk management and dedicated team, it can be an ideal relationship.

An OCIO can achieve economies of scale far beyond what many endowments could do on their own. We focus on alignment of values and risk tolerance for our clients, and we are accountable for the results.

Vailakis: In the context of an institutional asset owner looking to designate a third-party OCIO/discretionary investment advisor to share fiduciary responsibility, what advice do you give?

Dunn: An OCIO provides the resources and capabilities needed to manage complex investment portfolios, such as: asset allocation and (in some cases) asset/liability modeling; evaluating and managing the full range of asset classes; implementing complex investment strategies; liability hedging strategies and overlays; access to elite and potentially closed managers; and risk management analytics.

They also bring a complete back office with legal experts to negotiate and execute agreements with managers, independent compliance officers, and an operational staff to interface with managers and custodians.

The more we understand about broader objectives, the better we can work with clients to tailor an investment program to meet their long-term goals. We can be value-added in discussions surrounding spending policies, liability hedging, liquidity policies and more. On top of the critical work of serving as their investment adviser, we also endeavor to serve as an extension of the clients’ staff and for them to rely on us beyond the management of their portfolio for things like board education, capital campaigns, or support with their annual audit. 

I usually ask a non-profit endowment or foundation if they are truly ready to outsource considering politics, board engagement and the fact that they will be giving up some control.

We ask them to be painfully honest — what are their strengths, what are their capabilities, and what risks can they tolerate. Four, five or six volunteer trustees meeting a few times a year to spend 90 minutes picking managers is a terrible way to fulfill your fiduciary duty as a trustee of a non-profit. That said, understanding what it really means to outsource and how to best align your goals and expectations with your investment adviser is important. Based on all that, we can work together to create a vision that is ambitious but reachable.

Another critical aspect when considering any outsourced relationship is what it means to break up — unfortunately not enough institutions ask that question and may get stuck with very unfavorable terms when they choose to leave. This may include departure fees, gating of distributions, and in-kind distributions of illiquid assets, among other things.

Sometimes, longer lock-up vehicles are chosen as part of a discretionary arrangement. When allocating to these managers at the recommendation of an adviser, you are effectively skipping the dating stage and marrying those managers — for better or for worse.

Ten years down the road, you’re still paying a fee and you can’t sell the holding, so I advise firms to consider OCIO engagements in terms of how a breakup could occur. Any institution choosing an outsourced provider should go in ‘eyes wide open’ and be just as focused on what happens on the back end as they are on the front end.

Vailakis: Please speak to how the OCIO business is an evolution of the classic consultant (and/or fund-of-funds) model and where it fits in the private investing landscape.

Dunn: The OCIO model is a significant evolution from the classic consulting model. Hiring an OCIO is a way to have the benefits of a seasoned investment office, without having to build and maintain it.

As an OCIO you are responsible for success and failure. You shouldn’t blame the board of trustees or suggest they made the wrong hire. You don’t make recommendations as an OCIO, you have discretion over some or all of the portfolio.

I was a collegiate student athlete and one of the great things about playing sports is accountability — there is no hiding when you miss a block or overthrow first — you have to take responsibility for actions that don’t turn out well, just as you accept praise for the ones that succeed. You are a fiduciary as an OCIO, and that’s not easy for consultants to do. It’s a different mindset from that of consulting — it becomes more about accountability, process, relationships, and scale.

Vailakis: Does serving primarily non-profit institutions encourage certain unique considerations from a portfolio construction perspective?

Dunn: Absolutely.

Managing non-profit assets is an extraordinary privilege and a rewarding process — but it keeps everything in perspective. As an endowment investor you have the ultimate advantage, time. There is no asset or asset class you can’t invest in. Everything you do is measured in perpetuity, it’s an extraordinary concept and facet of the role.

Building a building, making an investment, creating a policy. It’s a unique perspective and makes things a lot clearer. For example, a 25-year investment in an Australian almond farm may be a viable opportunity for an institution designed to exist in perpetuity. That’s not an option for every investor for governance reasons or due to time constraints.
 
We are building portfolios that last for very long-time horizons in some cases. Many consultants think in quarters, we think in generations.

Vailakis: When engaging a new manager at Verger, what is your process?

Dunn: At Verger, we focus on the 6 “p’s”: People, purpose, passion, process, prospectus, performance…in that order! Too many investors start with performance screens and past performance. It’s been our experience that if the first five are evident, performance always follows.

Sadly, most research shows that this is the exact opposite behavior most investors display — retail and institutional alike. What is more common is buying stocks or hiring managers after strong recent performance, only to have them underperform afterwards. We’re looking for those managers who exhibit those first 5 “p’s” who may not be outperforming for any multitude of reasons. This may lead us to out of favor or sometimes under the radar managers who are primed for outperformance. Often it also means we can negotiate terms, fees, capacity, or something else that ultimately benefits our clients.

Vailakis: What advice do you give emerging managers that may be interested in being onboarded as an approved Verger manager?

Dunn: Show us that you are hungry and humble. Arrogance and hubris are a deal breaker for us at Verger. I say do your homework before you take a meeting with us. Rarely do managers do the work in advance for us. The best introductory meetings occur when managers listen more and talk less. 

I receive 500 emails a day and 100 of those requests are from managers who want to visit. We select 5-12 new managers a year and 7 or 8 existing managers in our book turnover each year.

Recently, to highlight our emphasis on relationships with humble and hungry managers, we declined to invest in a famous venture capital fund because the founder didn’t want to spend any time with us. I suppose we were lucky to simply be chosen for investment in their view, but no engagement with us means no allocation from us. For us, it’s all about the relationship.

Vailakis: What strategy sectors are of most interest to your clients and what do you find most compelling in the market right now?

Dunn: Our clients all want to discuss exposure to venture capital, and understandably so, because that part of the portfolio is performing extraordinarily well.

The challenge is that so much money is flowing into venture capital and private equity that the valuations there are getting rich and there are not enough good deals to meet the demand. The key to success in venture capital is getting with the best managers because the distribution between the best and the worst is massive. Sometimes the best managers are the smaller ones that can say no, more than they say yes.

What looks interesting in the venture sphere? FDA/human genome products. Disruption around healthcare. There are huge changes in the realm of education. Colleges and universities and lifetime learners. Carbon trading. Risks around carbon. The U.S. is five years behind Europe there.

Emerging markets are interesting and likely to present us with more investment upside, given the U.S.’s slower rebound out of COVID. Frontier markets, emerging market debt and equity and Japan are all on the radar.

Real estate is distressed, and in some areas and types, presents some interesting challenges and opportunities for investors. Consider the Metro office, retail malls, and medical research facilities and what they might become.

Vailakis: As this is a hot topic these days and Verger is known for surveying fund managers about diversity around hiring, fair pay policies, etc., how do you approach socially responsible investments (SRIs) and ESG measurement?

Dunn: There remains a disproven assumption on Wall Street that ESG-related or socially responsible investments generate lower returns across the board, and that this is a tolerable consequence of values, or that the “feel-good” nature of such an investment makes the decreased profitability worth it for a subset of “do-gooders.”

The truth is that there have been multiple studies from Harvard Business School, Yale’s School of Management and many others that have illustrated the exact opposite sentiment. Real-time data shows that ESG and SRI portfolios are equally competitive, and in some cases, they outperform peers that don’t analyze or similarly focus their investment activities. Chipping away at this disproven sentiment about underperforming social impact focused investments isn’t easy, but our clients tend to be very excited about the types of opportunities we secure for them in this sphere.

Verger officially announced the launch of an ESG Task Force last year, an independent advisory group of industry experts created to guide Verger in establishing a long-term, proactive approach to managing ESG responsibly.

The firm is also proud to support Climate Vault, a non-profit whose unique approach uses government-regulated markets to significantly reduce future CO2 emissions while also supporting the innovation in carbon removal technologies designed to eliminate historical CO2. Verger has worked with Climate Vault to reduce their carbon footprint by purchasing permits on government-regulated compliance markets to prevent polluters from using them. We’re very excited about this work and supporting more positive future focused initiatives on climate, diversity and in other spheres where we can make a difference.

Importantly, we hold ourselves and our managers to the same standards. ESG is a part of our firm’s culture; whether it is measuring and offsetting the firm’s carbon footprint, implementing policies supporting our team members’ philanthropic engagement in the communities, supporting the Verger Women’s Leadership Initiative (VWLI) which promotes and empowers Verger’s future leader’s development or our commitment to diversity that extends to our intern program, where we actively recruit non-traditional candidates. Since its inception, we’ve had 98 interns, of which approximately 40% have been diverse.

We’ll be the first to admit that this is more art than science and we still have ground to cover. What criteria are worth converting into metrics? How can we effectively contend that one manager is operating ‘better’ in ESG terms than another? We know that we are thinking differently than the firms who already claim they’re ‘thinking differently’.  By removing the insularity of established screens, due diligence, and divestment processes and replacing them with engagement, we as a manager of managers help those with whom we invest tackle ESG from the inside out. We take potential problems and help foster solutions that round out investment decisions.

Creating these solutions is a dynamic learning endeavor, and our objective is to continually evolve and incorporate full engagement into our investment process. 

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