by Sam Heller | FundFire April 17, 2023 [Manager Analysis Services strongly prefers conflict-free OCIO models] – OCIOs are not blind to the concerns around their investment strategies, said President of Manager Analysis Services Chris Cutler. Many of the coverage teams at OCIOs will work with clients to avoid these conflicts altogether, he added.
“There are many very high-quality coverage teams at those firms,… and they proactively avoid any conflicts,” he said. “I’ve seen these cases where they have already avoided all the internal products just because they don’t want these conflicts.”
While managing my own investment due diligence firm for the last 20 years, I also probe ahead to understand the next great investment themes. The ever-expanding crypto market was an obvious potential candidate from 2016 to 2019.
My initial read of this market was that the hype about replacing “fiat currencies” with cryptocurrencies detracted from the true opportunity: accessing incredibly cheap venture capital money.
How so? Consider the investors’ terms for investing in a cryptocurrency vehicle, of which over 20,000 have been launched. Investors typically receive no explicit rights to earnings, distributions, voting, nor other investor protections. They profit only if later investors are willing to pay higher than the original purchase price. In addition to these deficiencies, the regulators [particularly the CFTC] assert jurisdiction, but its oversight has proven ineffectual.
I have reviewed many venture LPs and I have never seen such unattractive investor terms in the mainstream venture markets. Cheap capital doesn’t get any cheaper than in crypto! However, that’s not to say all crypto ventures are flawed. Some of the capital from crypto launches have funded new and interesting technologies, and some excellent crypto-related businesses. Along with a handful of crypto enthusiasts, I wrote a white paper to create just such an innovative technology in the field of payments systems. However, after almost two years probing the crypto community, I decided the crypto landscape was too squirrelly for me to launch a venture or concentrate my business. Here’s why.
Venture Investing as a Reference Point for Crypto Investing
Venture Capital is a useful reference point when thinking about crypto market investments, since venture is like a midpoint on the diligence continuum between crypto and private equity investing. Venture investors incur risks that would be simply unacceptable to private equity, hedge fund, or traditional investors, yet venture investing can be tremendously successful. Venture managers seek to back exceptionally talented venture founders, from the creation of their nascent companies until their ultimate IPO or sale.
On the other hand, private equity managers will focus on existing businesses, conducting much more rigorous reviews of assets, earnings, management, and operations of the companies they purchase. Venture diligence practices would never work in private equity markets, yet both markets provide excellent investment opportunities.
In our business we see many talented venture managers–reviewing venture managers is one of the most interesting activities in our diligence business. We have also seen many problems. In the public arena, we are truly puzzled by Andreeson Horowitz’s backing of WeWorks founder Adam Neumann, for example.
Privately, we have rejected about half of earlier-stage venture managers brought to us and already reviewed by our talented institutional-investor clients, often because our additional digging found the venture managers misled about their backgrounds and track records in ways that are far more egregious than anything we’ve seen recently from private equity or hedge fund managers.
Crypto vs Venture
The crypto market’s key challenge is to rise first to the level of venture investing, and then to institutionalize the marketplace. There are big hurdles, and they make venture investing look easy. Crypto ventures have even less regulation than venture capital managers. Unlike in mainstream venture, crypto ventures are rarely audited, and they often do not have effective independent board directors or independent controllers. Insider trading is common, and usually no separation exists between executives and control functions.
However, crypto’s worst enemy may be the unbridled arrogance of a full generation of young crypto programmers who actually believe their work displaces principles developed over centuries about banking systems, currencies, and macroeconomic principles. Risk managers? Credit risk controls? AML controls?
Audits? Who needs them?
There are many morals to the unfolding saga of FTX, but rather than list them, we’ll just provide a sort of portrait-guide to some of the recently noted players in crypto space:
Alex Mashinsky – Founder of Celsius Network, a sort of crypto prime broker funded by crypto depositors that filed for bankruptcy in July. Banks? Regulators? Fiat currencies? Who needs them?
Steven Narayoff – Attorney charged with trying to extort additional large payments from cryptocurrency issuer-clients. Partner pled guilty. Narayoff’s pleading not guilty.
Jack Abramoff – Once one of Washington’s most influential lobbyists, just the man to trust to start an AML – compliant version of bitcoin?
SBF – FTX acted as a “custodian” but could not withstand the temptation to gamble clients’ assets.
CZ – No public audits, no obvious controls, no regulators, law enforcement interest in his activities, what could possibly go wrong?
Needs no explanation.
Conclusion
Investment conviction is not a substitute for independent diligence. Nothing in crypto negates the importance of having independent custodians to hold assets, independent diligence experts, independent administrators, independent attorneys, independent auditors, independent valuation, reputable international jurisdictions, and sensible investment agreements. Investors should be wary if they are solely relying on white papers or technology without the benefit of at least venture capital investment infrastructure.
You should ensure that you have the level of protection from your diligence process to evidence that you fulfill the duties that you as a fiduciary are charged with fulfilling. Even the smartest institutional investors face challenges in venture investing, and we have helped our clients focus on the more promising ventures and avoid catastrophic mistakes.
Many fiduciaries have been challenged by their OCIO’s performance this year, and question whether their OCIO’s performance is acceptable in light of terrible market performance [S&P 500 down 14% plus and bonds down 10% to 15%]. Returns are actually worse after considering 8% inflation, and many fiduciaries are finding that the actual buying-power is down over 20% in real terms.
What steps should you take that properly support your decision to retain your OCIO, or to explore whether you should search for a better-performing OCIO relationship? We suggest that a first step is to consider whether your OCIO is performing satisfactorily, relative to market conditions, to help inform your governance efforts:
Market returns have been exceptionally poor 2022 YTD. This year is only the third year since 1900 when both equities and bonds indices were both down. (2015 and 2018 were the other two years.) Indeed all 11 S&P sectors suffered with the notable exception of energy (+34.5%). Certain alternative funds provided effective diversification. Those OCIO managers that were sufficiently nimble to layer in protective equity puts, pivot to energy, avoid long duration fixed income, and focus on specialized hedge strategies were best able to reduce overall market losses. It is these types of OCIO managers who are the standouts.
Conversely, we have seen OCIOs underperform from several causes. OCIOs that pursued 60/40 allocations that did not dodge rising interest rates’ impact on their bond portfolios received a double hit. OCIOs that focus on “alpha creators” for their long only equity managers [an allocation approach we meet with great skepticism] also were hit hard by the fact that those OCIOs really didn’t diversify by style, and many of their managers are growth-and-tech bias at the epicenter of underperformance in year’s value-oriented equity market. OCIOs with a strong “geographic diversification” [i.e. underweight in the US markets] were hit by falling European currencies and weak European equity markets. Finally OCIOs that tend to use equity-oriented hedge funds missed the benefits of having the full suite of hedge fund strategies.
Whether you wish to continue your OCIO relationship or are considering a search potentially to replace your OCIO, we recommend that, as fiduciaries, you evidence that you have reviewed your relationship if you have had losses near or over 15% this year. We specialize in evaluating OCIO portfolio performance and can assist you in providing an objective third party analysis. Manager Analysis Services has nearly 20 years’ experience in this field. We offer your fiduciaries a complimentary discussion of your OCIO’s performance, and whether you should take further steps.
Re: A Discussion of broad static v specific dynamic benchmarks
This sort of “benchmark obfuscation” comes up often, said Christopher Cutler, president of Manager Analysis Services, a search consultant and due-diligence provider, in an email.
“A detailed manager-by-manager analysis of performance against underlying benchmarks helps cut through dense fog and brings a clearer picture of alpha,” he wrote.
Nevertheless, Aon’s position in the investment industry does not seem to have been adversely affected by the Blue Cross Blue Shield lawsuit, said Christopher Cutler, President of Manager Analysis Services, a search consultant and due-diligence provider, in an email.
“My sense is they escaped material damage to their business,” he wrote. Since Allianz GI appeared to be the one that covered investors’ tangible losses, that would bolster Aon’s argument that the problem lay with them, and not Aon, Cutler added.
“This approach would deflect from the central problem that Aon consultants exhibited a distinct lack of skill in understanding complex investment strategies by including Global Structured Alpha on their approved list,” he wrote.
(The $623B consultant is the latest industry firm to add scale or capabilities through an acquisition.)
July 8, 2022 | Justin Mitchell | Fundfire
Investment consulting firms are increasingly concentrating on their areas of strength, said Christopher Cutler, President of Manager Analysis Services, a search consultant and due-diligence provider.
Public sector retirement plans call for considerable specialization in that market, so Milliman’s decision makes sense, he added in an email.
“Nonetheless, clients are not the property of their investment consultants to be bought and sold,” he wrote. “Every public plan should undertake its own review of the acquirer, as with any acquisition, and consider a search. After all, they hired Milliman, not Segal Marco.”
Borrowing can be used for offensive as well as defensive purposes. Typically, it takes the form of a Letter of Credit or borrowing under a Securities Lending Agreement.
Research has shown that Endowments will often use lines of credit offensively to fund private equity capital calls. It enables better cash management and investment timing. Smaller Foundations tend to use lines of credit for that same purpose. Foundations also use Securities Lending defensively to avoid selling “underwater” equity positions to fund current grantmaking. This can make sense if the Foundation views itself as a perpetual investor and the equity sell-off is considered a temporary or short-lived phenomenon. (One should ensure that the Foundation’s governing documents either enable or do not preclude borrowing.)
Lines of Credit – Typically arranged with a bank and often is uncollateralized.
Securities Lending – Collateralized borrowing is an active part of the financial markets and many market players engage in this type of lending to boost returns.
We envision Securities Lending as a defensive means for Foundations or Endowments to avoid selling “underwater” equity positions, rather than “locking in” a loss. Securities Lending agreements are highly standardized and sample templates are available on the Internet. (You should of course use your own legal counsel) but the internet documents do provide the reader with a sense of the wide use and standardization that exists.
Goal – If the entity has a perpetual time horizon and believes that the equity markets typically rebound within a 2- or 3-year future time horizon, borrowing may make long term sense.
Collateral – Typically one would pledge securities that would be placed with a custodian. (Securities may need to be “aged”, i.e. fully paid for and have been held for a minimum time period, e.g. 1 month, prior to pledging.) The advance rates would be based on the specific assets pledged. Typically, the rate would be Libor + a spread.
Want to learn more? Please contact Chris Cutler or Tom Donahoe
We have led OCIO searches and selected providers as well as analyzed many additional completed OCIO searches. We’ve distilled the process down to 7 key steps. They are as follows:
CATALYST – There are typically specific concerns that trigger a search: performance, portfolio concentration, liquidity, poor service, and/or fees. Survey participants often tick the box as “fees.” While often true, we believe that “fees” may often be a stalking horse that provides cover for other motivating rationales.
AWARENESS – The Investment Committee or Board needs to educate themselves as to what’s available in the market. This takes time and direct interaction between providers and Board/IC. Internal staff is often understaffed and is not able to distill the information on a timely basis. (Surveys show internal investment staff to be 0.5 FTE or less.) Moreover, staff members may wear multiple hats and investing oversight may be hampered by manual processes.
GOAL(S) – Investment Committee members should agree on a clear articulation of the organization’s goals. If this is left vague or allows late-entrants into the bidding process, it will reduce the efficiency and transparency of decision making.
IDENTIFYING ELIGIBLE OCIO PROVIDERS – This requires someone with industry expertise, time in markets, and understanding of client’s needs and goals.
REQUEST FOR INFO – This should precede a formal RFP. It is a list of 5 to 7 key questions that are submitted to a larger, potential universe of OCIO providers. This enables you to surface issues (conflicts) early, review each submission on a conference call with the provider (and get a feel for working with that team.) You then go out with a formal RFP to a distilled subset of your RFI respondents.
INTERVIEW – This is essentially a semi-finalist stage. Then, there should be an on-site visit at the provider’s place of business once you are down to the finalists.
DECISION – Always have a first choice and a back-up, in case the first choice does not result in a final agreement. Entire search process is typically 3-4 months.
Want to learn more? Please contact Chris Cutler or Tom Donahoe.
Trustees are a great asset, provided you select and support them diligently.
The governance structure of non-profits tends to be the mirror opposite of for-profit organizations. It is a simple reality that those long-term board directors in non-profit institutions usually shape the policies and direction of their organizations. Having an effective governance strategy for selecting and rotating board governors is a great way to ensure that the non-profit institution has the right set of committed and unconflicted talent serving as directors.
Typical Tenors
For-profit Companies
Non-profit orgs (Institutionalized)
Non-profit (founding family-majority)
CEO tenure
6 – 10 years
10 – 20 years
+20 years
Board tenure
+20 years
9 years (maximum)
No real limit
N.B. – A non-profit Board is not considered “institutionalized” if the founders retain a Board majority.
Progressive term limits protect the institution:
Board member terms are best staggered, (similar to the US Senate, only 1/3rd of Trustees seats should become open each year.) This ensures stability and thoughtful transitions. Having three 3-year terms seems quite tidy but can make for an untidy mess. You expose yourself to “social loafing”, disruptive actions, and perhaps embrace too much risk with a new, untried Trustee.
As an alternative, one could implement progressive terms: initially 1Y term, then 2Y, and finally a 3Y term (you’ll know after 3 years if a director is good.) The rationale is that you could identify a new Trustee’s poor participation or lack of commitment early on, and this structure offers you a convenient (non-confrontational) way to limit damage to the institution. Also, try to avoid the romance of focusing only on the well-credentialed. You need to understand why a person is joining and if the new person also serves on another Board with one of your current Board members. This may result in a conflict.
A typical bylaw provision allows the “firing” of a Trustee at any time. In real life, most Boards simply plod ahead and refuse to face the friction of a contested exit that often requires near-unanimous agreement on ejecting a current director. A real-life anecdote is instructive. A Trustee missed 5 of 7 meetings and was considered “effectively” resigned. The Board woke up one day to a scathing press release that the Board member was “resigning in protest” about a sensitive issue.
Emeritus Status:
In a word, don’t! It’s better to have an annual dinner with current and past Trustees. Emeritus is an active designation and holders believe it confers power/access/voice in current decision-making. Emeritus may demand to see current minutes, etc. It is better to honor completed, past service. Moreover, ex-Trustees often simply want access to the library or email address. This can simply be approved by the Board and arranged by staff. Moreover, emeritus has often been given to large donors and this tends to annoy past Board members who served well but simply don’t have a thick wallet.
Want to learn more? Please contact Chris Cutler, Tom Donahoe, or Safia Mehta at 917-287-9551.
You’ll find below ten low cost, handy steps that can be implemented at your Foundation without spending Foundation resources.
AN INDEPENDENT GUIDE TO TRUSTEE DUTIES – For onboarding new Trustees or ensuring that current Trustees fully understand or are refreshed in their duties; the NY Attorney General’s office publishes RIGHT FROM THE START and also INTERNAL CONTROLS AND FINANCIAL ACCOUNTABILITY. What better way than having a neutral, authoritative voice review the Duties of Care, Loyalty and Obedience in a clearly written dispassionate prose?
START WITH THE TOUGH TOPICS – At Board or Committee Meetings, address the toughest topics first, do not let them hide deep in the agenda. Everyone is freshest and most alert at the beginning of the meeting. The priority topics will also ensure that Trustees join the meeting at the start. Ensure that there is a published time limit for each agenda topic.
PROPOSED MOTIONS SHOULD BE DRAFTED IN ADVANCE – Draft proposed motions BEFORE the Trustee meeting. This ensures a thorough drafting, unrushed by time pressures. It also provides a document to speak to and use as a gauge. The meeting also does not devolve into a word-smithing exercise that eats up valuable Trustee time. If multiple motions are needed or pro- and con- motions, those also need to be shared with the Trustees before the meeting. (Ideally via a link to Cloud storage.)
FUTURE TOPICS – Provide a list of planned topics on a rolling 3 quarters in advance so that Trustees know when major recurring topics will be addressed. They can also anticipate what projects might be helpful to align with the timing of future meetings.
TIMELY SCHEDULING OF COMMITTEE MEETINGS – Require that periodic Committee meetings be scheduled at least ten days to 3 weeks before the actual Board meeting. This ensures that information distilled will be current and avoids a rush analysis in order to place items in the “Board Book” in preparation for an actual Board meeting.
RECORD THE BOARD MEETINGS – It helps resolve disputes about what was said and ensures the accuracy and timeliness of the Board minutes, even if they are written weeks after the actual Board meeting. (Recordings can be deleted after one year or on a pre-agreed basis.)
FOUNDATION EMAILS – Require all corporate information to be communicated on Foundation emails, which means that all Trustees are assigned foundation-domain email accounts. As a potential compromise, Trustees may continue to use their personal accounts, but ALL emails need to be cc’d to their foundation email accounts. (The latter is not best practice but may be a viable work around if not abused.)
SOCIAL CAPITAL – All groups work best together if there is social capital built up. You should not solely rely on telephone meetings. There should be periodic meetings in person, even if only on an annual basis. The annual meeting or at least one meeting per year should be held at the site of the Foundation’s location or activities.
INSURANCE – You absolutely need to review ALL your insurance coverage on an annual basis and in-depth. Risks and coverages change, and insurance gaps provide a potential for a major loss to a Foundation if not properly addressed. Trustees may want to focus on D & O coverage and be conversant with any “indemnity” coverages that the Foundation has agreed to provide, typically in its bylaws.
CONFLICTS OF INTEREST POLICY– There are few topics other than conflicts that can cause as much damage to a Foundation, either reputationally or financially. With the Internet, scandal spreads quickly AND permanently. Your policy must allow for Audit Committee review, especially in a case of first impression. Avoid any appearance of conflict. An outside law/audit firm review could help.
Want to learn more?
Please contact Chris Cutler, Tom Donahoe or Safia Mehta at 917 287 9551.
