ETFs Have A Place In OCIO

The U.S. OCIO market is expanding rapidly and could be a growing source of ETF flows.

Reviewed by: Jessica Ferringer
Edited by: Jessica Ferringer

Michael Crook​The outsourced CIO (OCIO) market is expanding rapidly, with worldwide OCIO assets managed with full discretion for institutional investors totaling nearly $2 trillion as of March 31. This is a five-year increase of 125%, according to data from Pensions & Investments. Firms in this space like Mill Creek Capital Advisors use ETFs within their client portfolios due to the vehicle’s advantages.

Mill Creek was founded in 2006, and is an independent registered investment advisor offering OCIO services. The firm currently manages $9 billion in assets. Michael Crook is its deputy chief investment officer. He is responsible for running Mill Creek’s investment programs as well as providing asset allocation and market advice to the firm’s clients.

The following transcript has been edited for clarity and brevity. What does “OCIO” mean?

Michael Crook: OCIO is outsourced chief investment office. It refers to clients using us instead of building an investment office internally. That encompasses really all aspects of investment management, from asset allocation to manager selection, implementation, reporting and everything in between. What kind of clients does your firm serve?

Crook: We work with institutions and families. Our main focus, on the institutional side, tends to be private foundations. And our main focus with families typically is high net worth families. How do you use ETFs with your clients? Does it differ based on what type of client you’re talking about?

Crook: We use ETFs in our equity portfolios and in our fixed income portfolios. Our usage depends on the type of client, but that’s because no matter what implementation we’re using, we’re ultimately focused on achieving the best after-fee, after-tax returns we can.

The tax aspect is going to impact families, not usually institutions. It means that with taxable investors, ETFs frequently have a larger role to play in portfolios because they tend to be fairly tax efficient. That’s not true across the board, but as a general rule, ETFs are tax-efficient ways of implementation [relative to other investment vehicles].

That being said, we use ETFs with nearly all of our clients. It comes down to the investment exposure we’re looking to accomplish and the most effective way of doing so. ETFs frequently fit the bill there. Do you prefer to use ETFs in some asset classes over others?

Crook: We don’t have a philosophical preference. We typically use ETFs more in public equities and public fixed income. Our investment portfolios also include a lot of private investments where ETFs are not really applicable.

Generally speaking, we are focused, first and foremost, on the exposure we’re trying to accomplish in the portfolio and then looking at available implementation options. If we don’t believe there’s an active strategy that will outperform the cheap beta that's available through an ETF, then we’re most likely going to end up using an ETF for that exposure.

There are some areas of the market where we do use active management. And in that case, it’s because we believe that on an after-tax, after-fee basis, active management would outperform. But there's nothing philosophical about that. It’s on a case-by-case basis when we’re building a portfolio. Are you using any smart beta, thematic, or active equity or fixed income ETFs?

Crook: We’re not using any active equity or fixed income ETFs at this point, although we don’t have any philosophical [stance] against them. I think as that space continues to build out, we’ll be increasingly likely to [implement those] because there are some advantages to doing so. The ETFs we currently use are what you might think of as traditional market-cap-weighted ETFs [tracking] traditional indices.

We currently and in the past have used ETFs that are sector ETFs Typically, if we have a tactical view in a certain part of the market that we’re trying to get exposure to, ETFs are our preferred way of expressing a view like that in the market.

To give you an example, if we wanted to go overweight—say, emerging markets Asia, or growth or value, or even maybe a certain sector—an ETF would almost certainly be the starting point for implementing that type of position. What is your due diligence process like when researching ETFs? What metrics are you looking at?

Crook: When we’re looking at ETFs, the universe is massive. We start with a sorting exercise, where we’re just trying to work through the volume of ETFs and come up with a short list. It’s a different exercise than what we would use for active managers.

We want to use ETFs that are going to be around for a while and are competitive from a fee standpoint and from a volume standpoint. We’re looking at general metrics like assets under management, average daily trading volumes. We think of these as positions that we’re typically going to be holding for months, if not years, so we don’t necessarily need massive trading volume.

Another benefit of a firm like Mill Creek is we’re not putting billions of dollars into an ETF either. We’re able to access a wider part of the ETF market because of that. A lot of times, the quality of the index and whether or not it matches the exposure that we’re trying to accomplish, is really the main thing that matters.

Tax costs are [also] a big [consideration]. That comes down to making sure we have a good sense of what the real tax consequences of a certain investment will be. You’d mentioned the traditional versus smart beta versus active type of consideration. That would be part of the overall analysis.

We’re starting with a desire to have a certain exposure in the portfolio, so we’re able to narrow down the group of ETFs that looks at that fairly quickly, and then differentiate based on some other metrics. What is your favorite ETF for the current market environment?
 For the going-forward market environment, an ETF that I don’t think enough people have in their portfolio, [and] it’s an exposure that most investors could use more of, is international small caps. We have a position in the iShares MSCI EAFE Small-Cap ETF (SCZ).

I think that investors are underweight international small cap exposure. That's an ETF that gives you broad exposure to that area. Just as we saw in the U.S., as the rest of the world catches up from a COVID standpoint, from the immunization standpoint, it’s reasonable to expect that part of the market to start to outperform from a catch-up growth standpoint.

Jessica Ferringer, CFA, is a writer and analyst for She has 10 years of experience in investment research and due diligence, including helping to manage ETF portfolios. Jessica has a bachelor’s degree in economics from Lafayette College and an MBA from the University of Pittsburgh.