Asian Review of Financial Research Vol.35 No.1 pp.73-88 https://www.doi.org/10.37197/ARFR.2022.35.1.3
Multi-period Dynamic Equilibrium in the Outsourced Chief Investment Officer Market
Key Words : OCIO,Dynamic optimization,Game theory,Multidimensional auction,Multiperiod model,Outsourced chief investment officer,Procurement auction
This study analyzes the outsourced chief investment officer (OCIO) market using a multi-period, multi-dimensional auction model. The OCIO service is a type of consignment asset management system. Unlike a traditional consignment management system, however, the OCIO service can be characterized as a comprehensive wealth management service because the asset owner comprehensively delegates the rights to strategic asset allocation, which determines the proportion of investments in the core asset class, to the asset manager. Although the OCIO market initially developed in other countries, it has recently begun to attract attention in Korea, and the competition among managers is fierce. Managers and securities companies participate in the OCIO market as suppliers as fund-type retirement pensions are expected to be implemented, and, thus, private funds will likely emerge as the major consumers in the OCIO market. Korean OCIOs offer lower average fees compared to OCIOs in developed markets. This difference is due to the initial competition in the Korean OCIO market. Suppliers can offer lower management fees in the Korean market because even if they incur short-term losses, operating in the OCIO market will be profitable in the long run. The OCIO market is initially being evaluated as having high growth potential. As interest rates remain low, funds' demand for OCIO services to improve profits is increasing in the short term. Accordingly, the OCIO market has grown significantly, the ripple effect on the operating market is increasing, and interest in the OCIO market is rising. Because funds have less expertise in asset management than managers do, OCIO services may continue to be used to ensure high profits or stable management. The OCIO market is expected to grow, and, thus, management companies are competing to gain market share by offering low management fees. In addition, because the OCIO market is likely to take the form of a monopoly, a manager can benefit from taking over the OCIO market even if it incurs short-term losses. Because the OCIO service is a comprehensive asset management system, including strategic asset allocation, it is necessary to establish a separate OCIO system to provide efficient services. Accordingly, managers with experience in supplying these services may build OCIO systems more efficiently than those without experience can. Thus, the quality of OCIO services can be improved by enhancing intrinsic capabilities, such as by improving the system to manage assets according to a fund's purpose. This difference suggests that the managers who previously provided OCIO services may be superior choices for future OCIO services. Accordingly, it is very likely that a few managers that are selected as OCIOs in the early stages and create efficient OCIO systems will monopolize the market. For these reasons, managers have an incentive to offer low management fees to capture the Korean OCIO market given the potential future profits. Thus, the competition among managers in the Korean OCIO market should be analyzed with a multi-period model. However, previous studies of the Korean OCIO market focus on the agency problem and analyze the market using only single-period models. Accordingly, this study constructs a multi-period, multi-dimensional auction model. We expand upon existing multi-dimensional procurement auction models by assuming that a manager's efficiency and quality improve as the manager supplies OCIO services. This study analyzes the OCIO selection process using both a single-period, multi-dimensional model and a multi-period, multi-dimensional model, and we compare the results of both models. The equilibrium in the single-period model indicates that the more efficient the manager's OCIO system is, the lower the optimal service quality is and the higher the optimal management fee is. Thus, the manager with the most efficient OCIO system is selected as the OCIO. The multi-period model also includes the assumption that efficiency improves after selecting an OCIO in the single-period model. We derive a dynamic equilibrium through dynamic optimization and confirm that a more efficient system is associated with a higher optimal service quality and a lower optimal fee, as in the single-period model. In both models, we find that a highly efficient company is selected as the OCIO. This result suggests that the OCIO market is highly likely to be oligopolistic. However, the optimal fee in the multi-period model is lower than that in the single-period model. This finding shows that when supplying OCIO services is expected to improve efficiency, price competition among managers may become overheated.