(26 min podcast) In this episode of The Source, eVestment’s podcast covering trends and insights in institutional investing, we’re joined by Rian Akey, Global Head of Operational Risk Solutions for Aon, to talk about their ODD IQ solutions and how they approach operational due diligence.
Back in January, we announced a strategic collaboration with Aon to provide their ODD research directly through eVestment. This also includes building out a questionnaire in our input portal so managers can report ODD data to Aon that is then used to create this research. Rian expands more about the details of this strategic partnership and how the research helps asset owners conduct comprehensive due diligence while saving time to focus on their core business functions. That’s especially important as due diligence has been made more difficult in the virtual world we live in.
If you have any questions about how to access Aon’s ODD research or how to submit data to the questionnaire, contact us at email@example.com.
Highlights from the conversation:
Edited and condensed for clarity.
Rich: Rian, thanks for joining us. Before we jump in and start talking about ODD, can you give a bit of background about your current role at Aon?
Rian: Sure, thanks for having me. I was brought in about six years ago to build out the operational due diligence (ODD) program at Aon. We have exposure to around 1,000 managers globally running as many as 3,000 different strategies. In addition to that, we have lots of clients, so it’s not just one client that you’re managing. You have varying degrees of risk tolerance, different degrees of subject matter expertise, and so it can be pretty complex.
Rich: We announced our partnership early this year between eVestment and Aon where we’re going to be providing that ODD research to our clients through the platform, but before we get into that, can you give us some specifics about the ODD IQ solution?
Rian: ODD IQ, at its core, is designed to be a platform. The goal is to address some of the limitations of traditional operational due diligence approaches, so it’s focused on trying to find ways to efficiently identify and quantify, (that’s the “IQ”) or otherwise measure a broad range of definable operational risks.
Very often when people hear about a data-driven solution, there’s an expectation that we’re creating a secret algorithm that’s going to automate people out of jobs, or that it’s taking a purely scientific approach as opposed to all of the things that go with the qualitative and subject matter expertise that are part of an ODD assessment. With ODD IQ, we’re focused more on streamlining the administrative aspects, which is primarily: how do we collect information? And how do we create deliverables off the back of that information, but preserve the important qualitative and labor-intensive parts? That’s the critical thinking, the analysis, the subject matter expertise.
We want to economize the overall amount of time that we’re spending on due diligence engagements to make it more accessible and more affordable, but still preserve and even increase the amount of time that we have available for a true risk management risk reduction activities.
Rich: I would imagine the pandemic has impacted the demand for this. One, you want to understand more about what’s going on with the managers that you are going to be doing business with, but also that we’re now living in a virtual world, how have you seen the demand impacted over the last year or so?
Rian: This is such a common topic. There’s been lots of webinars about doing due diligence in a remote work environment. I think a lot of times, people focus on the cons. There’s a lot of emphasis on on-site due diligence, which is certainly something we think is important. At the same time, the inability to travel and go on-site has reinforced some of the capabilities of ODD IQ. We agree certainly there are things you can do better in an on-site environment, but there’s also plenty of things you can do perfectly adequately in a remote setting.
One of the things we think about a lot is the idea of gut instinct. People want to rely on gut instinct in terms of how they are assessing the character of an investment manager or the culture of an investment management environment. Everybody trusts their own value judgments, right? People tend to overweight their personal capabilities. They think their instinct, their gut sensibilities, are the best ones and they tend to overweight that a little bit. I think that’s human nature.
Take the car-buying experience. You go into the dealership, they’re nice to you, they have nice, shiny offices and they try to give you refreshments. Everybody who purchases a vehicle comes out of there and the first thing they say is, “I got a great deal,” right? That’s human nature and everyone will emphasize that. But meanwhile, as soon as you walked out of the dealership, the balloons are dropping and they’re all celebrating because they got done with the transaction. I think that’s a good example of the ways folks tend to overweight their own capabilities to assess the character and cultural side of things.
If we tie that to due diligence, everyone wants to think they’re better at assessing character and the intangibles. Think about the most famous hedge fund fraud ever, Bernie Madoff. I have to ask, how many people would see some of the very basic blocking and tackling things that were absent from that operating environment during a visit? He’s a charming guy, and he talked folks into overlooking some of those deficiencies because they had a good interpersonal experience. So, what are the drawbacks if your gut instinct is wrong? What if you’re not using empirical evidence or objective evidence to recalibrate your own gut instinct?
Do I think remote due diligence is better? No, not necessarily, but I think it’s complementary, and I think some of the things we’re able to do in a remote environment can free up resources so when you do go on-site, it’s worth it. The idea with ODD IQ and taking some of the work into an offline environment is trying to optimize resources. If on-site due diligence is the most expensive thing that you’re doing, why wouldn’t you want to try to optimize it?
Rich: That’s really interesting. You also make me feel like a sucker because we bought a new car late last year and I thought I got a great deal.
Rian: But you have tools now, right? Maybe 10 years ago, you couldn’t check, but it’s kind of the same thing, and that’s what ODD IQ is doing. It’s the way to do a gut check. Maybe you felt like the manager had a good compliance program and the compliance officer was nice when you interviewed them, but if you’re looking at the empirical output, you’re finding that there’s four or five things that they’re not doing that are basics. Cultural assessment is not just evaluating if they are nice to you and did you have a good interpersonal experience. If they’re actually doing something, that’s an objective link to culture. They can tell you they care, but if they’re not doing the things that you want them to be doing, how much do they really care? So, it’s a backstop to that gut assessment.
Rich: I like how you’ve described it as a combination of art and science. Specific to how the partnership with eVestment works, how is the research going to be delivered in eVestment and how can managers make sure that they’re providing the data necessary to conduct the analysis?
Rian: Ultimately, there’s a few different ways this is going to work, and it’s also going to evolve over time as the platform builds. The idea is to provide reporting, either through eVestment or your existing or your new clients, but also through Aon when that route makes sense. I think we’ve got some good paper capabilities and reporting capabilities currently. Over time, the idea is to make it a little bit more dynamic and interactive. Obviously, as the client base increases, those capabilities are going to evolve.
The second part of your question, though, is that we’re trying to create an environment where it’s not just the financial intermediaries or the asset owners that are benefiting, but creating ways for managers to engage with the process, and extract some value themselves. So getting managers to understand that this is important and that more and more, a due diligence questionnaire might become the face of the firm. That is critical. There are certain things we are doing to help managers with the process. One of them is just even creating a centralized platform. They only need to provide this information a few times instead of dozens or hundreds of times answering the same questions for different clients. As the platform grows, part of the goal is to find ways and synergies for the managers as well.
Another thing we’re learning is that managers can be afraid sometimes to ask questions. They’re afraid to say, “Well, what are you looking for here? What do you mean with this question?” I’ve had really smart, sophisticated groups admit to us in due diligence meetings that rather than reach out and feel foolish, they’ve actually left an answer blank. That’s troubling to me. Our approach is that we’re conducting due diligence, but the more transparency we can provide to the process, the more it helps everyone, and that helps the ultimate goal, which is reducing bad operational outcomes.
Rich: That’s an interesting point you make about people leaving fields blank. One of the most common things we see in our platform is asset owners screening on any information that is available. They say, “Has the manager provided this data, yes or no?” You’re immediately screened out when you leave information out.
Rian: We track response rates to understand, are we wrong? Are we asking a question in a way that’s confusing? Are we asking for a level of detail that’s considered proprietary? Again, the idea with this symbiotic environment is we don’t know all the answers, either. It’s not about being perfect, it’s about finding that Venn diagram overlap of what makes sense to the most people.
Rich: You’ve also talked about the ODD process shifting from a pre-investment exercise to something you see investors looking to do as part of their ongoing monitoring. How should pre-investment ODD differ from what’s happening as an ongoing monitoring process?
Rian: This links to my overall mindset thematically that the expansion of the ODD mandate has been geometric. Number one, we’re looking at more asset classes. It started in the hedge fund space and then moved into other public market strategies, and then ultimately into the private markets. Secondly, we are asked to look at more risk factors all the time. Then the third way it’s expanding is the frequency. It’s not just pre-investment anymore, the intent is to have ongoing monitoring, and so those three things create a geometric expansion of the mandate.
ODD IQ is a great tool for monitoring managers. It’s great for onboarding large multi-manager portfolios where you’re looking to optimize how to allocate resources and assess risk. It’s also great as a completely different lens than traditional qualitative ODD work because you can use it and see and understand patterns that you just cannot do qualitatively. But we don’t recommend ODD IQ for new investments. Pre-investment due diligence should be more than a desk-side review of a manager, especially if it’s a manager you’re new to working with. It should assess more risk factors than we can capture quantitatively. It should include a qualitative assessment – that gut check, if you will.
I know previously I talked about gut instinct and its limitations. Here, I’m saying the opposite. There’s a time and place for it. It’s really that one-two punch of the qualitative and the quantitative combining to create something that’s better. We’re more focused on finding the right balance, having different approaches and tools.
Rich: Something else you’ve talked about is that ODD analysis should be an ongoing effort and not just an upfront due diligence process. How often should investors be doing this? Is this something that you would recommend on a quarterly basis? Annually?
Rian: Where we are trying to head with this is to create an environment where operational monitoring is dynamic and continual, as opposed to at some kind of frequency that’s arbitrary. Some folks will say every year, some will say every three to five years, some will say there’s certain things you should do quarterly. All of those timeframes are a little bit arbitrary to me and as the discipline has evolved, I think of ODD migrating from a risk management discipline to more of an audit support discipline.
And by audit support, I mean there’ll be some requirement that you see every manager every year, or you see certain types of managers every three years, or you collect other kinds of information on a quarterly basis. Those frequencies and intervals, there’s nothing magical about them. What’s magic about 90 days versus 98 days? What I want to create with ODD IQ is something that’s more of an interactive and dynamic environment that’s less tied to arbitrary intervals and frequencies. It’s more of an on-demand resource that’s available when somebody needs it, even if it falls on April 30th instead of March 31st.
Rich: How much of your work with clients is about them coming to you wanting to offload their current process versus them coming to you saying, “I need help. Give me some best practices about actually implementing an effective ODD process.”
Rian: It’s a combination. One of the things we like to emphasize about ODD IQ is the idea that there’s not one right way to do something. We’ve created a platform that’s a tool that can and does contribute to many different approaches. We have clients that are expert users, but we’re trying to find ways to help them do their job better in a way that’s more consistent and more sophisticated.
The way we think about it is, can we be risk managers instead of report writers? What can we do with the extra time that we’re saving on an engagement? If we’re saving an average of five to 10 hours through consolidating some of the administrative aspects of what we do, what can I do with those five to 10 hours? I can really dig into things that can’t be captured in an empirical format, things that really require detective work.
I don’t know if the next big blow-up outcome is going to be found by the ODD IQ process, but what I do believe is that it may contribute to that discovery because it frees up somebody’s time to do the digging and to get under the hood in a way that they haven’t been able to do it historically. Groups aren’t hiring my team or looking at ODD IQ as a replacement for what they’re already doing, but as a complement, as a way to do their job better.
For other groups that don’t have internal capabilities, ODD IQ is really great in that environment. It helps to develop a credible program. The first way is through its pricing accessibility. A lot of groups that haven’t done much in ODD. They often recognize that it’s a gap, but it’s just been so darn expensive that they become paralyzed and it results in inaction.
I think another way would be just the language of ODD IQ. It’s much more objective rather than purely opinion-based. I think ODD can be so squishy and a series of opinions and value judgments. What other risk reporting exists that doesn’t normalize information into statistics or ratios or other kinds of objective or empirical metrics? Now, with IQ, we have a language that’s much more accessible. I think we’re also finding certain clients find that valuable because they feel like they’re getting something a lot more concrete for their resource allocation than some kind of a series of value, judgments, and opinions.
Rich: This was a really insightful. I know I’m excited on our clients’ behalf to be able to offer this as a continued value of the eVestment relationship and for what the partnership with Aon looks like now. Going forward, I think there’s a ton of possibilities and we’ve barely scratched the surface. Thank you for taking the time today to talk with us.