- Past issues - 2010
- Past issues - 2009
- November 2009 - More With Less
- September 2009 - Get a Grip on Market Data Costs
- July 2009 - IT Cost Management: Preparing for 2010
- June 2009 - Mergers and Acquisitions: Now What?
- May 2009 - Fixed Income Systems: Challenges and Opportunities
- April 2009 - The Current State of Trading Technology
- March 2009 - The Outsourcing Option: Is the Time Right?
- January 2009 - Riding A Tiger: When Risk Becomes Reality
- Past issues - 2008
- Past issues - 2007
- Past issues - 2006
CutterAdvantEdge
Issue 65, March 2009
The Outsourcing Option: Is the Time Right?
As the financial crisis intensifies, asset management firms are examining every possibility for cutting costs. With back office functions like custody and fund accounting already widely outsourced, managers are now looking at options for outsourcing the investment administration of their segregated institutional portfolios.
Go in with Your Eyes Open
Firms are attracted to outsourcing because they can replace fixed costs with variable costs, but that doesn’t mean overall costs will shrink without carefully managing the contract terms, implementation, and operation. And even if you manage these issues well, be prepared for a long payback period. Even with these and other caveats, the appeal of outsourcing is growing as offerings mature and outsourcers establish records of successful relationships. Clients are finding that outsourcing providers can efficiently supply the expertise and technology to cover both traditional and new asset classes.
Outsourcing Options
On the supply side, outsourcing remains dominated by the large custody banks that can offer a wide range of services, starting with custody and moving through the whole lifecycle of investment administration. Many of these banks now support trades from execution forward, including middle office services like analytics and performance measurement and attribution. While these large institutions are doing a good business providing middle office functions for derivatives and alternative investments, smaller, independent providers are thriving too, particularly those specializing in hedge fund administration. Several vendors now entering the market offer not only full outsourcing of investment administration, but also Software as a Service (SaaS). It is not unusual now for asset managers to outsource to more than one provider, going to the custodians for their traditional fund and investment administration, and to specialists for alternative investment and hedge fund administration. A few firms cherry pick functions such as trade support, reconciliations, or reference data management from different providers, sourcing the components separately and consolidating in-house.
High-Value Functions Require a Relationship
Providers and their clients agree that outsourcing a commodity like technical support is much different from outsourcing a function like investment administration, where quality of service can directly impact the investment process and client service. For higher-value functions like investment administration, a continuing relationship between client and outsourcer is critical. Responsibility for regulatory and portfolio mandate compliance, for confidentiality and risk management, rests with the client; the provider and client have to work together to ensure all needs are met.
Service is Critical
In the front office, people are accustomed to easy access to in-house staff for support, such as changes and additions to service. So if an outsourcing provider delivers only arms-length service, the front office will feel short-changed. Before you decide to go through with outsourcing, you must clearly understand the differences between the in-house service levels you’re accustomed to and the service you will receive from a particular outsourcing provider, and try to find ways to minimize those differences.
Find a Good Partner and Stay with Them
It can be hard to know for certain exactly what levels of service an outsourcing provider delivers until you work with them. So an existing positive relationship, where trust has already been established with an outsourcing partner, argues strongly for sticking with that partner for further outsourcing needs. A positive relationship is a “win-win” situation, where each knows the other’s business needs-the asset manager understands they can’t try to drive down the price of outsourcing to the brink of unprofitability, and the outsourcer understands how critical service is to the asset manager. For other factors to consider in an outsourcing partner, see the sidebar, A Consulting Perspective.
Sticking Points
Implementing a successful contract can be challenging or even impossible if your existing processes are ill-defined or your systems are complicated with workarounds. Even with a “lift-out” of people and systems, complex and undocumented processes never simply go away. But as outsourcing services mature, the need for lift-outs is diminishing because the large providers are now trying to migrate all clients to their common platform, although no provider we know of has yet fully achieved that goal.
High Demand
Outsourcing providers are investing in technology to standardize, improve, and extend their service offerings, currently targeting larger investment management firms. It’s uncertain when or if they will offer similar services to smaller firms, but many providers already deliver custody or fund accounting services to smaller firms. Overall, we expect the demand for outsourcing from firms of all sizes to grow.
