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White-Collar Outsourcing: 'Knowledge Process' Next


Since the collapse of credit and complex derivatives markets in 2008, outsourcing of middle-office functions by investment companies has been growing at a clip of around 25% a year. State Street estimates the rate of adoption of outsourcing among the 150 largest asset managers will double over the next three to five years.

Fund managers are increasingly jobbing out the basics of the middle office: trade communication, reconciliation and portfolio administration.

But it's not stopping there.

"The line keeps moving up into the front office. At this point, about the only thing people are not willing to source are the customer list, the actual algorithms and some unique trading methodologies and tools they've got,'' said C. Steven Crosby, senior managing director for asset management at PricewaterhouseCoopers in New York. "Everything else is up for grabs."

The relentless movement to turn fixed costs into variable ones may soon involve almost all the brain work that surrounds the C-suite-from legal opinions to fund accounting. The knowledge that gets "processed" by well-educated and long-practicing professionals.

"The interesting one that is exploding and driving a lot of the change is knowledge process outsourcing,'' Crosby told NICSA's Investment Operations Seminar earlier this month in New York. "You're outsourcing accounting, tax, fund accounting, some of the risk management, reconciliation. These things are done extraordinarily well in a centralized type of environment with a lot of bright people, good technology and low latency."

The movement has its roots in the destruction wrought within organizations by the bottom-line pressure of an economy still unrecovered from the financial crisis.

"Over the course of the crisis, people laid waste to their organization," Crosby said. "I have routinely gone to clients that are 20% to 30% below what they should be, in terms of minimal head count. So the people who are there are working really, really hard. They make mistakes. They don't have any bandwidth. They don't have time to think. Everyone is just flat out."

The lack of think time means outsourcers are, as a result, being brought in to...think for an organization. Or at least help drive its thinking, by creating process to advance knowledge and creative approaches to problems.

"Before, people were nervous about their jobs'" when outsourcers walked in, said Louis Maiuri, executive vice president, global outsourcing, U.S. financial institutions for BNY Mellon Asset Servicing.

Not now. "They're looking for help today," he said.

Bringing in top-level help these days has to be considered a business strategy decision, not a cost reduction tactic, said Larry Fahey, vice president, director of corporate operations at Eaton Vance Investment Managers. It requires a "holistic" view of the benefits to a company-and sponsorship at the top level of an organization, where the ultimate knowledge about operations lies.

When Eaton Vance considers bringing in the knowledge of an outside service provider, a big driver is augmenting its existing staff by leveraging the outside expertise, Fahey said. The outside knowledge becomes "an extension of your business," he said.

"We're looking for cultural fit. Because it's long-term. Not saying we're getting married. Let's just make sure we understand each other, we have the right values and we understand how we're going to operate [together]," Fahey said. "It sounds really soft, it sounds sales-y. It's real."

There are a number of key factors about a service provider that a fund company has to consider upfront in moving its "knowledge process" or middle office functions outside, said Jeff Conway, executive vice president, investment manager services for State Street.

These include:

* Geographic footprint: Does it match yours? If you're global, is it global, too?

* Technology: Does it have what it takes to actually support the operations of the business?

* Skill: Can you vet and determine the actual skill sets that will be assigned to your account?

* Scale: Are they big enough to handle your needs?

* Experience: Have they done what you need before?

* Track record: Have they delivered, for other fund firms?

In particular, have they delivered the trade record, customer account, portfolio, valuation and other data that is crucial to operating a family of funds-consistently and reliably, in cases similar to yours.

"When you're talking about middle office, you're talking about data," Conway said. "That's our product. That's what we deliver."

To make the process work requires not just executive-level sponsorship, Fahey said. It requires active involvement.

Executives from a fund firm's operations, technology, portfolio management, legal, compliance and front, back, and middle offices have to be "at the table."

But they can't just sit at the table and talk. They have to be committed to implementing the new systems and processes, making regular phone calls inside the organization to get tasks completed, attending regular meetings to resolve issues, assessing-and enforcing-agreements on the levels of service that the provider must maintain.

But even though service level agreements try to quantify every activity in the middle office or knowledge process that is being jobbed out, it's not enough to just watch how well the service provider is performing on the base numbers, Conway said. In fact, you have to rate the ratings.

How's that?

Let's say the service provider is achieving the agreed-upon service level of getting 99.9% of transactions reconciled. Poll the organization on how it's doing on that (and every) score. That number-the sentiment about how it is performing-may be completely different, Conway said. Why? The reports may not be clear, or how they're communicated may not be working. There's always more to an activity, than just a completion rate.

If anything, don't award the contract or judge performance based on cost, Crosby contends.

Responding to provisions of the Dodd-Frank Wall Street Reform Act will take years, for instance.

"There's a lot of change coming and you have to be ready for it," he said.

Long-term, "it's not about price,'' he said. "It's about your business."