Funds Outsource To Boost Margins
February 21, 2011
Fifty-nine percent of fund managers do not expect their return on equity to return to pre-crisis levels, and, thus, a majority are focused on cost reduction, product innovation and outsourcing.
This is according to a survey of 100 senior-level fund managers at 80 publicly traded companies in North America, the United Kingdom, Europe, Australia and the Middle East conducted by RBC Dexia and Accenture. Forty percent of those surveyed were chief executive officers, chief information officers and other C-suite officers.
That 59% forecasts a return on equity of 15% or less in 2011, and of this group, 14% expect return on equity to be less than 10%. Prior to the 2008 financial crisis, average returns for the funds managed by survey participants was 20%.
"Traditionally, banks and other financial institutions have been able to deliver a return on equity of 15% to 20%-until 2007 as we entered the credit crisis, which became much worse than anyone could have anticipated," said James Sproule, global head of capital markets research at Accenture.
While asset managers at first responded to the financial crisis by cost cutting, they have since redirected their focus to employing state-of-the-art information technology through outsourcing. "Now they are looking at building business longer-term and where to earn more," Sproule said. "They all realize that it now is very much a question of being as efficient as possible to be competitive."
"Turmoil in the global financial markets has deeply affected the profitability of the investment management industry," said Rob Wright, global head of product and client segments at RBC Dexia. "Falling market prices and a general move away from high-margin products to highly liquid, low-fee products have driven down revenues. Our research suggests that fund managers are looking to solutions that allow them to concentrate on their core competencies and provide access to the latest technology necessary to securing front-office performance."
Thus, fund managers are looking to outsource in order to lower costs, improve service quality and support more advanced products to achieve growth.
Seventy-seven percent believe asset management firms will increase outsourcing over the next three years in a wide range of functions-ranging from fund accounting and custody to back-office technology and risk management.
Areas that asset managers are most commonly outsourcing include IT services, custody (especially following the Bernard Madoff scandal), settlement, internal financial operations, reconciliation, basic human resources and basic legal functions.
"Asset management firms are doing wholesale outsourcing in some cases, and selective outsourcing of operations in others," Sproule said.
And it is not just small asset management firms that are outsourcing, but large companies as well, said Paul Compton, head of product management at SunGard Alternative Investments. Regardless of size, asset management firms are finding that third-party partners such as SunGard offer economies of scale.
Prime broker Conifer Group has seen increased demand for its fund administration, multi-prime broker reporting and outsourced trading capabilities, said Jack McDonald, president and chief executive officer. Asset managers, particularly those whose assets diminished during the crisis, are looking for systems that offer variable costs and turnkey solutions that can be customized and ramped up, McDonald explained.
Among those that expect to outsource, 95% said it is driven by cost reduction, 84% said it is due to operational flexibility and 78% attributed it to service quality.
"The backdrop of low-equity returns and pressure on fees and revenues has made efficient operations a priority for fund managers," said Pascal Denis, a senior executive in Accenture's financial services group and the managing director of Accenture's operations in Luxembourg.
"At the same time, their clients are demanding new financial products that have greater clarity of risks, and they would also like to see risks mitigated. This means that products are complex, but in a different way than before the credit crisis," Denis said.
"All of this is happening in combination with clients expecting to pay lower fees for financial products," Denis continued. Thus, in order to offer these lower fees and support these newer, more complex types of products, he said, "having efficient, scalable operations and access to the new technologies will be a key competitive factor for any fund manager in the years ahead."
RBC Dexia estimates that outsourcing can save 20% to 25% of operational costs for fund managers. "This trend will appeal to many funds, which are looking to increase operational efficiency and are urgently looking to grow their businesses by launching new and innovative products faster or by expanding into new geographies," Wright said.
However, Sproule noted that the asset management executives typically had very ambitious time scales for cost reductions but found that it often took them longer to achieve those goals. Once they achieved the benefits of outsourcing, however, the results often surpassed these targets.
"They felt they went through a J-curve," Sproule said.
The executives planned for an average of 32% savings in the first year of outsourcing, but in reality achieved 22%. However, after three years, savings came in at 27%. Likewise, they planned for a 22% increase in service quality in the first year, which actually came in at 14%.