January 19, 2004
By Stephen M. Wynne, Executive Vice President, COO, PFPC Worldwide
The mutual fund marketplace is more keenly competitive than ever before. In the past, fund companies have traditionally considered outsourcing daily, high-volume tasks and specialized functions as a way to gain the benefit of automation and economies of scale. But as the industry faces new pressures, administrative outsourcing providers are bringing additional solutions to the table to help fund companies manage risk and meet new regulatory and compliance requirements while containing costs.
Think of this new outsourcing value proposition in terms of playing both offense and defense, as in a football game. Defensive skills include meeting regulatory demands and managing risks, including risk to reputation. Offensive skills support growth into new product areas, including 529 plans and separately managed accounts, and can include middle-office functions such as distribution services.
With an expanded range of capabilities and constant technology development, outsourcers can be considered as flexible, resilient and dependable as the old-fashioned two-way football player -- like Bronko Nagurski, who stopped his opponents as a defensive tackle and linebacker and then piled up yardage as a fullback on offense for the 1930s Chicago Bears.
On defense, the traditional outsourcing goals of cost containment and processing efficiency are playing out amid ever-increasing demands on fund companies. Asset managers are responding to SEC requests, meeting Sarbanes-Oxley and USA PATRIOT Act requirements and anticipating new, more stringent laws on disclosure of fees and costs (see lead story, page one).
Financial services companies play a key role in the PATRIOT Act, which beefs up our ability to identify national security threats. To help detect and prevent money laundering and terrorist financing, mutual fund companies must implement Customer Identification Programs (CIPs), including procedures to prescreen customers to verify identities, reject those who fail to provide adequate identification and maintain records for the program (see MME 9/1/03, 9/15/03).
By outsourcing CIP implementation, funds can avoid the expense of designing their own system. As they manage tight margins and seek to compete on the basis of performance, fund firms cannot afford to divert attention and resources to operations makeovers necessary to comply with all of the new regulations and requests for information coming out of Washington or Wall Street.
Fines & Penalty Risk
Risk management is another element of defense. Complying with new regulations is not an option, so funds are at risk of fines or other penalties if they fail to get it right. With the steady stream of new regulations, not to mention alterations and overhauls of the tax code, expertise is as important as efficiency in an outsourcing agent. Reputation has always mattered to mutual fund companies, and never more so than in an era of scandal and other threats to investor confidence. Risk, nowadays, goes beyond fines or other penalties. A fund company must guard and nurture its reputation.
Then there's the other side of the game -- offense. Profitability over the long term relies on revenue growth as well as cost containment. Over the past two decades, 401(k) plans helped drive tremendous growth in the fund industry, but as that business matures, new products will help bring in assets.
How does outsourcing support growth? Consider a few examples.
529 Plans: Assets in these college savings vehicles nearly doubled in 2002 to $25 billion, according to FinAid.org, an independent Web resource on college financial aid, which projects assets will reach $350 billion by 2010. A fund company trying to break into this business faces significant operational challenges. Outsourcing with the right provider, however, can offer a key to continued growth in 529 plans through recordkeeping platforms that promote flexibility, efficiency, accessibility, scalability and the aggregation of complex earnings calculations on withdrawals from the plan.
Separately Managed Accounts: The highest barrier to entry in this market is operations and technology, but even small money managers can establish a new product line by tapping into the scale of a large service provider.
Distribution Services: Outsourcing is no longer confined to the back office. Given their expertise and long experience with shareholder servicing, fund accounting and other support functions, outsourcing partners can provide clients with the tools and expertise necessary to identify, sell and service their shareholders across multiple distribution channels.
As EVP & COO of PFPC Worldwide, Stephen M. Wynne oversees accounting and administration, custody and securities lending, alternative investments and offshore services.
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