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Outsourcing Shifts to Catch-as-Catch-Can: Third Parties Do More; Degree of Specialization Heightens

AUSTIN, Texas - As the industry continues to embrace outsourcing as a means to cut costs, the models for doing so have evolved to the point where, quite frankly, no single, prevailing model any longer exists.

Just 10 years ago, many medium- to large-size fund families were actually bringing various back-office functions, like transfer agency services, back in-house. But these days, fund executives are scouring their businesses in search of outsourcing opportunities and the chance to wring out a few more dollars in savings.

Factors that are driving this sea change, experts said during the recent Investment Company Institute 2005 Operations and Technology Conference held here, include a technology boom that made issues of geography a non-factor, a shift in employer and employee sentiment toward the practice, and a prolonged bear market that left fund families scrambling to shore up their bottom lines. A proliferation of new fund classes, a slew of new products and services, recent regulatory problems and a surge in assets that came with the return of the bull have also been primary factors.

"For example, two of our clients that were full-service fund families back in the mid-1980s, decided in the late 1980s to in-source the transfer agency as part of a trend where they got to be a certain size and they were going through substantial growth," explained Tom Schmidt, vice president of mutual fund operations at outsourcing giant DST Systems in Kansas City, Mo. "Within the last two years, those fund families have actually kind of come full circle and outsourced their entire transfer agency operations to either DST or Boston Financial."

More than 50% of DST remote customers, Schmidt said, are taking advantage of that sort of shared service model, a rapidly emerging form of outsourcing where a fund family works with a third party but also tracks those specific services internally. Exactly which functions get shared varies widely from family to family, but it can include elements of transfer agency services, fund accounting, investment management, property management or any number of customer touch points.

"The message here is that there really isn't a model for everyone," Schmidt said. "Everyone just picks and chooses the functions they think work best strategically and that they want to partner with someone else on."

Disaster recovery models, for obvious reasons, are becoming an increasingly popular topic among fund families and outsourcers. For example, Schmidt said, DST might handle a firm's incoming mail service or their check remittance service, as well as a percentage of their transaction processing, and, if a disaster were to occur, the outsourcer would fully recover those aspects.

"Historically, in the event of a disaster, we've been asked to assist on an ad hoc basis," Schmidt said. "But, realistically, there's a lot of challenges with those types of models. There are communication lines and protocols there. How do you provide training in 24 or 48 hours? How do you provide a knowledge base to a staff to where you can maintain customer service levels?"

Going forward, Schmidt thinks outsourcing functions will become increasingly specialized. He said DST is already performing previously obscure transfer agency tasks like year-end functions, business escheatment processes and even control functions, such as bank account reconciliation.

"Historically, [bank account reconciliation] is something we didn't talk too much about, unless we were talking about outsourcing the entire operation, but it's something that has become quite popular. For instance, we reconcile over 1,400 bank accounts in Kansas City alone," Schmidt said.

From Schmidt's perspective, a successful outsourcing project starts with an agreement that clearly defines the project's goals. Without that, he said, there's no way to measure success. The client's focus should always be on the end result, too, he added. While the process whereby the goal is achieved is indeed important, Schmidt noted, it's more important that the client allow the outsourcer to do what they do best.

"What works is when we do things with each other, not to each other. The more our associates understand and interact with the client, the more they identify with the job," he said.

Peter Callahan, senior vice president with San Antonio-based transfer agent Alliance Global Investor Services (AGIS), a unit of AllianceBernstein, said his firm enjoyed unprecedented sales and account growth in the late 1990s. But the subsequent bear market ultimately compelled the closure early last year of a 600-person unit in New Jersey - it was planned to accommodate a staff of 1,200 - as well as a 120-person operation in Pennsylvania. The group has also chosen to outsource a small 401(k) plan business to Boston Financial and consolidate remaining processes to existing sites.