The financial crisis has left most asset managers nursing painful losses of 30 and 40 per cent, while widespread job cuts across all parts of their business have left them stretched and under-resourced.
Whatever route investment firms choose to navigate their way out of choppy waters, it is increasingly likely they will look to service providers to help them shape future business models, as a new world order dictates that players of all sizes must do more with less.
“The liquidity crisis means the trend to outsource has now become more of a necessity for investment managers,” says Veit Schuhen, chief executive of Maitland Fund Services.
Outsourcing is not a new phenomenon. Since the late 1990s, managers have been handing over responsibility for back office activities such as custody and settlement to service providers, while at the same time shedding a portion of the expense associated with these operations.
According to a recent report by Create Research, 62 per cent of the 225 asset management firms surveyed already outsourced custody and settlement, while 52 per cent had handed over responsibility for asset valuation.
“The outsourcing business has always been a healthy business but the market challenges and conditions of the last 18 months have certainly changed the game,” says John Alshefski, senior vice president and managing director of SEI Investment Manager Services.
Faced with the unwelcome prospect of having to increase spend on creaking infrastructures, investment managers are increasingly using service providers as a tool to help keep fixed costs to a minimum.
“Those investment managers that were not considering outsourcing before are certainly looking at its potential now. A significant portion of deals used to be driven by cost, but eliminating operational risk and a focus on core competencies is now driving this trend,” adds Mr Alshefski.
The US firm’s growth demonstrates the interest outsourcing some of these “non core“ functions has received. Its assets have grown by more than 30 per cent over the past 18 months to $135bn (£81bn, €93bn).
Asset managers are also turning to service providers in response to investment structures becoming too complex for existing in-house systems. Derivatives processing was one area managers expected would be outsourced in the next five years, according to the Create Research report.
“Historically, back office functions have been the ones outsourced but we are seeing more middle office and front office capabilities joining that list,” says Mr Alshefski.
“We’re not seeing a complete movement to outsource trading or what the manager does to generate alpha or find clients, but things around reporting, transparency and risk management are increasingly becoming more common,” he says.
Ken Back, managing director of business development, securities and fund services at Citi, also recognises more interest in outsourcing middle office functions.
“Traditionally, areas such as performance measurement, risk management and client reporting have not been outsourced, but we expect more activity in these areas in the future,” says Mr Back.
Despite fewer “landmark” deals being completed this year, Mr Back expects appetite for outsourcing to increase once markets stabilise.
Outsourcing is also viewed by some asset managers as a way to benefit from greater economies of scale. A back office operation involving a handful of people can be outsourced to a service provider with a workforce of hundreds.
John Campbell, senior managing director of investment manager services at State Street, says: “Some of our European clients considering moving into Sicav structures in Luxembourg face moving billions of euros within a 12 to 18 month time frame.
“If they do this in-house, they will struggle as they are not equipped to manage these types of operations. Their core competency is to manage money.” But clients are demanding more transparency, and they are not alone. Following the fallout from the Madoff scandal, which exposed serious flaws in investment firms’ risk management procedures, regulators are also placing pressure on managers to demonstrate they have independent oversight of such areas.
“We envisage a situation where regulators are more likely to prefer a professional asset servicer to drive and support these operations for managers, rather than firms attempting to do this on a smaller scale themselves,” says Mr Campbell.
However, while outsourcing goes some way to solving managers’ back and middle office woes, it is by no means a panacea. It can also come with some unintended drawbacks. “The biggest risk is if the two parties do not get on,” says Mr Campbell. “We are cautious who we partner with and it has to be someone we get on with . . . separating can be expensive following a huge investment into systems