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CIO Challenge

Lately, it seems that one investment management firm after another is outsourcing back-office functions. But as providers expand their service offerings beyond the back office, how do CIOs determine which functions to keep in-house?

Charles Schwab Investment Management became the latest Wall Street firm to enter the outsourcing game with the news, announced May 31, that it has turned to JPMorgan Worldwide Securities Services to support Schwab's separately managed accounts program. Under the deal, JPMorgan will provide a range of back-office functions, including shadow accounting, account reconciliation and performance calculation.

The news follows the announcement that Henderson Global Investors, a London-based investment manager with $127 billion in assets, also has tapped JPMorgan's outsourcing services, handing over its $2 billion hedge fund business to JPMorgan Hedge Fund Services (HFS). JPMorgan HFS will assume responsibility for Henderson's hedge fund middle- and back-office functions -- including its employees -- to provide daily operational services and fund administration.

Indeed, 2006 already has seen a fair amount of investment operations outsourcing action. In February, Mellon Financial's Investment Manager Solutions group agreed to provide back-office operations support for Pasadena, Calif.-based Provident Investment Counsel and Evercore Asset Management (New York). Meanwhile, in April, Schroder Investment Management North America decided to outsource investment operations support for its $3 billion private client and fund business to The Bank of New York. The range of responsibilities include trade support, data management, investment accounting and performance measurement, with BNY also developing and hosting a private-labeled Web portal for Schroders.

The BNY agreement adds to the global patchwork of third-party arrangements Schroders has in place. The investment manager outsources, for example, its U.K. unit trust accounting to State Street, while JPMorgan handles fund accounting and custody for Schroders' Luxembourg fund range. Such componentization of service functions is likely to increase, says Dr. Suresh Gupta, a partner in Capco's New York office and codirector of a recent research project, conducted with the London Business School, into outsourcing and offshoring.

Gupta points to an evolution in the outsourcing industry, on both the buy and sell sides of the fence, that will see the financial services industry follow a similar path as has the manufacturing sector. "Eventually, companies will look at their middle-office and back-office services, look at the components of those processes, and find the most appropriate supplier to service particular parts of those, in the same way that General Motors does," he says.

However, the market will follow a dual approach in this regard, reckons Gupta. Small firms, such as start-up hedge funds or boutique investment managers, are more likely to hire a single provider that can provide a complete service package, such as one of the large global custodian banks that have been ramping up their third-party capabilities. By contrast, large players with more experience in outsourcing likely will employ a multitiered strategy that leverages a variety of suppliers, Gupta argues. The large organizations will adopt a cross-product, cross-geography approach that incorporates in-house and outsourced capabilities in a variety of locations, whether provided on-site, near shore, or from lower-cost offshore centers in places such as India and China. Deciding what to outsource where and to which provider will then depend on how much value-add the service offers a firm and how much control it wants to maintain over the function, Gupta explains.

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