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Paul Allen
Paul Allen
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The Evolution of Outsourcing

As investment operations outsourcing begins to take hold in the U.S. financial services industry, the service model is changing.

Though most trends in the financial services industry tend to be U.S.-led, fund management outsourcing has been more of a U.K. and continental European phenomenon to date, with a raft of high-profile deals hitting the headlines in the past two years. While outsourcing is the norm in the U.S. for areas such as shareholder servicing and custody, operations outsourcing, including fund accounting and fund administration, has not taken hold in the same way that it has in Europe. In addition, outsourcing of many middle-office functions, such as client reporting, performance measurement, risk analysis, data warehousing, compliance monitoring and corporate actions processing, also have been slow to catch on.

The reason, says Steve Papulak, business development manager for Mellon's Investment Manager Solutions, is that the European environment tends to be more complex and cross-border, with more product sets to manage. Therefore, it requires robust infrastructure, a costly proposition, particularly when it comes to reinvesting in new platforms. As a result, outsourcing becomes a logical alternative to supporting operations in-house, Papulak contends. By contrast, many U.S.-based fund managers have big books of domestic securities, which require a less complex and more automated processing environment with fewer operational challenges.

But Tim Lind, senior analyst with TowerGroup, believes a slow shift toward outsourcing investment operations will continue to emerge among U.S. fund managers as the asset management industry increasingly resembles a manufacturing-type paradigm. "Just as auto manufacturers have moved from manufacturing to supply chain management and assembly, so asset managers will focus more on assembling components of the final product."

Asset allocation strategies and customer-facing activities will remain core parts of the asset manager's role, but areas of lesser consequence to the end customer can potentially be farmed out, according to Lind. "I see this world becoming more specialized, more componentized, and outsourcing services will follow that general trend," he says.

Historically, the rationale for outsourcing was rooted in the cost constraints facing asset managers as they struggled to survive the bear market. While conditions have eased somewhat, cost pressures remain. In addition, competitive pressures continue to build in the U.S. fund market, as participants wrestle with reduced net inflows and less captive distribution, relates Joe Keenan, managing director, head of product sales and marketing for global fund services, The Bank of New York. The upshot is that managers continue to focus on core competencies, he adds.

One of the inflection points toward greater outsourcing, suggests TowerGroup's Lind, is that many fund firms are looking to renew their core infrastructure now that markets have risen and they can breathe a little easier. "If I am going to replace a portfolio accounting system, or recreate my data management infrastructure, or develop a new reporting capability, outsourcing is one viable alternative to building my own system or licensing and deploying one," he says. "That systems-renewal process is leading to more substantive conversations about outsourcing."

The regulatory environment is fueling the outsourcing proposition further. The slew of new regulations introduced in recent years, and the compliance burden that has resulted, pose challenges for both fund firms and service providers, according to Neal Andrews, senior vice president and senior managing director of fund accounting and administration at PFPC. "A lot of the regulations really don't have a precedent, so clients and service providers are working hard to study their application and ensure they meet the requirements," he says. "Both clients and service providers are spending a lot of resources in that area."

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