There will come a time, possibly in the not too distant future, when a fund management firm will look to outsource virtually all of its operations – even trading – for funds with the right strategy.
Of the biggest challenges facing fund managers today when it comes to running their businesses for success, performance is the obvious and ongoing challenge. But putting that aside, from a business standpoint, it’s the uncertainty from the regulatory environment which is causing the most pressure. New regulations regarding FATCA require investment management firms to invest in new technology and systems to deal with these types of pressures. Managers will have to either build technology on their own or outsource it. From a compliance standpoint this is very expensive because the regulatory environment is always changing.
Costs continue to grow for investment management. The cost of building technology is obviously very expensive, and it’s not viewed today as an expense that is always necessary. The majority of the management firm’s expense should be focused on research, and a lot of managers believe that anything that’s post-trade should be at least somewhat outsourced. Whether it is regulatory reporting, risk reporting, or portfolio accounting, if outsourced, the management firm can spend their money and efforts on research, execution and, obviously, raising capital.
Another major challenge facing management firms is the ability to react to their investors’ demands, from a transparency perspective. During the operational due diligence process managers are required to show how they are calculating risk and it’s very expensive to build up that type of infrastructure. Going forward, more regulation will drive the need for more transparency. With the uncertainty of the regulatory environment, successful managers will focus on their core activities and outsource many of these functions to their administrator.
Not only are costs rising, but fund management firms are also increasingly being pushed down on fees. The 2/20 and 2/30 model just does not exist anymore; the new paradigm is closer to 1/15 or even zero management fees. As performance fees come under increasing pressure, other fees for running a fund are being passed along to investors rather than at the management level. Management firms, as they are being asked to reduce fees, are looking across their operations and deciding whether they need a full time compliance officer, a full time trader or a full time COO. The answer may be “no, no, no.”
Having all of your services bundled into one relationship is the new concept. For today’s fund management firm, simply making trading decisions and raising capital with everything else being outsourced is very much the play. Fund management firms are rationalizing their business not just to reduce cost but to focus on their core responsibilities.
As a result, various stakeholders within the fund management firm are looking at which functions can be outsourced. Funds are looking to completely outsource the COO responsibility to an external firm including compliance, reporting, daily administration, and technology infrastructure, allowing the principals to concentrate purely on capital raising and portfolio management. And increasingly, broker services are being built to outsource trading for those funds that only need to execute smaller daily orders, allowing some funds to outsource front office functions as well.
The issue of outsourcing is both a time and cost factor. But having one vendor or provider can limit the amount of cost, whether the function is risk reporting, compliance services, or administration such as striking the actual NAV (net asset value). It’s about aligning priorities. By bundling all these services to one provider, a fund management firm can significantly push down the cost of ownership.
At the same time, fund managers want to avoid the complexities and headaches of dealing with multiple vendors. It’s much easier to manage one service level agreement with one entity than having multiple services level agreements with multiple entities.