The bear market and economic downturn that caused a sharp decline in fund managers’ revenues and profitability has, in spite of a fitful recovery, bred an enduring cost-consciousness in the investment industry.
Exacerbating the downward pressure on margins, is increasing commoditisation which has made it more difficult for fund managers to charge premium prices for their products.
Many asset managers are taking a hard look at their businesses to determine whether it might be more cost-effective to outsource non-core operations such as back-office processes to a third-party supplier.
While cost savings can result from carefully planned and executed outsourcing agreements, some such deals in Europe have not proved to be quite as beneficial to the outsourcing client as anticipated. This has been mainly due to disputes over service level agreements.
So if middle and back-office outsourcing is not yet the panacea for the business problems facing asset managers today, what’s the alternative?
The answer to that question may seem obvious – do it all in-house. But deciding on this course begs further questions. Do you build your own proprietary IT system, incorporating full front to back-office processing capabilities?
Such an approach is costly and tends to be the preserve of the largest asset managers. Once built, in-house systems need to be updated continuously which is costly.
Another option is to build an asset management platform using different off-the-shelf systems software packages. Supporters of this so-called “best of breed” approach say that it reduces operational risk because the asset manager is not relying on a single firm for support and service. If something goes wrong with a component and the supplier fails to satisfy, the user can source a compatible product from another supplier.
Critics of the “best of breed” approach say that multiple software applications require additional interfacing technology to enable data to move between the systems. The user is required to hold a number of licences and to pay external maintenance fees for multiple software components, databases and the necessary middleware to link the disparate systems.
Integrated systems package
An alternative to patching together multiple pieces of application software is to acquire a fully integrated systems package from a single vendor. There are no shortage of providers in this space, offering systems designed to automate the entire investment management process, from front to back office. Most providers, however, are promoting their products to asset managers, banks and insurance companies at the higher end of the market, leaving small to medium-sized investment houses with fewer vendors to turn to.
Steve Audiens, sales manager for the Benelux region at SimCorp, says that asset managers usually buy the back-office modules first and return for the complete package “once they’ve been won over by the technology”.
He says that when buying systems software, asset managers should consider carefully how they expect their business to develop and the functionalities they will need over time.
“If they are small, for instance, and looking for a very specific function, it might make sense to buy a best of breed solution. If you want all your investment processes handled in one system, it can make more sense to buy one integrated system,” he explains.
One firm which was set up to cater for the investment management technology needs of smaller asset managers and hedge funds, is UK-based Financial Tradeware. Managing director Alberto Fontana maintains that these companies face difficulty in finding affordable systems software tailored to their needs.
He says that many players are reluctant to take the outsourcing route because they do not want to lose control over their middle and back-office functions.
He maintains that outsourcing can involve the unwelcome payment of large commissions to brokers for the execution of trades. Added to which he contends that many outsourcing service providers are not interested in taking business from smaller asset managers.
Hedge funds, says Mr Fontana, face the problem that not all the investment management systems available to them cover all the asset classes and financial instruments they trade.
He notes that the investment process for small to medium-sized asset managers is still marked by much manual processing due to a lack of automation. He says: “Smaller players must change their structure in order to survive, and straight-through processing technology can help them greatly. Such firms need the same connectivity for clearing and settlement as the bigger players in order to ensure the operational efficiency and to lower their costs.”
Mr Fontana finds it remarkable that all of the main software vendors are focusing on the bigger financial institutions.
“With IT expenditure decreasing so much, it is a problem for these vendors to complete a sufficient number of sales,” he comments.
While the adoption of a single integrated front to back-office system with real-time processing capabilities may reduce operational risk and cut costs in a fund management business, one vendor notes that asset managers tend not to rush out and buy the “full monty” all at once.
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