Making the leap from burning IT platform to safe cost haven:

how standing still is not an option

Moving from a legacy IT platform to a system supported and regularly updated with new functionality can make an investment management company more efficient. Despite costing more in the short run, it can prove more cost-efficient in the long term. This is one of the conclusions of a recent Australian survey by consultancy company Investit, which in this article focuses on how replacing an outmoded system with an enterprise solution is a viable option for investment management companies to consider and adopt.

by Doug Neill, Principal at Investit, Sydney, Australia.

As the global competition among the outsourcers of investment operations intensifies, one of the main conclusions to be drawn by the industry is that investment management companies must prepare for disruptions and often change as the outsourcers seek efficiencies through consolidating their local operations into global operating models. This affects not just the services delivered but also the means of delivery, which must include how the technology platforms are structured and run – an area that all investment managers are keenly interested in.

If Australia is taken as a local example, the inevitability of consolidation among outsourcers demands that investment management companies evaluate their operational cost strategies sooner rather than later, and it may come as a surprise that the cost difference between outsourcing and internal operations is less significant than most believe. Instead of focusing exclusively on cost, companies are well advised to consider how their IT systems, including the core operational systems, contribute to the execution of their overall business strategy.

Investment management companies must also consider other consequences of their choices. For example, managing an outsourced relationship can be extremely complex and not necessarily an advantage in terms of cost savings. On the other hand, the cost of a retained operation can quickly escalate if the right people and management structure are not in place. Taking this into account, the best results will be achieved when investment operations are selected and executed based on long-term strategies, rather than short-term cost or convenience considerations.

AUSTRALIAN SURVEY RESULTS WITH GLOBAL IMPLICATIONS

At investment management consultancy Investit, we have recently performed an independent survey into the future of investment operations. Confined to the Australian market but with global implications as well, the survey consisted of more than 40 in-depth interviews conducted with Australian investment managers, service providers and software suppliers between July and September 2011.

The survey revealed that as Australia’s investment management sector enters a phase of increased investment operations activity, managers must make an informed decision about their under­lying operations strategy. With the average investment operations outsourcing project taking at least 12 months, and probably much longer for more complex businesses, investment managers need to act now so they have discretion and choice and are not forced to leap from the burning platform.

Since the introduction of compulsory superannuation in 1992, Australia has developed a sophisticated investment industry worth an estimated A$1.23 trillion. Although the market is mature and operates within the frameworks of the developed world, it is small in global terms. The market is also extremely concentrated with 50% of the total assets under management held by the top 10 investment managers and 75% across the top 30.

Unlike other mature markets, the Australian investment sector has a substantial amount of funds investing in other funds, rather than through portfolio structures. Australian investment managers are also affected by local taxation rules that must be strictly provided for. These specific taxation rules are challenging for both software providers and service providers. Meeting these requirements is both a barrier to entry for new providers and a challenge for existing providers.

Outsourcing suppliers catering for bespoke service requirements experience increased risks and costs. Investments managers are, therefore, frequently forced to retain additional internal staff to cope with customised system operation solutions.

COST NOT DEEMED PRIME DRIVER IN OUTSOURCING

The Australian outsourcing market has only really developed in little over a decade. This has presented an alternative for investment management companies, which previously had to manage their own internal operations and systems. Currently, these companies have a choice of selecting their investment operations from a range of seven global outsourcing suppliers, two software providers, one local outsourcing supplier or from a number of smaller boutique outsourcing providers.

The managers’ highest ranked reason (for not outsourcing their investment management operations) was the need to keep flexibility and agility. This reflects the difficulties in managing a changing business through an outsourcing arrangement. This is in line with outsourcing providers, who are even firmer in the belief that outsourcing is shunned by companies requiring sufficient agility and flexibility in their operations. The managers who considered what factors would lead them to run an internal operation ranked keeping flexibility and agility as their top priority (58%) as shown in Figure 1. Over half (53%) ranked the ability of specialist resources to be their second highest factor when choosing to run an internal operation.

Figure 1. Reasons not to outsource 

For those investment managers who choose to outsource, a number highlighted the challenge for outsourcing providers to transfer functions to their global centres of excellence, without losing their ability to provide local thought leadership.

Despite the perception that the cost of outsourcing is lower, the findings of the survey indicate that the total cost of operations does not differ significantly between investment management companies that outsource (2.9 basis points) and those who manage their systems internally (4.0 basis points) as illustrated in Figure 2.

Although the motivation to outsource may be to enable the company to allocate more resources and time to areas of the business that contribute to the bottom line, the results of the survey suggest that the reality for most is that there is some frustration that the cost and size of their retained function is growing.

RETAINED FUNCTION: THE ‘SPIRAL OF DECLINE’

The research results show a growing concern by some companies which opt for outsourcing, particularly among those running complex investment strategies and multi-jurisdictional businesses, that the size and cost of the retained operation are mounting and in some instances are already too large.

According to the indications, this growth is occurring for two reasons; the first is because of the outsourcing suppliers’ reluctance to absorb the cost or risk of providing bespoke solutions; the second derives from an inability by investment managers and outsourcing providers to re-establish sufficient trust after an error has occurred, prompting the client companies to increase their checking processes.

Checking and validating data is a common practice in the investment management industry. There is a fine line between checking and validating the outsourcer’s position and a duplication of processes. It is easy to see how the trust between investment managers and their providers can quickly deteriorate if the investment manager is spending undue time and resources checking data. This situation may also lead the outsourcing provider to believe that the issues are resolved and subsequently back away from the problem altogether.

This continual process of checking for errors and the gradual shift in responsibility for data quality from the provider to the client is referred to as the ‘spiral of decline’. Once this process of data validation has commenced, it is exceedingly challenging for the provider to re-establish trust in the quality of their data.

COST AS DIFFERENTIATOR RATHER THAN MOTIVATOR

The effects of the ‘spiral of decline’, and subsequent need for client companies to maintain a hands-on approach with their outsourcing providers, can be seen in the difference in staffing levels between those that outsource and those that manage their systems internally. According to the survey performed, average staffing levels between those that outsource (15%) and those that manage investment operations internally (23%) differed by only 8% as shown in Figure 3.

While the survey demonstrated that cost is not typically a motivator for investment management companies when selecting investment operations systems, it is certainly a differentiator. There is a palpable lack of historical experience, data and information for companies to utilise when estimating the long-term costs of outsourcing operation requirements.

Where some companies have preferred to outsource to reduce their total head count by almost a quarter, the marginal difference in head count between those that outsource and those that insource shows this is frequently not the case.

However, the decline in outsourcing relationships is not always the fault of the provider. This highlights the need of both the provider and the investment manager to ensure that they implement the most appropriate structures with the relevant staff in place to make the relationship work. Managing an outsourcing provider requires a different set of skills and organisational structure to manage the expectations and needs of both the provider and the internal stakeholders.

Figure 2. Actual costs of investment operations.
Figure 3. Operations head count difference between internal and outsourcing operations 

ONE VIEW OF THE FUTURE

As investment management companies recognise that there are internal challenges in managing an outsourcing arrangement, they are also aware that the industry is entering a period of change.
A decade ago, when the outsourcing providers first entered the Australian market, the only way to build market share was to develop a local presence, with local systems and processes.

Outsourcing providers are now under increasing pressure to migrate to global operating models to reduce their operating costs. This, coupled with pressure from other providers perhaps better positioned to service the Australian market with their global capabilities, accelerates the decision by some outsourcing providers to reduce their local footprint and to leverage their own global operating model.

The research results show that 43% of the investment management companies surveyed rated as very likely, and 57% as likely, that the investment management sector will see consolidation among outsourcers. When asked about what outsourcing providers will need to do in the future, 69% of the respondents felt it was very likely that the outsourcers would need to leverage their global capabilities. A further 73% of the companies surveyed believed outsourcers would need to increase their efficiency locally.

One possible conclusion to draw from this is that the Australian investment management sector should prepare for the creation of new service models from outsourcing providers, with a broader range of products and functionalities available. The most likely scenarios will include a strong middle-office focus.

A move away from best-of-breed architectures towards more integrated systems and data architectures is required, argues Doug Neill, Principal and Head of Investit's Austrailian operations. According to Investit, standing still on the 'burning platform' is no longer an option.

LEAPING FROM THE BURNING PLATFORM

As the industry enters a phase of increased investment operations activity, it is vital that investment management companies take stock, assess and plan for their future strategy. In the survey performed, investment managers consistently ranked robustness of systems architecture as a top priority when considering the services provided by outsourcers.

When asked what would make them consider changing their investment operations strategy, corporate changes among outsourcing providers ranked as the number one reason (37%). Service issues, such as errors and relationship concerns, only accounted for 16% of investment managers’ reasons to change strategies. These errors would also need to be regarded as catastrophic for investment managers to take action.

The recommendation to investment management companies that demand a guarantee that they will be supported by a modern platform must therefore be to manage their operational requirements internally. Having the ability to perform non-standard operations and to maintain specialist capabilities in-house – listed as prime drivers against outsourcing among surveyed companies – add to the argument of replacing a legacy system with a new internal system. However, the solution to this challenge for Australian investment management companies is not as simple as choosing between outsourcing providers or internal management.

For some, the decision will be to run an internal investment operations function to ensure flexibility, fixed future costs, specialisation and scalability. Those that choose to outsource will need to meet and support similar business needs and objectives but must also consider how the provider will manage the product they are buying. The priority for all Australian investment management companies, and indeed for companies elsewhere on the globe, must be to maintain a programme of awareness to anticipate changes, allowing them to develop a coordinated and aligned IT strategy for future business success.

Doug Neill heads Investit’s Australian operations, working with clients in Australia and Asia to build efficient and effective investment organisations. He has extensive experience in working with clients to assess, plan and implement operational and systems solutions. Doug Neill formed the Chief Operating Officers’ forum in Australia to facilitate the collective discussion about local and global issues affecting the industry as a whole. He is a regular contributor to the Investit Intelligence service. Prior to joining Investit Doug Neill held senior IT positions within the investment management industry in the UK and Australia.