Asset managers are contemplating a new outsourcing model where everything, front to back office, is on the table. Nicholas Pratt looks at the implications.
The industry is on the cusp of a third wave of outsourcing. So say both the outsourcing providers and the asset managers. Participants have got used to the idea of back-office outsourcing and are currently experimenting with middle and even front-office outsourcing.
The next stage is the front-to-back outsourcing offering that covers the whole breadth of functionality from the fund accounting to trading and, more importantly, the data that comes with it. And all provided by a single vendor.
But while this third and possibly final wave may seem like the logical conclusion for operational outsourcing, will it lead to a less diverse marketplace, like we see with global custody, and with no place for specialist vendors? Will it deprive fund managers of the ability to be technologically innovative? And will it leave chief operating officers twiddling their thumbs with nothing to do?
Not according to two operations heads at leading asset managers.
This third wave became a possibility following acquisitions in the summer of 2018. Chief among these was State Street’s purchase of order management system (OMS) provider Charles River, but there was also Ion Investment’s acquisition of Fidessa and SS&C’s various buys, including Eze Software.
The acquisitions were a reaction to BlackRock’s Aladdin system, which started life in the 1990s as an in-house tool for evaluating bond portfolios and has grown into a ubiquitous multi-asset, front-to-back platform available to other asset managers. Aladdin’s 2019 acquisition of eFront, a portfolio management system (PMS) for private equity and alternatives, will see it look to expand its reach yet further.
And there are other OMS providers that have offered front-to-back functionality such as SimCorp and its Dimension product. But right now, says Derrick Hastie, global chief technology officer (CTO) at Aegon Asset Management, all eyes are on State Street to see exactly how well its new Alpha outsourcing model holds up, and to see which major asset manager will be the first to take them up on it.
Hastie’s idea of a third wave is shared by Mike Tumilty (pictured right), global chief operating officer (COO) at Standard Life Aberdeen. “The State Street acquisition was a pivotal moment for the industry,” he says. “The idea of a back-office outsourcer acquiring a portfolio management system to create a full suite of asset management services with the data all fully loaded and in the cloud is a move on from where most asset managers are to date.”
Right now, most asset managers have outsourced their back office to a global custodian or asset servicer (wave one) but may be using a best-of-breed approach for everything else, using an on-premise PMS for the front office and taking overnight feeds from a number of different middle-office providers (wave two).
So, the idea of a third wave where everything comes from a single provider, including the data, could be compelling for asset managers, big and small.
“Increasingly, operations are becoming more commoditised than esoteric and firms are becoming increasingly interested in a front-to-back offering, particularly for anyone that is running an enterprise data management operation and spending all day scrubbing and distributing industry-level data,” says Hastie.
Tumilty believes this ‘third wave’ of outsourcing would be a healthy development. “As asset managers, we spend an inordinate amount of time sourcing, sorting and transporting data. The State Street proposition would negate the need for asset managers to be embroiled in those activities.”
Managers may be sold on the concept, but they will want evidence that there is the breadth and depth of capability. “We would want to see a marquee signing and clear roadmap and a demonstration that it meets that roadmap and it happens on schedule,” says Tumilty.
Just this month, Charles River announced a deal with the newly merged Janus Henderson Investors, which will use its investment management system, delivered as a service rather than on-premise. However, we are yet to see a major asset manager sign a front-to-back deal with State Street Alpha.
It is two years since the acquisition and while it would be reassuring if State Street were taking its time to work on the operational plumbing, the likes of BlackRock continue to work with managers and develop offerings such as Aladdin. “The world is not standing still waiting for State Street,” says Tumilty.
One potential complication for these front-to-back deals is the fact that asset managers typically have complex relationships with their asset servicers, says Tumilty. And when there are mergers between asset managers as well as vendors and asset servicers, the issue becomes even more complicated. “Maybe when asset managers are looking to renew their contracts with asset servicers, that will be a time to consider a new, front-to-back outsourcing arrangement.”
So, how far are firms prepared to go with their outsourcing and where will they draw the line in terms of what remains in-house? “Securities are well understood now,” says Hastie (pictured left). “There are still some real assets and other illiquid asset classes that require specialist systems, but that it just because of the relative maturity of the technology. In time, those could be available too.”
Mark Trousdale, chief growth officer for InvestCloud, which provides digital services to wealth and fund managers via the cloud, agrees that there is a third wave of front-to-back outsourcing. “Areas that were previously sacred cows – from trading to the investment book of record, or IBOR – are now being considered for outsourcing. Everything is on the table.”
This will only become more pronounced during a further squeeze on operational costs. “The lockdown will lead to some hard decisions about operations. Firms are closing offices and merging divisions and this forcing them to reconsider what they will outsource and where they are going to specialise.”
Nick Wright, CEO, funds and IT at SS&C, says the distinction between what remains in-house and what is outsourced is constantly being challenged. “Previous hard lines are now being reviewed as investment managers focus on their core business,” he says.
“They are doing this for two reasons – scale and risk. They are growing and don’t want to end up running a large operational area and they want their current employees to concentrate on areas of risk, whether operational or investment, to make better investment decisions.”
Earlier this year, asset servicer Northern Trust (NT) carried out a survey on the outsourcing strategy of 300 asset managers, which showed that many are prepared to outsource middle and front-office functions, like trading. To Clive Bellows, head of global fund services, EMEA at NT, it also shows how far the outsourcing industry has evolved, from its beginnings in the early years of the millennium and the back-office lift-outs to the present-day focus on more data-driven front and middle-office functions.
“When you go back two decades, outsourcing was predicated on the idea that the outsourcing firms could do big operations better than asset managers. It was kind of true then, but I’m not sure it is true anymore,” says Bellows.
Nowadays it is less about scale and staffing numbers and more about data and what he calls event-driven architecture, he says. “It is about providing asset managers with accurate and quality data in a way they can use and that they could not provide themselves.”
Technology is critical to this model, especially cloud technology, which allows for greater scale and more storage of data. The cloud will also make it easier to connect to clients at a time when there is no common outsourcing model – some want to connect via a web portal, others via APIs and others via a Swift connection.
But where does this leave smaller independent, specialist vendors that have previously formed managers’ best-of-breed strategies? Is there still a place for these vendors? “They may end up being component parts in a proposition of the large banks and part of the solution offered back to asset managers,” says Aegon’s Hastie. “Ultimately the industry needs economies of scale from its vendors, so it is better if they have 20 customers via a third party than two customers on their own.”
Unsurprisingly, it is a view shared by the large outsourcing providers. They see themselves becoming the de facto manager of an asset manager’s various vendor relationships. “In theory, you could get smaller vendors with good technology that disrupts the old order,” says Bellows. “But it all comes back to the data. If you are not able to provide good, accurate data sets, the best technology in the world will not make a difference.”
And typically, it is the large custodians that have access to that data. However, this need not mean that there is no place for smaller and more innovative technology providers. Bellows (pictured right) says that NT is increasingly partnering with smaller technology firms rather than developing its own technology in-house. He cites the example of Lumint, which applies machine learning to FX data. NT partnered with Lumint before eventually acquiring the company and incorporating it into its outsourcing offering.
Bellows argues that this gives asset managers greater access to new technology than they would have outside of an outsourcing arrangement. And with the outsourcer acting as the point of contact, it is a more convenient approach for fund managers. “Managers want access to technology, but they don’t want to deal with multiple vendors. Outsourcing providers also have greater global spend to dedicate to new technology, either directly or via partnerships,” says Bellows.
InvestCloud’s Trousdale does not believe that this trend for out-and-out outsourcing will lead to a less diverse market or that firms will become less innovative. “The asset servicers may have a one-stop shop offering, but they are not forcing anyone to take every service on offer, just as we don’t push the whole stack of 300 apps on our clients. Providers are becoming more modular.”
The increase in front-to-back outsourcing will aid rather than impede innovation, says Trousdale, giving asset managers greater access to new technology. “The asset servicers are hungry to find new technology and they will pass that on to asset managers. It also gives asset managers more breathing space and to innovate in areas that are important to them – such as sustainable investment and financial planning tools for intermediaries.”
Another potential implication is that outsourcing will reduce or raise questions about the role of asset managers’ ops and tech teams. As Bellows says: “Asset managers are focused on managing money, which is what they do best.”
But he also says that outsourcers are enjoying a more direct relationship with asset managers that goes beyond liaising solely with the operations teams. Firstly, there is more contact with the technology teams, something Bellows says would never have happened 20 or 30 years ago.
Outsourcers are also dealing more directly with portfolio managers and with the distribution teams. “The data on fund flows is much more valuable. Managers can see what strategies are successful in which countries.”
The traditional role
And where does this model leave the traditional CTO or COO? Will they have little to do when all operations are outsourced? Far from it, they say. There has been an ongoing trend in which the COO role is more about defining the firm’s strategic roadmap and how best to achieve it, says Tumilty. “It is less about operational activity and more about strategic relationships with third parties.”
It should also allow COOs to be more innovative, he says. “If a third party is spending more time on the plumbing, it should free you up to spend more time with subject-matter experts and portfolio managers on what new tools they need.”
“The reality is that even today, there are areas in which many asset managers are underinvested,” says Hastie. “Such a model would allow them to spend more time supporting their front-office teams or their distribution teams with good-quality analytics.”
Nor does he think there is any likely tension between the CTOs and the outsourcers and clients over the provision of these value-added services. “It is about partnerships and we use all of our partners to contribute to our product development. There is no shortage of good ideas out there, and the key thing for us is to be able to get those insights in the first place.”
Not only has Aegon worked closely with the likes of Citi and JPMorgan to explore new innovations, it has engaged with more than 140 fintechs in the past year and gone live with several of them. Some fear that outsourcing more to large providers will create a less innovative market, but Hastie thinks otherwise, and that asset managers will find they have much more access to new technology such as AI and ML.
“I think this model is applicable to all asset managers and everyone will be watching this area very closely in the future to see how durable the model is, how well integrated the various parts are, and it will be interesting to see which firms are going to go first.”
In terms of the next steps for Aegon Asset Management, Hastie says, “we will continue to watch the industry closely and we still have to decide on our strategic direction”.
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