Asset management firms take committed approach to outsourcing

Think investing is hard to get right? Try outsourcing. A failed attempt in the asset management world could mean disaster. Bottom line: You've got to commit and take it all the way.

NEW YORK -- Outsourcing is like marriage: You're in it for the long term -- at least you should be. Getting out is costly and wrought with disappointment and contractual chaos. In the asset management world, the pain is intensified by compliance and culture.

"This is a multiyear marriage, for better or worse," said Sean Kelley, global head of technology and operations at Deutsche Asset Management. Kelley, the keynote speaker at last week's Second Annual Asset Management Industry Outsourcing Forum, said asset management firms had better "KYP," or Know Your Partner, before entering into any outsourcing relationship because, "getting out is harder than getting in."

Adam Schneider, principal with Deloitte Consulting LLP in New York, rang the alarm too. "This is not a trim, where if you don't like the haircut you go to a new place the next time. This is a heart transplant, a marriage, a one-way street. If you have any doubts about it, don't go down that road," he warned.

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Why so stern? Outsourcing in the asset fund management industry has changed dramatically since the early 1990s, when firms first saw a benefit in paying somebody else to do the back-office chores. Fifteen years ago, most firms were not looking at outsourcing as a means to leapfrog a competitor, or establish a global presence. "We wanted good, not great results," Schneider said.

Compliance, cost, complexity and a culture that wants to be online all the time have changed all that. Today, outsourcing needs to be justified. This is challenging on many fronts, Schneider said. For starters, the "first-mover advantage" is taken. It's costly to outsource. The vendor banks know the economics of back-office outsourcing better than their customers. "They understand your alternative is to spend $20 million. And they really know your alternative, because they own much of the technology," he said.

Offshore players continue to build strength, but until a Tata Group, for example, hooks up with a SunGard Data Systems Inc. and a big bank, offshore has "limited ability to offer a complete solution," he said.

In addition, as outsourcing moves from back-office services to the new frontier of middle-office functions, such as trade operations and reconciliations, firms face another dilemma: Do they count on the same provider to handle both back-office and middle-office tasks, or spread the risk with multiple vendors? To build a network of vendors, however, the firms' technology teams need to prepare a consolidated and scalable infrastructure.

Kelley is convinced the traditional approach to outsourcing has been rendered obsolete by technology. IT is the "lubricant" that allows companies to distribute their "beta," or market services to others, and forces them to focus on their "alpha," or what makes them special. "IT will unbundle your value chain," he said. The old outsourcing model of "hitting people over the head and telling them to get it done better, cheaper and faster," no longer works. "After all that root canal, you're flat," he said.

He believes firms need to build an "ecosystem" or portfolio of vendors that -- if chosen correctly -- will not so much save money as make money for the firm. The hedge fund model illustrates the power of the portfolio approach, he said.

"The hedge fund model was formed by people who don't want to be bound by traditional chains. Everything in the hedge fund world is a portfolio. Alliances are their oxygen. They have got the trick that to succeed geometrically, partnerships are the keys to success," Kelley said.

Dan Bikowski, a partner in IBM's financial markets practice, offered attendees some data points for getting their outsourcing strategy together. An IBM research study of 400 business leaders in the financial markets shows that the business model for the industry will shift by 2015. Agency profits will die, because clients increasingly see little value in the simple execution of trades. The bundling of active management of portfolios will split, because clients are "less and less willing to pay alpha fees for beta returns."

Asset management firms should identify their alpha and partner accordingly, Bikowski said, quoting the "focus on the core and outsource the chores," rule. "Alpha and beta will separate," he said. In this new financial landscape, "alliances will be critical." The decision by Merrill Lynch & Co. to sell its investment management business to money manager BlackRock Inc., while maintaining a 50% stake in BlackRock, is an example.

The potential better-than-average returns that come with partnering also carry greater risk. British Airways found that out when partner Gate Gourmet Inc. didn't show up for work at Heathrow. Ford discovered that when partner Firestone's tires started blowing up. Know Your Customer, or KYC, is standard practice for financial institutions. KYP, or Know Your Partner, before distributing parts of your business, Deutsche's Kelley stressed. KYP due diligence should include questions like: Does the provider have scale and continually invest in building scale? Is it metrics based? Does it have rigorous standards? What about a demonstrable focus on quality control and delivery?

Finally, don't commit the cardinal sin of relationships, and take your partner for granted. The partner portfolio must be actively managed, Kelley said. "Monitor, monitor, monitor." And a good fight now and then is par for the course. "Because this is a relationship, fighting and making it up is OK."

Let us know what you think about the story; email: Linda Tucci, Senior News Writer

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