Buy Side - Outsource or Not? IT and Operations for New Entities

2010-07-29T08:46:00.003-04:00

When new investment firms are being formed, one of the fundamental questions is “Should we consider outsourcing? And if so, what functions should we outsource?” The two areas that are typically included for consideration are systems and operations, but there are other areas that can be included such as: HR services including payroll and benefits; finance and accounting operations; compliance; PR and marketing communications; branding; sales. For the most part the decision whether to outsource each individual functional area will depend on the circumstances of the new firm formation - startup or spin off - and the skill areas of the formation team. With spin offs, often the firm includes many of the core functions including sales and marketing, finance, compliance. We will examine the potential value of outsourcing other functions in a future blog entry.

Regarding IT and operations for both startups and spin offs, a strategic decision will need to be made whether to adopt the existing IT infrastructure (if it is available to be included in a spin off situation) and to retain/hire IT and operational staff. There are several much discussed key drivers typically presented by consulting firms and industry experts for assessing whether outsourcing is favored:

Smaller asset base tends to favor outsourcing for its variable cost model;
Outsourcing is recommended for those functions not considered core competencies or strategic differentiators
Outsourcing can meet very aggressive time frame requirements to go live

Most organizations will not go wrong making a decision based on their assessment of these drivers, but as important as these drivers are in the decision making process, there are additional considerations that trump all other considerations. If the management team has a cultural bias toward having control over IT and Operations, it doesn’t matter that the logical decision is to outsource. Outsourcing would be doomed for failure because the management team will not be able to exert the level of control over vendors in a similar manner it could with a captive set of resources. In contrast, if the management team does not have the bandwidth or interest in actively managing and making decisions associated with IT and Operations – resourcing, hiring, budgets, system selection, training, etc. – then in-sourcing it could result in either gross over or under budgeting, and sub-optimal or over-engineered infrastructures. More importantly, the organization will have to have the wherewithal to hire qualified resources across an additional set of functions and skills – application development, production support, desktops and networks, trade processing, accounting, asset services, data management, etc.

In the hedge fund industry, it is virtually standard practice to outsource systems and operations for a new entity. The prime brokerage industry is highly evolved, providing most trading and back office services needed – execution and clearing, funding, collateral management, recordkeeping, etc. And most systems firms supporting the hedge fund industry can offer a managed service model and outsourced office IT support.

In the long only investment industry, operations and systems outsourcing is still relatively young, although there is clearly a growing trend toward outsourcing these functions. New startups and spin offs especially are now favoring outsourcing driven by all the above criteria and most importantly, recognizing that the core competency of the business is investment strategy and a desire to hire a resource team exclusively focused on driving the core competency.

Outsourcing typically works in circumstances where the stars are aligned from a business strategy and management propensity perspective, and the relationship with the service providers is managed as a partnership. The providers are structured to deliver these services to a broad range of clients, and can offer insights and recommendations in support of their clients’ needs. That said, investment firms need to proactively manage their relationship with the providers, and not assume that the providers will be able to “take care of things” as expected. Beyond the typical standard service level agreements and contract language, it is critical early on to work closely with the providers to establish expectations and define tasks and items of importance, in order to ensure the providers focus on providing a level of comfort that will allow the investment firm’s management team to focus on their tasks at hand. Service providers may not have similar perceptions of what is important and will need to be guided, at least in the beginning. This active management of the relationship should be able to subside once the “steady state routine” is established and meets the investment firm’s expectations and needs.

For both the hedge fund and long only industry, if this active management is not done up front, the work involved to get it to a state acceptable to the investment firm’s management team will at least triple in effort and time frame. What would normally take 1-2 months to iron out in the beginning, will take 3-6 months of active management once the bad habits are formed by the service providers.

Outsourcing is a positive and growing trend across all of the buy side industry, and can offer real benefits to investment firms, especially for new and smaller firms where managing the support aspects of the business can be very distracting to the management team and where outsourcing can offer access to much more robust infrastructures and services than can otherwise be afforded. But as with many business decisions, although the contracts may be arms length, the relationship must be a partnership and treated as such, and must be proactively managed to ensure both sides work on the relationship and are happy working together.

Bernard Chen
Managing Partner
Madison Consulting Group

Madison Consulting Group Updates Website

2009-05-05T08:13:00.002-04:00

Madison Consulting Group has recently updated its website to reflect it's expanded consulting services. As part of the update, the website has also been given a new makeover to improve navigation and the user experience.

A summary of the expanded services added to the site:

Hedge Fund Risk Services offering operational risk assessments, DDQ response templates, and investor marketing support

Business Performance Improvement program to dramatically improve profitability by aggressively managing an initiative lifecycle program in a manner similar to managing a product lifecycle program.

Business Innovation program to implement an innovation process and culture to identify strategic innovation opportunities.

Performance Measurement program to assist management to identify and implement the most effective performance measures - not just financial but operational, organizational, market and service - to ensure alignment with management objectives.

Anti-Money Laundering Scorecard Service to provide management with an enterprise level assessment of the AML compliance program.

Madison CG

Buy Side - Outsource or Not? IT and Operations for New Entities

Madison Consulting Group Updates Website