Why are investment management business models shifting towards outsourcing?

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If there is one thing that’s constant, it’s change. But looking back at the last two years, that’s an understatement for asset and alternative fund management. Facing the rise of new ways of working and new asset classes, what we have seen is nothing short of a paradigm shift – especially when it comes to the normalisation of outsourcing and its applications across the front, middle and back offices.

The investment and fund managers of today are starting to leverage the benefits of outsourcing in novel ways, in order to meet the challenges that hybrid and remote working have brought head on. According to our Global Asset Management survey conducted with Aite Novartica, nearly a third of investment firms are looking into outsourcing opportunities in the upcoming year for their middle office operations, up from just 17% in 2019.

Be it in reducing costs, accessing senior expertise or increasing efficiencies for business-critical functions, outsourcing is fast defining a new business model in the back and middle offices in this industry.

Overcoming the outsourcing taboos

The pandemic reframed not just ways of working, but assumptions, attitudes and approaches that had long gone unquestioned and unchallenged within hedge funds. These were ideas that dictated that only very few and very specific functions could be outsourced, and some processes should only be done within the four walls of the office.

In short, outsourcing could be taboo.

Fast forward to today, and the conversations at investment management conferences, roundtables and panels play out very differently. Roles such as management accounting, bookkeeping and records are no longer the sole responsibility of the in-house team. For hedge funds, outsourcing is not just increasing in the middle office, but is also growing in popularity in the front office for the first time. Activities such as investor reporting are becoming resource-heavy as the regulatory environment grows in complexity and the quantity of information needed increases. As a result, the highly manual tasks of collecting, organising, and validating data are being outsourced to free up time for employees – according to our Fund Oversight Challenge research, 54% of fund managers use third-party fund administrators to produce critical data such as their net asset value (NAV).

Diversifying products and services and new technologies have driven fund houses and investment firms to abandon notions that outsourcing can only be utilised in a single area. More and more, the front office is realising the value of prioritising time spent finding the next investment rather than servicing existing funds and assets, working on highly manual data processes, and carrying out complex reporting procedures.

Bridging gaps in talent and technology

As trends in the investment management industry fluctuate, fund managers can find themselves scrambling for the expertise needed to expand the products and services they offer. The private debt market is set to grow to $1.5 trillion by 2025, posing a big challenge to the many firms wanting to compete but finding themselves lacking on a technical and personnel level. In other areas, experts are needed not just in an operational sense, but also for better client service in classes such as alternative lending, crypto and ESG. Regarding the latter, our Global Asset Management survey data suggests that 41% of firms have sought ESG specialists, be it from internal or external sources, in the last year.

Yet, for many, keeping talent on standby for the more ‘niche’ areas is an expense that not every firm can afford. Nor is it particularly efficient to do so, for those that can afford it. So, what we’re seeing is that the growth of the market and its diversity of assets has normalised the outsourcing of talent and expertise at a far more senior level. This can enable firms of all sizes to bring experts in as and when needed, rather than maintaining large teams of experts.

At the same time, there is the question of maximising the benefits of technology. Managers, particularly those working on private funds, are operating in an environment where greater transparency is needed. Regulators are looking closely at the amount of capital that’s being allocated in these large, expensive deals, and expense tracking is very hard to do manually. For 35% of investment firms, the regulatory burden was cited as an operational challenge in our Fund Oversight Challenge report. Yet we often see firms are still working on excel documents or cobbling together several tech systems that might not communicate with each other.

Adding to this, as each deal is unique and takes place in a fast-changing borrower market, it leaves execution teams in the front office bending over backwards to make things work. Coupling that with our survey findings that 72% of hedge fund managers and 54% of asset managers are developing less technology in house, it is clear that strategic deployment of outsourcing is becoming a critical factor in maintaining efficiency and staying competitive in a complex growing market.

Addressing the growing pains of digital transformation

Diversifying and competitive markets, increased regulation and new technology brings swathes of new data to analyse and check, adding hours of additional manual work for asset and fund managers. Even with artificial intelligence and machine learning automating manual processes, in-house capacity can only achieve so much in making that data manageable and consumable. So, the human element remains for now, but outsourcing is growing in popularity across the front, middle and back offices. Introducing outsourcing into business models is freeing up cash and human resource by removing the need to build and maintain internal teams to compete in the ESG, crypto and private debt markets, or invest in introducing new systems.