Asset managers face unprecedented pressure from shrinking margins, changing distribution models and regulatory challenges, driving the industry to the brink of its third major outsourcing wave since the 1980s, according to a new white paper from Northern Trust. The paper, The Third Wave of Outsourcing: A Tipping Point for Outsourced Trading in the United States, examines how outsourcing the front office, particularly the trading function, can help investment managers in their drive for Operational Alpha®.
Echoing two previous outsourcing waves, the first for custody operations in the late 1980s and the second for middle office functions in the early 2000s, adoption of front office outsourcing is occurring as rising costs and unrelenting margin pressure become a major focus for investment managers.
Between 2007 and 2017, costs for North American asset managers increased by an average of 5 percent per year, and 6 percent in the final 12 months, according to McKinsey & Company. As managers evaluate what parts of their operating models are core to their value proposition, an increasing number are determining that front office functions like trading do not need to occur in-house.
“Outsourcing front office functions like the trading desk was once considered off-limits, but we believe this ‘third wave’ is likely to establish a new status quo across the industry,” said Dan Houlihan, head of Asset Servicing, Americas at Northern Trust. “We are seeing asset managers of all types beginning to outsource up the value chain. In doing so, investment firms are mitigating risk, more easily attaining compliance with complex regulations, increasing transparency, enhancing scale and efficiency and, ultimately, reducing their costs.”
Investment managers considering outsourcing some or all of their front office functions must first determine which in-house activities add the most value in their drive for alpha. For activities determined to be non-core, outsourcing to a trusted provider with the requisite scale and expertise can be an effective way for firms to streamline their operations and take advantage of newly created efficiencies.
“Asset managers are now reviewing their operating models to see where efficiencies can be gained and costs can be reduced without impacting their value offering,” said Gary Paulin, global head of Integrated Trading Solutions at Northern Trust. “As asset growth has slowed for many established firms, outsourced trading has developed to a scale where it’s a viable solution for large in-house managed funds as well as traditional investment managers looking to enhance their reach, scale, efficiencies and expertise.”
The white paper identifies factors to consider in the outsourcing decision, including six different categories of cost in establishing and maintaining a trading desk, and provides a list of questions to guide asset management firms in their decision-making process.
“There are a number of things asset managers should consider before outsourcing trading and other front office functions, many of which we outline in this paper,” said Houlihan. “The decision to outsource functions once considered sacrosanct can be daunting, and we believe that managers should fully evaluate their options before making a decision.”
The Third Wave of Outsourcing: A Tipping Point for Outsourced Trading in the United States can be accessed here.For additional insights on outsourced trading and front office outsourcing, please visit Northern Trust Asset Servicing.