Investment Insourcing – Don’t Forget Operations

The ‘insourcing’ of investment management by superannuation funds is a topic closely followed by many in the industry. Much of the discussion has focused on the merits of this strategy from an investment performance perspective and the need to drive down investment related costs. However, dealing with the operational and IT issues associated with investment management can present significant challenges to Funds.

In March, we hosted a roundtable session for leading industry superannuation funds to discuss these challenges and the following themes emerged that should have relevance for all Funds going down this path.

Getting the definition right

So what is meant by insourcing investment management? The simplest definition is that a Fund has ‘insourced’ investment management when it has sacked a manager and chooses to run a mandate in-house. Whilst this is one definition of ‘insourcing’, it is far from the complete definition. For example, many Funds may not manage direct mandates but will manage overall asset allocation or will be responsible for manager selection. Put simply, they are making investment decisions that have a consequence on the portfolio(s) of the Fund. When considering this broader definition, we believe that many, if not most Funds, have ‘insourced’ investment management to at least some extent.

The danger here is that, outside of the investment team, there may be very limited understanding or visibility of the internal investment process and the extent that it is reliant on data and systems to make informed decisions. Rather than communicating these requirements back to the operational and IT functions, thereby risking a prolonged and painful IT development process, many investment professionals will simply ‘build’ their own tools through spreadsheets and source their own data. Whilst this approach may address the needs of the investment team, this unstructured approach exposes the Fund to a raft of operational risks that remain hidden from the rest of the business.

Preparing the Business Case

When a Fund considers whether or not to ‘insource’ investment management the business case (if it is prepared) will generally consider two things:

1. Can the Fund meet or exceed the current investment return by insourcing investment management; and

2. Will the extent of expected savings from external manager fees more than offset the expected investment required in people and technology?

Whilst these are fundamental questions to address, we believe that the business case should consider the Operations and IT consequences in further detail. Specifically, the business case should address the following questions.

• Scope – What investment decisions will be made internally and what data and tools are required to make these? (this should also consider what current investment decisions are being made even though the Fund may not have ‘officially’ insourced investment management)
• Data availability – Where will investment data be sourced, validated and stored? If it is from the custodian, has their ability to supply this data in a timely, accurate and reliable way been validated?
• Systems availability – what functionality is required to support the investment process and do systems currently exist to support these? (supporting investment management by ‘asset owners’ is a developing area for many IT vendors and solutions may not exist for some requirements)
• Operational risks – What operational risks are likely to exist? A useful way to construct this is to consider the consequences of an ‘incorrect’ investment decision being made due to errors in the data and/or applications

The Importance of a Target Operating Model

Prior to implementing changes to systems and processes to support insourcing investment management, a Target Operating Model (‘TOM’) and IT architecture should be prepared. Whilst this need not be overly prescriptive and detailed, this will enable the following questions to be answered in a structured way:

• What functions does the Fund need to undertake to support investment management?
• What functions may be outsourced and to whom?
• What skills and tools are required to support the functions?
• What is the best way to organize these functions?
• What is the preferred IT architecture model (e.g. single vs best of breed systems) and data model?

Preparing an upfront TOM and IT architecture will ensure alignment of implementation activities towards a common set of objectives and will provide the framework for making key decisions. Further, from a stakeholder management perspective, the TOM/IT architecture is a useful means of communicating the desired outcome and activities required to achieve it.

Selecting the Right Vendors

The vendor landscape to support investment management is a pretty crowded place (see below slide)

However, completing an IT architecture design will help define the requirements for IT solutions and should make the selection process more straightforward. Whilst functionality (and Cost) will always be important factors, our experience is that non functional issues are often as, if not more, important and can mean the difference between failure and success. Further, the difference between ‘outsourcing’ and ‘technology’ is becoming blurred with many vendors providing BPO solutions as part of their offer. These present interesting propositions to Funds, especially where internal expertise may not be present.

Bruce Russell
Director