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When outsourcing essential middle-and back-office functions to a third party, asset managers should always follow the golden rule: you can profitably outsource many functions and tasks, but you can’t outsource accountability.

We’ve distilled a few core principles for outsourcing success based on our experience with institutional investors, hedge funds, and other asset managers.

Collaborative Partnership

First, the most successful outsourcing relationships are genuine partnerships, whereby the managed service provider becomes an integrated and seamless part of the asset manager’s operations, working in concert to carry out a firm’s investment, compliance, accounting, and reporting activities. Building and then acting on this model is essential.

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<ul><li>Maintain a partnership mindset centered on joint success. When firms and providers commit to achieving a common goal, the interaction becomes a productive two-way street.</li><li>Agree on concrete deliverables and metrics with explicit SLAs (service-level agreement) so that agreed and mandated expectations aren’t forgotten or diluted over time. Each outsourcer should also have the business continuity plan needed to deliver on those SLAs when unexpected circumstances arise.</li><li>Use non-disclosure agreements to clear the way to open communications. Mutual transparency helps both sides of the partnership succeed. The closer the working relationship between firm and outsourcer, the more benefits will accrue from a solid partnership.</li><li>Plan for regular meetings, at minimum every month. These meetings should include updates, the specifics of what’s been accomplished, and how effectively it was done. They should also cover areas that could’ve gone more smoothly, as well as suggestions and requests. A monthly frequency prevents issues from lingering for an entire quarter or even a full year.</li><li>Monitor the partnership continuously as it progresses. Reviews aren’t just a formal exercise. With a trusted relationship, both parties should constantly be managing and molding the process.</li></ul>

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The Big “E’s”

Second, outsourcing operational tasks lets investment firms focus on revenue generation and growth. There are three big “E’s” of managed service success: efficiency, expertise, and education.

Outsourcing middle- and back-office responsibilities helps firms enhance processes with both time efficiencies and cost efficiencies. When investment firms need more capacity to handle a spike in trading volumes or take on a new Separately Managed Account, for example, the managed services model allows them to scale up quickly and then scale down when operational needs return to prior levels. Service levels dovetail to business needs. By contrast, insourcing means maintaining unused staff capacity “just in case” or spending several months sourcing, hiring, onboarding, and training new staff. It means always playing catch up to regulate the balance between need and capacity.

Any activities outside of growing assets or investment strategy and decision-making can be a candidate for outsourcing. The goal is for each party in the partnership to focus on what they do best. It goes beyond small firms simply using outsources for extra arms and legs.

An outsourcing firm that handles many clients with a wide array of operational requirements has likely encountered similar situations in the past. An outsourcing provider can also offer suggestions and insight into how others optimize their operations or a fresh way of approaching a problem.

Trade reconciliations offer an excellent case in point. An outsourced provider delivering dedicated expertise in reconciliations can quickly identify and resolve trade breaks. Their work can rapidly unlock the expertise of an internal senior operational team member, who no longer needs to spend the first few hours of the day tracking down and matching files.

Similarly, a function like compliance requires a high degree of expertise that can be challenging and costly to develop organically, with no room for errors. A provider who can handle straightforward tasks such as quarterly updates, compliance attestations, employee attestations, reviews, and the like gives firms the power of “instant-on” expertise, with tools and team members dedicated to handling essential compliance tasks that mitigate risks.

Firms need to educate their investor, too. It might seem that investors would be concerned by a high degree of outsourcing when making allocation decisions. But firms can change the conversation by making sure investors understand that service providers are mandated to take on tasks, not take on accountability. Firms set the policies, and service providers play a role in executing on those policies.

The investor is essentially looking for reassurance that an outsourcing firm is highly competent, with the ability to handle the workflow. The key is to demonstrate to the investors that firms have carried out rigorous due diligence and have a thorough understanding of the processes of the providers they engage.

In fact, firms can make outsourcing a competitive advantage by educating investors on benefits such as increased efficiency, expertise, and business continuity. Doing so requires firms to understand in detail what providers are doing. Going back to compliance, for example, what should you say if investors inquire about your process? Saying that you have no idea because you just send it over to your outsourcing provider is not a viable option. A much more appropriate answer would be to describe the compliance policy, the role of the provider, and the process for ongoing review.

Bottom Line: Maintaining Accountability

Finally, adopting the golden rule of accountability is essential. Firms can outsource all manner of tasks, from the routine and repeatable to even entire functions, but they can’t offload their responsibility to investors.

When outsourcing back- and middle-office processes, firms get easy and efficient access to expertise for a range of time-consuming projects. Middle-office tasks run the gamut, from trade processing, reconciliation, and position lifecycle management, to stock borrowing and swap financing maintenance. Likewise, the back office provides coverage from trial accounting and shadow balance reconciliation to non-trading accruals and payments to tax lot management.

In a successful partnership, there’s always a distinction between taking advantage of professional expertise and owning the final product. It’s entirely reasonable to delegate clearly defined tasks to experienced outsourcing providers, but it always remains your firm that holds accountability for the results.

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