“Investment firms often fail in enhancing the value of outsourcing by not having a strategy.”
Dave Shastri, CEO, TrussEdge
Building an investment firm is a challenge: regardless of the where, when and how, the attraction of the private assets industry means founders are faced with significant competition and consequently critical decisions need to be made on the development of the business.
Private markets are becoming crowded and emerging firms have costs and fee pressures to confront. On the cost side, managers face increased regulatory requirements that have developed as the industry has matured. Additionally, the main private markets investors, including pension funds, endowments and family offices, have set due diligence requirements which require emerging firms to demonstrate institutional-grade infrastructure. Fee pressures have also risen as managers enter increasingly crowded strategies and investors demonstrate the leverage that their capital can exert. The current prevalence of specialised investor mandates in the form of managed accounts can also serve to drive down fees.
Clearly the private markets investment firm must have some unique attribute(s). But there are other features driven by the market which are crucial to success. New firms are expected to have that institutional infrastructure from the outset, because that is the level set on the playing field.
Controlling costs AND best practice
Most emerging private market firms also seek to maintain a flexible cost structure, which requires outsourcing functions that are not part of their unique attributes. A flexible costs structure can support a longer runway to achieve the critical mass necessary for success. Administration and technology are obvious examples of the areas where a flexible costs structure is now commonly employed. CFOs of earlier stage firms overwhelmingly choose to outsource these functions, seeking to swap capital expenditure, in the form of licensing or building technology, and the cost of full-time employees, for ‘renting’ the resources needed. This can include software as a service and outsourced operational support.
However these outsourced activities still need to support critical functions including financial management, especially in areas like liquidity, portfolio management, trading and cash management. It may even include support for investor relations. These functions are complex, so they need very careful and strategic consideration.
For an emerging firm putting together a structure for the first time, we have found that there are a few key factors private fund managers need to be aware of to leverage outsourced functions effectively:
Talent in private markets is scarce
This includes the talent needed to implement technology and to manage change, both of which are in short supply. The emerging private fund firm should recognize where it can obtain excess value from its outsourcing partners: these partners may bring the added value of expertise, experience and talent that the firm can leverage.
Emerging private market investment firms will find it cost prohibitive to hire the experienced people needed to set up their core processes, to establish mission critical operating procedures and to innovate in order to make their business efficient.
Once the management team has selected its vendors, they need to ensure that their process implementation and structure take best advantage of those solutions. This includes considering the advice of the vendors and recognising where they may bring experience from servicing other clients. The firm’s external vendors should be able to demonstrate how to best take advantage of their solutions.
Investment firms expect to scale up
As a private fund management operation grows, GPs expect to enhance the use of services from their outsource partners. A sensible approach by an emerging firm is to ensure the infrastructure is right-sized, growing as needed as the firm grows in terms of funds, assets or investors.
When managers or their advisors ask if their outsource partner can scale when required, they want to ensure that they do not need to change vendors unnecessarily as the business grows. There is a significant cost to replacing solutions down the road and generally this means wasted time and money in implementation and stored value.
As a result it is common for firms to believe that for the vendor to handle scaling, it means that the outsource partner has a large market presence. Larger outsource service providers often have more product coverage, but this belief misses the point of what scaling actually means.
In reality, scaling involves expanding the solutions the firm needs to cover operational areas that the asset manager did not require when it was smaller. This includes, for example, more risk reporting, or investor services. It does not mean the manager needs to partner with a big firm to accomplish this. Often larger firms accomplish these goals by using multiple product suites. This does not solve the problem of expanding services without the added time and cost of further implementations. It is often better to find a set of vendor solutions that allow a firm to start with a suite of core features and then “turn on” expanded features as they are needed.
The need for a proactive strategy
An investment advisor will need to decide how to manage an outsourcing relationship, rather than be reactive to the relationship. This is where alignment with the outsourced provider in terms of their attention or focus on your business is important.
A strong outsourcing strategy will ensure that there are “owners” in the firm of the relationships with specific vendors. Being active in this process means ensuring that you develop regular interactions such as meetings with the vendor to ensure operational effectiveness. You may need to make your vendors aware of your developing needs, which may also raise further support requirements, but at the same time they may be able to offer some experience.
Building the outsourcing relationship means using it to enhance your overall organization effectively. And the talented people working at your vendors can become an extension of the infrastructure of your firm. If your vendor does not bring that type of support, it is likely that your firm will find little enhancement of your business through that relationship.
Ultimately investment firms often fail to enhance the value of outsourcing by not having a strategy, usually because the outsource partner(s) are not considered to be strategic relationships.
Developing and implementing an outsourcing strategy in private markets can be a significant enhancement to an emerging firm – it deserves the thought needed to not follow the herd, in the same way an emerging firm hopes to be perceived as having a unique offering by its own investors.
www.trussedge.com I sales@trussedge.com