The emerging manager faces a wide range of challenges rather than just making money. Nigel Fielding looks at the role of outsourcing and its importance to a growing fund management business
Within the offshore world, the outsourcing of administration is standard practice among the well-established fund players. For new or emerging managers, outsourcing is not seen as an immediate necessity, but it can have substantial positive effects on the success of the business. Additionally, by providing an extra level of support to the manager, the third-party servicing provider can add value to its client relationships by approaching its role as a 'partnership.'
Emerging managers are new management teams establishing independent investment management businesses ' a burgeoning trend in the UK and Europe and one which has developed in tandem with the rise in popularity of alternative investments. Yet such groups face a much wider range of issues, responsibilities and challenges than simply managing money.
Fund companies are entities which contract all of their services. Day-to-day considerations not only include the main aim of the fund ' being to meet its investment objectives ' but the development of a significant degree of business infrastructure in order to support the investment process. This is where the administrative function is so crucial. In addition, the rising cost of investment in technology requires managers to carefully consider the level and types of business they undertake in house.
Structuring a fund
There are a number of different functions which the emerging manager needs to look at and there are many advantages in seeking external guidance. At start-up the issues which the manager must address include size (often a small operation), unique investment approach (which may not be well understood by the investor), use of offshore structures (often in less regulated jurisdictions), degree of transparency and the implications of risk management. The emerging manager is wise to seek partners to help solve these problems, at least to the degree to which they are important to their business. Hand-holding start-up fund managers can be performed by a single group or by hiring separate advisors, but the list of needs are greater than they were a few years ago.
New Business. The emerging manager generally has a good reputation, but often no track record in running an investment management business. Starting such a business has a low barrier of entry with minimal capital requirements, therefore the manager will seek to partner with institutions that have a strong reputation. Such groups include not only an administrator and custodian or prime broker, but also legal counsel, auditor and any other supporting advisors including marketing consultants. Such alliances provide comfort to the investor and support the sales effort.
Business Plan. The business plan requires ' and receives ' a great deal of attention. Emerging managers increasingly understand the need to have focused and structured business plans in place. The ability to clearly communicate the objectives are essential to marketing the investment manager's expertise which will be distributed through the fund. However, it is only when the regulatory requirements are in sight that these matters get documented, and often it is the administrator who brings these issues to light when discussions are in place regarding fund structure and jurisdiction. Focused marketing strategies are essential. Emerging managers were once extremely rare, however, now as they are rising in large numbers, they start to compete for the same target market and so a plan of action in marketing the fund is essential.
Marketing. The manager needs to identify the sources of capital and then present their case to these groups, but this process is more often assisted by a dedicated group. This could be an in-house team, but there is an increasing trend to outsource this function to consultancy groups to help raise money. The business of such companies is much more advanced in the US, but is growing in Europe. Emerging managers can be given assistance with presentations, targeting and contacting the appropriate market niche and communicating their style ' in other words providing the support and expertise of a full marketing team.
Middle and back office
Outsourcing sounds great, but what do investment managers want and what is straight-through processing? The basics of fund administration can be best illustrated below:
With regards to systems and support, sophisticated money management systems are available off the shelf which provide a fair degree of integration with the custodian and/or prime broker. The middle office function needs to handle and book deals and initiate the straight-through processing to the custodian in order to enact settlement. Increasingly, managers seek to have integration with service providers as they recognise there are both efficiencies to be gained and improved delivery in the end results of the process. An overall lower structural cost to the business is the goal. Whereas these functions are well supported in large money management operations, outsourcing supports this for an emerging manager.
The traditional focus of outsourcing has been the preparation of the net asset value calculation. This function highlights the importance of independent pricing for the emerging manager. Many astute investors require a third-party issued valuation and it creates a level of comfort in the controls that are in place. The administrator thus takes on a fiduciary role for open-ended investment vehicles which enables the manager to offload the risk associated with this function. New managers may be tempted to perform their own net asset value calculations as they already have the portfolio and pricing information. Preparing the net asset value is not really a specific advantage to the manager. Managers are becoming aware that there is a risk of issuing an incorrect net asset value. The possibility of an error creating a financial exposure for the manager is unnecessary where the net asset value is not a key to their business. As a result, there is a shift towards having an administrator with the financial strength and reputation to support pricing/trading risk, thus reducing the risk of the manager making any errors.
Increasingly, there is a call to improve the transparency of reporting, requiring attention of a greater deal of time to this discipline. However, it is a requirement which can, particularly in a small fund operation, create additional burdens. The obvious choice here is to outsource to ' and seek guidance from ' the administrator. In instruments such as guaranteed fund structures, the party providing the guarantee needs to have comfort that the appropriate controls and monitoring of investment guidelines are in place. An independent group is again of value in providing the frequent compliance reporting.
This approach is becoming more important as emerging managers are increasingly seeking to raise money from institutional investors. The traditional investors for new independent groups have been predominantly high net worth individuals/families and endorsements/foundations. The difference between these two groups is that the institutional investors often have higher demands. While allocations are generally larger the institutions may seek lower fees. Demands with regards to reporting and the level of third-party support are often high as well. This does not make the business unattractive, however it does require that a high level of infrastructure be set up by the manager. The obvious means of achieving this is to outsource. The partners chosen by the manager become paramount in the delivery of the product to the end investor and provide the manager with a level of expertise and experience not available in-house. It is important for the outsourcing partner to develop an understanding of the client's business, and for both parties to establish up front what they expect to gain from the relationship. This includes analysing the current servicing structure to identify the strengths and weaknesses and then capitalising on the strengths. The approach of each partner is important, common philosophy and goals should be discussed to confirm that there is a mutual understanding of the way business is performed.
Managers must recognise the value in establishing good relationships with their outsourcing partners. Aside from the initial burden of making the change to outsource (cost of restructuring internally), the reputation of such partners can enhance the fund's marketability and should provide an expert level of guidance from groups who are a) well connected in the industry, and b) have the strength and experience to carry risk.
The need for improved servicing to the fund management business is growing. This is mainly due to investor ' particularly the institutional investor ' demand for better risk management, transparency and communication. It is also due to the manager's need to reduce unnecessary risk and meet requirements without a significant growth in operations. By seeking guidance in the planning process the emerging manager can successfully leverage off the expertise and reputation of others.
The development of a significant degree of business structure is important to support the investment process.
The rising cost of technology requires managers to consider the level and types of business they undertake in house.
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From 6 April 2019