Outsourcing of Investment Operation

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In a smaller fund management firm, the back office operation is usually outsourced to external parties such as custodian bank. Some fund managers will call the broker and place the order themselves instead of hiring a trader. As the firm’s Asset Under Management (AUM) getting bigger, then a trader is added to the team so that the trader will be responsible for managing various brokers and monitor trade execution done by the brokers. Eventually, the front office team will include fund managers and fund manager support staff. The trading team will include a second trader and some trading support staff. 

The fund managers and traders are the essential team members to the investment firm, although some larger companies have outsourced its support operation overseas. For example, some fund managers may outsource some of its data analysis work to companies in India. However, it is rare for fund management firm to outsource other front office support operation. 

For middle and back office operation, we need to ask if we need to outsource them or do it in-house. Please note that because of the arrangement of using custodian bank to hold the portfolio asset, it usually doesn't cost much for the custodian bank to provide fund accounting services and portfolio valuation service. However, such custodian bank may not provide in-depth performance analysis.

The advantage of outsourcing the back office operation is that you are free from the problem of staffing the back office team, managing them and managing the back office operation. The management will also be free from investing in investment technology and IT staff. In addition, it gives client some assurance for mitigating fraud risk since the fund management and the back office operation is not done by the same company. 

The disadvantage is that you do not hold the investment data and there is not much you can do for data analysis except to rely on the standard report. Additional costs is required if you want to transfer the investment data back to you for data analysis. However, custodian banks are gearing up to provide additional services such as performance analysis. 

The cost of outsourcing the back office operation is cheap compare to setting up your own back office operation especially if your AUM is small. As your AUM grows to a certain amount, it might be feasible for you to setup a back office operation and mirror the investment data. 

Please note that base on a dollar to dollar comparison, it might not be feasible to outsource the back office operation. The management should consider hidden cost such as the efforts on managing additional staff, cost of operational mistakes and cost of managing the technology.

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