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Bank-Sponsored Conferences Dropped Nearly 40% in First Half of 2020

Investment banks reduced the number of conferences they sponsored by 37% in the first half of 2020 from the prior year, according to data collected by investor relations platform provider Virtua. The large decline in conferences has generated concerns whether research payments will also fall. However, the falloff in bank conference programs was far less than non-bank conferences which shrank by nearly 60%. A few banks, notably RBC Capital Markets and Wells Fargo, increased their conference volume.

Fewer events

Only half as many conferences were held in the first six months of 2020 compared to same period in 2019, according to Virtua’s StockConferenceCalendar service. 2020’s tally of 1084 conferences was nearly evenly split between those sponsored by banks and conferences organized by other sponsors. Most of the decline was in the latter group, as non-bank sponsors cut back programs by 56%.

If the trend of the first half continues, the full year results for 2020 will see a major disruption in conference activity. Conferences are running at a rate that implies a decline of over 1700 events from 2019, the majority being those sponsored by non-banks. However, banks have been cutting back their events since 2017, likely in response to MiFID II’s prohibitions against paying for conferences with bundled commissions.

Leading bank sponsors

JP Morgan, Citi and Credit Suisse remained the top three conference sponsors overall during the first half of 2020. JP Morgan cut its conferences by less than Citibank, taking the lead during the first six months. On average the top three sponsors cut their programs by about a third, but JP Morgan dialed back by ‘only’ 25%.

RBC Capital Markets and Wells Fargo Securities bucked the trend, increasing their conference sponsorship during the first half of the year. RBC was particularly aggressive, upping its events by over 40%, moving it to the fourth most active bank sponsor. Deutsche Bank, which began shutting down its equities business last July, and Jefferies cut their conference activity the most among the top bank sponsors, paring back by over 60%.

The analysis is based on data supplied by Virtua StockConferenceCalendar, considered to be the largest global database of investment conferences and presenters. Virtua is a financial services technology company focused on providing platform-based analytical tools and services tailored to the workflow needs of Investor Relations (IR) professionals and publicly traded issuers. Although the firm is headquartered in Boston, much of the analysis and data collection is done in India.

Virtua acquired StockConferenceCalendar in 2015 from Dremer IR Counsel, an IR consulting company.

Integrity Research’s Take

Despite large balances in US CSA accounts set up for research payments, banks worry that fewer events will translate into lower research payments. These concerns were echoed by sell-side panelists at a recent conference who observed that although virtual events have been well attended, the perception is that quality of virtual events is diminished.

Nevertheless, Virtua’s data shows that banks were more successful in adapting to the exigencies of the pandemic than most non-bank sponsors. We’ll see if that trend continues when we do a full review at year-end.



Banks’ Share of Conferences Increased in 2019 As Overall Sponsorship Fell

Investment banks reduced the number of conferences they sponsored by 4% in 2019 yet gained share as the overall number of conferences dropped 11%, according to data supplied by investor relations platform provider Virtua.  Two of the top three sponsors — Citi and JP Morgan — cut their conference programs by over 10% while most of their direct competitors increased event sponsorship.  Overall, banks sponsored nearly 40% of all conferences.

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Fewer events

The number of conferences in 2019 tracked by Virtua’s StockConferenceCalendar service decreased by nearly 430 events to 3,588 conferences.  MiFID II-induced cutbacks in conference spending were one factor in the decline.

After increasing their conference sponsorship in 2018, Citi and JP Morgan cut back their programs 26% and 14% respectively.  Credit Suisse, which is trying to rebuild its equities franchise after four years of decimation, increased its events in 2019 by 21% to tie Citi as 2019’s top conference sponsor.

Jefferies added the most conferences during 2019, raising its total by 31 events, a 62% increase.  UBS also expanded, becoming the fourth largest sponsor by adding 12 conferences.  RBC upped its program by 10.

With the exception of Deutsche Bank, which began shutting down its equities business in July, the other bulge bracket banks – Bank of America/Merrill, Goldman Sachs, Morgan Stanley and Barclays – all increased their conference sponsorship in 2019.

Favorite locations

The top financial centers – New York, London and Hong Kong – remained the most popular conference venues.  Their market shares are off slightly from 2017, but it is not clear that they are losing their long-term appeal.  The diversity of conference locations fell in 2019 but remains higher than 2017 as the number of venues dropped to 350 in 2019 from 380 in 2018 while up from 333 in 2017.

The analysis is based on data supplied by Virtua StockConferenceCalendar, considered to be the largest global database of investment conferences and presenters. Virtua is a financial services technology company focused on providing platform-based analytical tools and services tailored to the workflow needs of Investor Relations (IR) professionals and publicly traded issuers.  Although the firm is headquartered in Boston, much of the analysis and data collection is done in India.

Virtua, which provides platform-based analytical services for Investor Relations (IR) professionals, acquired StockConferenceCalendar in 2015 from Dremer IR Counsel, an IR consulting company.

Integrity Research’s Take

Not captured in Virtua’s statistics are more customized bank events such as reverse road shows, site visits, small venue meetings, and more specialized forms of corporate access which are more highly valued by investors than standard conferences.  Thus, part of the fall in conference sponsorship might be explained by banks devoting more resources to non-standard events rather than conferences.

Broader pressures on cash equities units from declining commissions and reduced spending by the buy-side on advisory services are also likely causes of bank conference cutbacks.  Nevertheless, it is notable that the largest banks tended to increase conference sponsorship in 2019, suggesting that conferences remain an important part of their overall advisory services.



“X as a Service” Providing Flexibility to Asset Managers

McKinsey’s latest annual review of the North American asset management business found the industry-wide profit pool declined nearly 4% y/y in 2018, driven by a 4% increase in costs and relatively flat revenue growth.i Heightened pressure on profitability is forcing asset managers to look harder for opportunities to reduce operating costs without impacting the quality of investment capabilities. This largely entails searching across the organization for ideas to enhance productivity, either targeting steady workload volume at a lower cost, or squeezing more output from a comparable level of spending. Automation is playing a role in this endeavor, but “Anything as a Service” (XaaS) outsourcing programs are also a critical part of the equation.

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XaaS in the Asset Management Business

The XaaS concept riffs on popular Software as a Service (SaaS) technology solutions. Across much of the value chain, asset managers are choosing to forgo the significant time and resource commitment required to build credible internal non-core capabilities. Rather, forward-looking firms are opting to hire expert vendors to handle burdensome, complex or capital-intensive functions that are an undifferentiated component of their offerings. An outside provider furnishes the people, tools and processes required to maintain a world class capability and rent the platform to its clients, offering “Anything as a Service.” Buyers benefit from accessing the skill and scale of an expert without allocating capital to finance upfront and ongoing operating costs (targeting higher ROI by shrinking the denominator), and the asset manager can often acquire these non-core services at a lower total expense vs. running them in-house. Furthermore, buyers can maximize business flexibility by shifting costs from fixed to variable, as firms have the option to increase or decrease invoice size by altering the volume of services assigned to the XaaS provider. Going forward, active managers will likely respond to elevated competitive pressure by adopting more performance-based management fee structures. Firms’ income will become less predictable, waxing and waning with investors’ ability to generate excess returns. In this environment identifying opportunities to convert fixed costs to variable will become an important lever to reduce business risk.

The Investment Front Office is Fertile Ground for Savings

Asset managers have spent the last decade-plus automating, outsourcing, offshoring, and right-sizing back and middle office and other support functions. What is different as we enter the 2020s is that those cost-cutting wells are experiencing declining production. Firms must now focus on identifying savings in the high cost, undifferentiated capabilities of the investment front office. To date, many investment teams have endured “do more with less” headcount reductions, but most firms have failed to put serious thought into reimagining the investment operating model to gain efficiency without affecting quality. According to asset servicer Northern Trust, “the industry must radically address their cost base and given that the front office has been relatively immune from previous outsourcing trends, it represents the greatest opportunity for cost reduction now.”ii Firms must honestly assess the capabilities in their investment value chain and judge where the organization maintains truly differentiated competitive advantages. Asset managers should maximize resources allocated to developing and extending those advantages, while all other workflows should be considered candidates for cost-optimization. Data Management as a Service, Trading as a Service, Research as a Service – if it is not a differentiated capability, every function should be on the table as a potential opportunity to enhance results at a lower price point.

i “Beyond the Rubicon, North American Asset Management in an Era of Unrelenting Change.” McKinsey & Company. November 2019.
ii “The Third Wave: A Tipping Point for Outsourced Execution Services in the United States.” Northern Trust. October 2019.


Fee Compression Dogging Asset Managers

As mentioned in the recent Virtua Insights post “Asset Owner Insourcing, Another Unwelcome Headwind for Asset Managers,” asset managers’ profits continue to come under pressure from both sides of the P&L. Revenues are declining from fee compression, mix shift (investors moving from active to passive, and growth to hedging strategies), and clients insourcing investment management. Expenses are rising due to regulatory compliance requirements, technology spending, and the costs of meeting clients’ customization demands. While the prior post focused on insourcing, this piece will drill deeper on declining management fees and what asset managers can do about it.

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A Challenging Environment

Asset consulting firm bFinance recently published a paper assessing the current state of investment management feesi. bfinance’s findings and analysis point to a fee-constrained world for asset managers. Over the last 3 years prices have declined across much of the industry, dropping most sharply in absolute return bond (-15%), emerging markets debt (-10%), and emerging markets equity (-6%, and -13% since 2013) strategies. The authors also developed a framework to scope where price competition for a product set is most intense, evaluating the impact of fee transparency, barriers to entry, size of the provider universe, credible substitute strategies, product differentiation, and investor demand as key drivers of asset managers’ pricing power (or lack thereof) for a given style/asset class.

No Relief on the Horizon

Price compression shows no signs of subsiding, and smart buyers are employing tactics to actively encourage it. For example, bfinance is advising their clients to leverage the firm’s insights to promote price competition, recommending approaches such as searching within broader lists of managers that include less established firms, negotiating fees earlier in the search process (before determining the finalists), and agreeing to serve as an anchor investor for an asset manager’s proposed new vehicle launch or planned expansion into a new geography. Similarly, Greenwich Associates found that institutional investors are rigorously analyzing fees much earlier in the search process, including adding pricing metrics to the screens used to cull the total universe of potential providers to a more manageable number in the initial stages of due diligenceii.

The Asset Manager’s Roadmap

While low headline fees may attract the attention of some prospective clients, overly aggressively pricing can cause the product to be viewed as low quality (customers still believe that you get what you pay for). Furthermore, asset managers must embrace the self-evident truth that pricing a strategy below what a client is willing to pay for it leads to foregone revenue. Large, diversified asset management firms are responding to pricing pressure by setting rack rate fees at realistic levels, empowering sales people to offer pre-determined discounts, establishing cross-functional committees to approve outsized fee reductions, and in at least one case adding a management fee czar to resolve conflictsiii . Boutique managers generally have the advantage of operating within a flat organization, allowing for more nimble approaches to pricing.

Establishing rack rate and mandate specific fees is a critical decision, complicated by the opacity of live competitive pricing intelligence and the intense competition to win new institutional asset management business in today’s revenue-constrained commercial environment. Before setting fees, an asset manager must first develop a reliable framework for estimating the cost to service a new mandate in order to truly understand the impact of pricing on profitability. The cost model should include variable costs that are incurred by a mandate, along with allocated costs of key inputs required to manage that piece of business (investment management, trading, operations, client service, reporting, legal/risk, compliance, etc.), but it should exclude corporate overhead that is not impacted by winning or losing clients or AUM.

A credible estimate of the cost of service is an important data point, but it should not drive the fee-setting decision. Cost-plus pricing is an ineffective business strategy because it fails to consider two critical factors:

  1. The client – who is the client, what are their objectives and constraints, what problem does your investment capability solve for them?
  2. The competition – how is your capability differentiated, do you have defensible competitive advantages, where are your competitors willing to price comparable or substitute strategies?

Legendary management guru Peter Drucker advocated for price-based costing vs. cost-based pricing. Successfully implementing price-based costing requires developing an understanding of the needs of target clients and the competitive landscape, then managing costs to deliver a targeted profit margin for mandates priced at the prevailing market rate. If revenue at the market price will not outpace a reasonable forecast for the future cost of service plus the required margin, an asset manager must maintain the discipline to walk away from unattractive engagements – new or existing. Price-based costing is difficult to execute, but it is the only path to sustainable profitability in a hyper-competitive market like today’s institutional asset management business.

i “Investment Management Fees: Is Competition Working?” bFinance. October 2019.
ii Thomas, Dervedia. “Managers Grapple with Where to Draw the Line on Fee Discounts.” FundFire. 25 October 2019.
iii Ibid


Asset Owner Insourcing, Another Unwelcome Headwind for Asset Managers

Asset managers’ profits continue to come under pressure from both sides of the P&L. Expenses are rising due to regulatory compliance requirements, technology spending, and the costs of meeting clients’ customization demands. Revenues are declining from fee compression and mix shift (investors moving from active to passive, and growth to hedging strategies), along with sophisticated institutional clients insourcing investment management. While not attracting the same attention as fee reductions and the active to passive migration, insourcing is taxing index, active, and even some private market strategies, and is an unwelcome headwind in a challenging environment for asset managers.

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A recent paper by asset servicer Northern Trust found that global asset owners (pension funds, endowments, sovereign wealth funds and other stewards of institutional assets) are moving towards insourcing investment management to reduce costs, increase transparency, and gain more control over their portfoliosi. Clearly, these objectives are attractive to the vast majority of asset owners. However, only those with the scale and resources to design and implement the required investment, operational and governance platforms are candidates for insourcing. Those organizations are also often asset managers’ most profitable clients.

Investment consulting firm bfinance’s 2018 survey of 485 global asset owners determined that 40% had increased in-house investment staff in the prior 3 years, while an additional 7% had not boosted staffing but planned to do so in the following 12 months. bfinance also found that 19% of those surveyed had increased the proportion of assets managed in-house in the previous 3 years, and another 10% had not but planned an expansion in the coming yearii. Insourcing is a global trend, with asset owners including Alaska Retirement Management Board, CalSTRS, Colorado PERA, and MassPRIM in the US, Abu Dhabi Investment Authority in the middle east, and Australia’s UniSuper and Telstra Super recently in the headlines for planning or executing a ramp up of internal investment capabilities.

Northern Trust also concluded that “asset owners are increasingly outsourcing non-core functions to focus on the activities that add the most value.” This prioritization makes sense, whether looking at back, middle, or front office capabilities. Within the front office, asset owners’ expanding in-house investment teams must objectively assess where they have, or can credibly develop, an investment edge. Whether that value-add comes from data science, fundamental research, trading acumen, or something else, outsourcing the remaining, non-core front office investment functions (the work unrelated to an investors’ edge) will free up resources to maintain and extend competitive advantages. Like their asset owner clients, asset managers must prioritize their own front office investment capabilities, funding greater resource allocation to true differentiators by outsourcing or automating other nodes in the investment value chain. This prioritization practice will only gain in importance as insourcing and other headwinds continue to wilt asset managers’ revenues and profits.

Asset managers can further defend themselves against asset owner insourcing by implementing effective product strategy and pursuing a low-cost provider approach. Savvy active managers will focus on developing and enhancing high quality, differentiated strategies that are aligned with clients’ needs and are difficult to replicate. These in-demand investment capabilities are less readily insourced and offer providers a degree of pricing power. Managers of commoditized products must skinny down costs to prepare for a two-front battle with clients eyeing lower fees and competitors hungry for market share. Asset managers should also focus on fine tuning their operational platform for accuracy and efficiency, and then tactfully remind want-away asset owners that one large operating error can subsume many years of expected fee savings from insourcing.

i “The Changing Tide: The Evolution of the Asset Owner Investment Model.” Northern Trust. September 2019.
ii “Asset Owner Survey: Innovations in Implementation.” bfinance. September 2018.


ESG Impact: The Third Dimension of Investment Analysis

An Emerging Opportunity for Asset Managers

In a March 2019 speech at the KangaNews Sustainable Debt Summit, Richard Brandweiner introduced a due diligence framework that adds Environmental, Social and Governance (ESG) impact to risk and return as essential measures required for thorough investment analysis. Brandweiner, Pendal Group’s Chief Executive Officer for Australia, explained that until the 1960s investors made allocation decisions based solely on expected returns. Following the popularization of modern portfolio theory, investors considered both expected return and forecasted risk (as measured by volatility) as part of the capital allocation process. Brandweiner believes that ESG impact will become the third critical axis of investment analysis.

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ESG insights fill many roles in today’s global investment management industry – a basis for thematic investment strategies, a “greenwashed” marketing gimmick, and a resource for alpha generation and risk mitigation, among other use cases. Going forward, regulators, asset owners and asset managers are likely to demand, and corporate issuers will need to furnish, increasingly standardized data to measure positive and negative ESG impact. Comprehensive disclosures could help to quantify concerns including carbon footprint, process inputs and outputs (energy, water, natural resources, pollution), gender and demographic balance of board/management/workforce, state of labor relations, and short-term vs. long-term strategic decision-making horizons. This expanded ESG transparency will enable innovation and empower thoughtful asset managers to develop products and processes to exploit opportunities that align with the needs of their clients. ESG-minded asset owners will also be better armed with tools to distinguish between experts and charlatans.

As ESG data becomes more uniform and gains further acceptance, ESG impact analysis will likely prove to be analogous to traditional risk assessment. Some investors largely ignore risk and swing for the fences on returns. Other, more conservative, investors focus solely on avoiding potential drawdowns. Still others look for maximum efficiency of expected return per unit of risk. ESG analysis will probably evolve similarly – a minority of investors won’t pay attention to ESG issues, a second group will be hyper-focused on impact attributable to their investments, and a third set of investors will intentionally shoulder ESG risks that are rewarded with sufficient expected return. Regardless of the lens, investors who pay no heed to risks (traditional or ESG) sooner or later will be separated from their capital.

Motivated investors will likely continue to express interest in thematic ESG strategies that target hot button issues of the day such as the environment, women’s advancement, and organized labor. The most commercially successful products are likely to have heavy exposure to ESG attributes and maintain high tracking error vs. comparable non-ESG alternatives. Aside from specialized products, there will be little opportunity for asset managers to rollout mainstream “ESG” strategies, as most investors will expect their managers to integrate Brandweiner’s third axis of investment analysis and assess the opportunities and risks of ESG impact in all portfolios. That said, unique approaches to evaluating and exploiting ESG impact will continue to offer skilled asset managers a welcome opportunity for differentiation, along with the potential to charge premium fees.



Reasons to be Optimistic About Active Management

The last decade has brought a flood of negative punditry regarding the future of active management. The sentiment is well deserved, as active managers have charged too much and delivered too little value since the Massachusetts Investors Trust introduced the mutual fund to the investing public in 1924. The final straw for portfolio managers’ reputation was the Global Financial Crisis and its aftermath, which saw active managers consistently underperform in the pre-crisis bull market, the crisis-related bear market, and the subsequent recovery that commenced in 2009.

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Despite this uninspiring backdrop, there are three good reasons to be optimistic about the future for active management. Investment, asset allocation, and commercial forces will create opportunities for skilled asset managers who prioritize targeted market segments, deliver differentiated investment strategies aligned with the needs of those clients, and refine their operating model to right-size costs and ensure a positive user experience for investors.

The Investment Case for Active

Flows into passive and out of active investment strategies are well documented. US domestic equity funds alone have seen $1.32 trillion gush from active strategies over the last decade, while $1.36 trillion has surged into passive during the same periodi. These aggregate net flows into indexed portfolios create opportunities for disciplined active managers with sound investment processes. Active investors often favor similar traits that determine the securities on their buy and sell lists, leading to overcrowding in popular trades. Fewer dollars in actively managed strategies decreases the competition for alpha, lowering the degree of difficulty for capable investment teams. Of course, these mis-valuations will require a catalyst to unlock the profits, but the opportunity awaits intrepid investors.

One additional investment consideration to note is that assets are increasingly concentrated with fewer, larger managers. According to Morningstar the top 25 mutual fund families in the US manage 82% of assets. Larger managers of funds with daily liquidity have a difficult time taking meaningful positions in small cap or other less liquid securities, thus avoid those names where possible. The absence of natural buyers creates alpha-generating opportunities for skilled active managers trawling the less liquid segments of the investment universe.

Asset Allocation Rationale

There Is No Alternative (TINA) to active management (credit for coining the “TINA” investing acronym goes to our friends at Strategas, who believe TINA to holding equities in the current environment). Asset owners routinely target expected returns in excess of 7% from their portfolio investments. For example, the National Association of State Retirement Administrators found the median expected return in 2019 was 7.25% for state pension plans in the USii. However, according to Blackrock’s June 2019 Capital Market Assumptions, Private Equity, Infrastructure Equity, Direct Lending and Emerging Markets Equity are the only asset classes with 20-year expected returns above 7.25%.

In today’s markets, it is impossible to build a diversified portfolio of beta exposures that will meet the return requirements of many clients. The challenge is compounded by the continued decline in interest rates, leading to negative yields on many sovereigns, which limits the forward-looking income and total return potential from holding bonds. Historically low return assumptions leave asset owners who require liquidity in their portfolio to choose between sharply reducing expected returns (which likely restrains spending plans, or necessitates additional contributions from the sponsor) or adding active management. TINA.

Commercial Dynamics

The lion’s share of today’s investment flow is pouring into passive, smart beta and rules-based strategies (Morningstar calculated that passive US equity funds’ AUM surpassed their active peers’ for the first time in August 2019). The problem for asset managers is that these products are commodities. Investment firms have little pricing power on commoditized portfolios, which can be readily replicated by competitors willing to reduce fees to win market share. An extreme example is Fidelity’s Zero Funds, with zero management fee and no minimum investment. It is very difficult to compete with free.

BCG expects AUM in passive strategies to increase 10% annually from 2019-2023, but fee compression to limit annual revenue growth to only 3%. The consulting firm forecasts roughly 4% annual growth of both AUM and revenue for active strategies over the same 5-year period. Active management offers the opportunity for skilled providers to commercialize differentiated, high quality investment strategies that are well aligned with the needs of their clients. With differentiation comes pricing power if a strategy can maintain a track record of delivering against clients’ expectations. Given the incentives, clever asset managers should look to cull low quality strategies that are unlikely to help clients meet their investment objectives. At the same time, investment firms should endeavor to develop the next generation of active strategies, prioritizing unique investment approaches that are most likely to help clients attain targeted outcomes. Over time, this industry transformation should lead to better-quality offerings yielding superior value for money to investors, and reasonable management fees for providers.

Key Takeaways

  • The current environment looks bleak for active managers. However, thoughtful investment firms that prioritize which client segments to target, curate differentiated investment strategies aligned with the needs of those clients, and develop an effective operating model with costs appropriately sized vs. expected revenues have an opportunity to enjoy commercial success from active strategies.
  • The torrent of assets moving from active to passive strategies reduces the competition for alpha-generating investment opportunities in the market.
  • Expected asset class beta returns fall short of portfolio total return requirements for many investors. Active management is the only realistic option to bridge the gap for investors who require liquidity.
  • Passive strategies are commodities, with deteriorating economics due to price competition. High quality active strategies designed to help clients attain targeted outcomes offer the opportunity for differentiation and pricing power.

i Lim, Dawn. “Index Funds are the New Kings of Wall Street.” Wall Street Journal. September 18, 2019.
ii Steyer, Robert. “Public Pension Funds Abandon 8% Dreams.” Pensions & Investments. September 30, 2019.


Services Businesses are Adopting a Global Supply Chain Framework to Optimize Resource Allocation

By the 1960s, manufacturing companies across the developed world had observed the abundant, capable talent available in lower cost markets and began to offshore manufacturing capacity. Global outsourcing (offshoring via a third-party partner) of manufacturing gained traction by the 1980s. Similarly, over the last 30+ years manufacturers have re-evaluated the entire supply chain, assessing vendors across the world and thoughtfully considering make vs. buy decisions for critical inputs. This strategic evolution has freed corporate resources for adherents to reinvest in high value-add differentiators like design and engineering, while remaining competitive on product pricing.

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The same transformation is now occurring in services industries as competition across commercial sectors intensifies. While the global outsourcing of IT is well established, the trend is gaining momentum in the broader services space. Services firms are transitioning important but undifferentiated activities from internal operations in high cost locations to third party providers maintaining capabilities in less expensive markets, creating a more complex global supply chain. Global outsourcing partners are delivering quality output at a lower cost per unit, generating savings that can be reinvested in programs aimed at enhancing the truly differentiated capabilities that create value for a services firm’s clients.

Lessons from Peter Drucker

One of the critical advantages of global outsourcing is the flexibility it provides organizations to focus on extending their competitive advantages. As renowned management sage Peter Drucker said, “Do what you do best and outsource the rest.” Collaborating with a global outsourcing partner enables a services firm to leverage the scale, expertise and efficiency of an expert to handle important but routine activities, freeing capacity to develop and extend the firm’s own differentiators. Drucker famously noted that “your backroom is someone else’s front room.” He defined the front room as an organization’s “strengths, or the activity that is most important for you to do – that which stirs your passion and shows off your excellence.” One business’ undifferentiated activity is another organization’s showcase capability.

Ricardian Comparative Advantage

Partnering with a global outsourcer enables a services firm to leverage the vendor’s skill and scale to reduce operating costs. Note that engaging a third party can still make sense even if a firm is quite adept at executing certain undifferentiated nodes on its value chain. Global outsourcing can be analogous to David Ricardo’s theory of comparative advantage.

David Ricardo developed the classical theory of comparative advantage in 1817 to explain why countries engage in international trade even when one country's workers are more efficient at producing every single good than workers in other countries. He demonstrated that if two countries capable of producing two commodities engage in the free market, then each country will increase its overall consumption by exporting the good for which it has a comparative advantage while importing the other good. Agents have a comparative advantage over others in producing a particular good if they can produce that good at a lower relative opportunity cost. One shouldn't compare the monetary costs of production or even the resource costs (labor needed per unit of output) of production. Instead, one must compare the opportunity costs of producing goods across countries. (from Wikipedia)

Firms do not necessarily outsource work because they are incapable of effectively completing those tasks on time and on budget. The organization may be highly proficient in that field. Nevertheless, if the work in question is not a competitive advantage it could make sense to minimize the resources allocated to that function, allowing greater investment in differentiated capabilities that drive customer satisfaction and affect buying decisions.

An Example from Cupertino

Apple is one of the most innovative companies of our time. The firm is well known for the “designed in California, assembled in China” disclosure on the back of its devices. If Apple wanted to develop an in-house hardware assembly process, the company could most likely leverage technology and design thinking to create an efficient, highly successful capability. However, hardware fabrication is not a priority that would maximize return on investment for the firm. Apple can have a greater impact on profitability by focusing its resources on designing innovative new products that customers love. Assembly contractors have a different set of core competencies as compared to Apple’s. For Apple’s third-party partners assembly is a differentiated activity, and those firms invest heavily in the talent, technology, and processes required to raise quality and lower cost. The optimal resource allocation for Apple entails directing maximum investment and organizational focus at product design, development, and marketing, while entrusting assembly to skilled third-party vendors.

Unbundling in Asset Management

Drucker also recommended “unbundling” support work from core capabilities. Asset managers have begun to outsource back and middle office activities (the work is largely done offshore), and outsourced trading is increasing in popularity (still mostly executed onshore). In these cases, specific roles, and sometimes entire departments, are outsourced. The asset management industry is making progress, but an unrealized opportunity remains to functionalize investment professionals’ existing job descriptions, separating differentiated from routine activities. This functionalization will empower analysts and portfolio managers to focus on the high value-add work that creates an “edge” in the investment process.

Take research analysts as an example. Analysts are among the most expensive resources in an asset management firm. Those investment professionals are paid for their judgment and expertise, but their job descriptions today include a mix of high value work and undifferentiated activities like data acquisition & validation and maintaining financial models. Functionalizing the role and entrusting to a global outsourcer the routine elements of the financial modeling process will free up more time for research analysts to spend on model design, engaging with management teams, thinking critically about strategic issues and new investment opportunities, and other mission-critical work.

Key Take Aways

  • Services firms are following the lead of manufacturers in globalizing the supply chain, optimizing on cost and quality, and thoughtfully considering which functions to perform in house and which to entrust to a capable third party.
  • Global outsourcing enables services firms to leverage the scale and expertise of external vendors. Even if a firm possesses a strong in-house capability in an undifferentiated function, global outsourcing could still make sense if the resources spent on that activity could be redeployed more effectively to extend the organization’s competitive advantages.
  • Asset managers can functionalize investment professionals’ job descriptions, unbundling routine work and freeing time for skilled investors to focus on high value-add activity.


The Impact of MiFID II on Investment Research

The EU-wide rollout of MiFID II in January 2018 has left its mark on sell side and buy side research. As expected, sell side coverage shrank and buy side spending on external research declined after the directive launched. However, unintended consequences are beginning to impact the investment management ecosystem as asset managers wean themselves from brokerage research.

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In a recent paper , authors Bingxu Fang, Ole-Kristian Hope, Zhongwei Huang and Rucsandra Moldovan confirmed that sell side stock research coverage contracted post-MiFID II. The ranks of brokerage firm analysts decreased after the directive went live, and 334 European small and mid cap stocks lost all coverage from the street. On top of firms losing sell side coverage completely, Bloomberg asserts that the total number of recommendations on Stoxx Europe Small Cap 200 names fell 7% y/y in the first nine months of 2018. The drop was nearly twice the rate of decline in European large cap stock recommendations for the same period . This data strongly suggests that smaller cap names with less trading volume are in fact attracting less attention from the street. The good news is that lack of coverage could abet the development of inefficiencies in the small cap space, creating opportunity for skilled asset managers. The bad news is that smaller, less glamorous firms will have a quieter megaphone to publicize ttheir story, which could contribute to a higher cost of capital for those companies.

A related, perhaps less anticipated, discovery from Fang et al. is that buy side firms added research staff post-MiFID II, and those analysts did more hands-on research. The introduction of the directive didn’t happen in a vacuum - risk assets rallied from the US Presidential election in Nov 2016 through September 2018, bolstering asset managers’ revenues and possibly increasing their appetite for new hires. Regardless, Europe-focused buy side analysts attended earnings calls in greater numbers and asked more questions in 2018, suggesting increased direct engagement from asset managers’ in-house researchers. In a speech to the European Independent Research Providers Association in February 2019, UK Financial Conduct Authority CEO Andrew Bailey estimated that asset managers’ external research spending declined 20-30% post-MiFID II. Bailey’s finding supports the thesis that the buy side is decreasing its reliance on broker research. Internal research appears to be plugging the gap created by reduced consumption of externally generated analysis and data.

Replacing cheaper sell side research with expensive in-house resources is not an advantageous trade for asset managers seeking factual data, context, and other undifferentiated background information. In lieu of leveraging broker research to support the investment process, asset management firms can cost-effectively procure data, financial models and call notes from a trusted vendor, enabling in-house analysts to focus their attention on high value analysis, and ultimately drive better investment decisions.

i Fang, Bingxu; Ole-Kristian Hope; Zhongwei Huang; and Rucsandra Moldovan. “The Effects of MiFID II on Sell Side Analysts, Buy Side Analysts, and Firms.” May 2019.
ii Lee, Justina. “Where are the Analysts? Europe Small Caps Battle to be Seen.” Bloomberg. September 10, 2018.


Next Gen Outsourcing for Asset Managers

A host of unfavorable developments are impacting asset management firms’ profitability, prompting leadership teams to consider drastic actions to protect margins. While risk assets have been well bid for most of the last decade (providing a tail wind for industry financials and masking business challenges), selloffs like the one seen in the fourth quarter of 2018 have exposed problems on both sides of money managers’ P&Ls. Revenues are under pressure from price compression, mix shift (flows from active to passive and growth to hedging strategies at lower fees), and in-sourcing by sophisticated asset owners. Expenses are rising due to the costs of regulatory compliance, spending on technology, and heightened client demand for customized portfolios and servicing. Hoping for the continuation of a long running bull market is not a prudent business plan, thus asset management executives are evaluating strategic options.

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Since the onset of the Global Financial Crisis, asset managers have generally defaulted to headcount reductions as the first line of defense against softer margins. This was an impactful strategy in 2008, when organizations were bloated following the robust decade between the internet bubble’s aftermath and Lehman Brothers’ bankruptcy. Today, after 10+ years of cost cutting, asset management firms are running lean. Further headcount reductions and “do more with less” spending cuts are unlikely to pay off without impacting quality and productivity, as ineffective people and resources have already been jettisoned. In this environment, fundamentally re-imagining the operating model is required to reduce costs while maintaining the capabilities needed to satisfy client expectations.

A rigorous approach to prioritization is necessary to reach profitability and efficiency goals. This prioritization exercise should seek to maximize spending on competitive advantages, while executing all other functions as cost effectively as possible (or eliminating unproductive activity). Some of the deprioritized functions will be critically important (e.g. risk management or trading), but if the activity is not a competitive advantage the goal should be executing at the required level of quality and the lowest cost. Asset managers should evaluate each activity in the value chain and ask the question “can this function be automated, moved to a different location, process re-engineered, or outsourced to a third party to produce the desired results more cost effectively?” If the answer is yes, that activity should be optimized in the reimagined operating model.

Automation, location strategy, and process re-engineering will all play a role in the design of the asset management firm of the future, but that is a conversation for another blog post. This post will elaborate on how firms should think about outsourcing in a revamped operating model.

Functionalizing Roles in an Outsourcing Strategy

In the HBR article “Getting Offshoring Right,” Ravi Aron and Jitendra Singh1 draw a distinction between core processes that must be controlled by the firm, critical processes that can be procured from a best in class vendor, and commodity processes that can be conveyed to a business process outsourcing (BPO) provider. Most industries, including asset management, have embraced moving commoditized activity to BPO firms. The next step in the progression is identifying the critical functions that can be executed more cost effectively by a trusted third party. Firms must think expansively about this opportunity. Rather than solely reviewing capabilities or roles to determine which are core (out of scope for outsourcing) or critical (potentially in scope), firms should also look to functionalize specific job descriptions to separate high value from undifferentiated work contained in a single role. Part of a job description may be core, and require highly skilled, well compensated staff to execute. However, the person holding that role may spend considerable time working on commoditized or critical tasks that could be performed reliably at a lower cost by an outside specialist provider. Functionalizing that role empowers a firm’s highest paid staff to concentrate on high value work, while undifferentiated activity is executed at a lower price point.

Functionalizing expansive job descriptions also grants greater flexibility to firms as they increase or decrease capacity in that area. This enables management teams to shift fixed costs to variable, and facilitates improved operating leverage in strong or weak business environments.

An Example

Investment research is a core function at most asset management firms. However, the typical research analyst job description includes both judgment-dependent analysis and undifferentiated tasks like data acquisition and model maintenance. Transitioning data and model management to a trusted third party empowers the firm’s analysts to focus on high value work and reduces the cost of modeling. Furthermore, as business requirements change, the firm can increase or decrease the volume of work outsourced to the third party, thus variably costing a portion of its research capability. The alternative approach of adding more high cost analysts as the business grows creates organizational debt and diminishes operating leverage. The firm hires too many high cost resources when times are good, and those analysts spend much of their time working on undifferentiated activity. When business conditions sour and margins fall, the firm must grapple with reducing capacity and the accompanying loss of skills and accumulated institutional knowledge.

Key Take Aways

  • The current challenging commercial environment for asset managers demands a creative, holistic business strategy to protect profits
  • Rather than solely evaluating roles or entire capabilities as candidates for outsourcing, firms should also functionalize key job descriptions to separate work that directly enhances competitive advantages from undifferentiated activity, and outsource the latter to a trusted third party
  • Job functionalization enables high cost talent to focus on high value work, reduces the cost of executing undifferentiated tasks, and creates additional flexibility for management teams by converting fixed costs to variable

1 Aron, Ravi and Singh, Jitendra. “Getting Offshoring Right.” Harvard Business Review December 2005.