Fund management operations have benefited greatly from improved technology in recent years. Developments in fund accounting; securities administration and client reporting make it possible to achieve both client customisation and economies of scale. These benefits have, in turn, moved processing from in-house operations to outsourcers, consolidating operations volumes at a few, very large-scale service providers.
However, the ability to outsource the operations has also removed significant barriers to entry for niche players, enabling them to enter the market without having to build the infrastructure.
We view an emerging model of fragmentation through the supply chain, in which large transaction service providers use scale advantages to support niche fund managers.
Economies of scale
A recent study by The Bank of New York, which examined 21 outsourcing deals worth over USD21trillion, found that outsourcing on average adds over 10 per cent to shareholder value, of which technological advantages are a factor. In addition to cost reduction there are significant benefits through the freeing up of management time to concentrate on performance.
The Aberdeen Asset Management acquisition of Deutsche Asset Management in the UK, which is three times its size, will certainly be assisted by the simultaneous outsourcing of operations to BNP Paribas.
The platforms these big service providers have created provide the opportunity for niche players to achieve access to scale they could never build themselves.
The channel economics of retail fund distribution have much in common with breakfast cereal marketing and distribution. It is important to have a complete set of products on the shelves, products that, while often quite niche in their appeal, are sure to address one or more of the preferences of buyers. Just as consumer brand managers elaborate from corn flakes to sugar frosted corn flakes, to corn flakes with raisins and nuts to corn flakes with vitamins, institutions want to offer a full range of investment products. Institutions can offer these products without creating their own infrastructure.
In Australia local fund managers are building relationships with overseas partners, helping them to minimise operational risk and costs. Elsewhere, the growth in Hedge Funds has also demonstrated the willingness and ability of new and initially small players to provide niche services once the barriers of technology and capital investment have been overcome.
Changing market
There are three significant market pressures that will continue to drive the fragmentation of the supply chain. Firstly, UK pension reform will result in demand for greater flexibility in investments. Secondly, low growth in the market is putting downward pressure on fees and in turn the cost base of fund managers.
Fund Supermarkets may also contribute towards increasing specialisation. Fund Supermarkets provide consumers with easier access to niche players, without having to invest large sums.
A PA study examines how changes in investor preferences will cause dramatic changes in the cost and pricing of institutional investment products. The analysis suggests that, for index-benchmark investments (as opposed to outperformance investment products) downward pressure on the cost structure will continue and a move towards performance-based or flat fees would result, putting further downward pressure on the cost base.
As ever technology has been, and looks set to continue to be, a major engine of delivery of these changes, enabling operational efficiencies, cost reduction and the scale benefits that have encouraged outsourcing. However, this outsourcing is also providing opportunities for smaller focused niche players to enter the market.
