As Industry super funds gain scale through consolidation many have or are considering insourcing of investment management activities. Whilst the business case for insourcing may be clear, the operational implications can often be significant and represents both a threat and an opportunity to custodians servicing these funds.
Custodians who have a track record in servicing investment managers may believe that it’s a simple case of importing these services to Super Funds. This approach is dangerous as it fails to recognize the following 4 key differences between investment managers and Super Funds.
1.Differing investment data requirements
Investment managers are typically engaged to manage assets at an individual portfolio level in accordance with their particular mandate. They have had limited need to view investment asset information at a total enterprise view.
Unlike investment managers, Superfunds are responsible for the management of the entire funds assets and many investment activities such as the implementation of tactical asset allocations or the equitisation of cash balances require visibility of the entire Fund’s assets, often down to a security level.
Investment reporting deployed by custodians is typically structured in terms of the ‘portfolio level’ view required by investment managers. This is unlikely to address the data requirements of Superfunds and may require the deployment of more robust data management solutions for Superfund clients.
2.Enhanced investment risk reporting requirements
By operating as an agent, investment managers have been primarily motivated on achieving investment returns at a product level and as long as they complied with the investment mandate have traditionally had relatively unsophisticated market risk reporting requirements. In many cases risk reporting has been deployed as a front office decision support tool with limited involvement from the middle or back office.
Superfunds operate as an investment principal and as such carry a direct ‘balance sheet’ exposure to market risk. The ability to manage investment risks is fundamental and requires the Fund to actively monitor and manage its market exposure risk.
To prevent investment managers and Superfunds deploying expensive risk management systems market risk reporting should be a core component of any custodian offer.
3.Reliance on custodian expertise
A number of custodians have built their administration service offering to the market off the back of large scale outsourcing of functions from investment managers. Custodians have been able to leverage and transfer the knowledge resident within the investment manager. Where services have not been transitioned custodians have had to develop knowledge internally. As a result there is still limited knowledge by custodians over some front and middle office activities.
Where Super Funds are developing internal investment management capability there may be limited investment management related operational knowledge resident within the organization. Superfunds may look to their custodians to supply this expertise. Whilst this likely requires custodians to ‘tool up’ their current knowledge base it also allows them the opportunity to define processes that align to their standard operating model.
4.Leveraging custodian technology to support investment processes
Most investment managers have existing technology to support investment processes such as portfolio management and dealing. Custodians are expected to provide the data required to support these systems.
Where Super Funds have made the decision to insource they often don’t have front office systems in place and need to select and implement these platforms. Depending on the system selected, this often represents a challenge to custodians insofar that many systems require data to be provided that cannot be easily supplied by custodians without a significant change to their model.
Super Fund’s and Custodian’s should consider whether there is an opportunity for such systems to be supplied by the custodian even where this represents a departure from a traditional outsourcing model. For example, the provision of dealing systems is not something that custodians would typically offer to the market but is something that could be sought by Super Funds, particularly those entering the investment manufacturing space.