Scalability of the Investment Management Middle Office

In a Financial Times article from 2011, writer Paul Taylor helped define the term “middle office.” As word about the middle office spread, consultants like PwC chimed in on the conversation and offered their view of middle office scalability in times of profit pressure.

I wonder sometimes why it takes so long for common sense concepts to get named and published. The major banks and brokerages have been dealing with this issue since the mutual fund boon of the 1980s, an era I spent helping large firms’ operations leaders deal with the global tidal wave of new retail investors.

Admittedly, things are different now. Investment Managers’ product mixes are broader and their clients’ needs are more diverse. The regulators come in with microscopes instead of telescopes. Managers seek profitable growth, and operational inefficiencies can no longer be overlooked.

Here’s an anecdote from a colleague, who was focused on an investment management firm’s new accounts process. He shadowed Louise, the new accounts processer. Louise would input an account on the system, then put all the paperwork into a folder on her desk. When she finished with the morning’s input, she walked the folder around the office to other people within the firm – one to check suitability, one for a restriction review, one to enter sales tracking data, one to generate fulfillment materials…and so on. The folder finally landed on a trader’s desk so the accounts could be invested. At Louise’s firm, new accounts input on a Wednesday were not traded until Thursday, at the earliest. We used to call that achieving scale with sneakers.

Louise did a great job with the tools she was given. But think about the hidden costs, including the opportunity cost, involved in her process. Expand this thinking across the operations activities of a retail firm and you’ve got…

• Trading errors caused by poor data flow or slow operational procedures;
• Poor results on regulatory audits because sufficient command of the business is not demonstrated;
• Missed investment opportunities caused by an inability to quickly assimilate portfolio data and/or to reconcile across multi-sleeve accounts;
• Missed marketing opportunities caused by an inability to easily access client information

I mentioned PwC’s paper about investment management operations. In it, they list investment managers’ operations processes and assign each process to a category…front, middle, or back office. Here’s their view:

I don’t agree completely with their categorization, especially when you consider the needs of firms operating across multiple channels. In my view, trade order management for the retail manager is a middle-office function…technology can be easily applied to efficiently re-balance multiple accounts – and account sleeves – to portfolio models. This isn’t true for the private wealth manager where customized portfolios require high-touch expertise.

How you view the middle office is important when considering outsourcing as an opportunity to scale operations, especially if the opportunity to replace SG&A with variable expense is part of your strategy. The bottom line is that the functions that add value to the product mix or client relationships should not be outsourced. And since these are different for each channel, retail managers – or any manager looking to get into the retail space – need to consider only those vendors willing to work with a hodgepodge mixture of some-outsourced-some-not services. Keep in mind that managers’ responsibility to control their operations can never be outsourced, so transparency into the vendor’s activities and results is really important.

PwC is smart in acknowledging this: “We see leading asset managers changing the role of their middle office from that of a transaction processor to that of a strategic business partner through the use of right-sourcing. We define right-sourcing as the process by which an asset manager determines how to most efficiently and effectively provide each middle-office service. Options include insourcing, right-sizing, co-sourcing, or outsourcing (either in full or in part).” PwC then explains that right sourcing enables asset managers to “leverage scarce resources to focus on strategic decision support and address complex compliance issues.”

In other words, efficient scalability is achievable…with the right partners.