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Hedge Fund outsourcing: Please don't start with the price!

While outsourcing offers inherent economic benefits, it should not be where the conversation begins – and certainly not where it ends.

Matt Jarvis

​​​Most frequently, when hedge fund managers consider outsourcing, the immediate consideration is a commercial one: how low can the price go? While outsourcing offers inherent economic benefits, it should not be where the conversation begins – and certainly not where it ends.

Instead, start by understanding exactly what value your outsourcing partner should deliver, and what are the keys to a successful relationship. Then find the partner who can provide the right solution, at the best price.

When engaging an outsourcing partner, critical boxes to tick include:

  • Quality Assessment & Control
  • Suitability
  • Accountability
  • Scalability
  • Security

Quality Assessment & Control

It goes without saying that you relinquish some elements of quality control when you outsource parts of your workflow. That being said, how do you ensure that your chosen outsourcing partner’s output is adequate and meets you and your investors’ requirements before handing them the keys to your workflows – and your reputation?

Some key areas you should consider:

  • Workshop: You can gauge your outsourcing partner’s work methods via a small proof of concept workshop.
  • Vendor reputation: Asking your peers for references of the outsourcing partner always helps.
  • Staff interviews: Get a glimpse of the talent who manage your day-to-day work and their standard operating procedures (SOPs).

Outsourcing should allow investment managers to scale their operations in tandem with the investment climate.

​​​​​​​Suitability

A primary reason to outsource is freeing up internal resources to focus on value-added tasks, such as assisting with investor relations or long overdue ad-hoc projects with the COO. In this scenario, the outsourcing team must act and think as an extension of your fund, highlighting the need for suitability.

Like a carefully tailored investment strategy for investors, does the outsourced team’s core values match your own? Does your prospective vendor put a premium on care, accuracy and prudence?

Suitability does go both ways, and I have personally had to turn away business in the past from prospects whose values did not align with ours. Valuing high value add and best practices, we did not want to enter a relationship with those who did not wish to commit to best practice workflows.

Accountability

While you free up internal resources when you relinquish control over your workflow, you do not abandon accountability on behalf of your investors. It is vitally important that your partner has adequate accountability ‘handshakes’ internally to guarantee that the necessary procedures are in place.

These include a clear and defined set of policies, with checks and balances, to ensure that any errors can be tracked and resolved promptly with minimal disruption. Service Level Agreements (SLAs) and Key Performance Indicators (KPIs) can help translate the service delivery requirements into black and white. If SLAs fail or KPIs start dipping, there should be a system in place to ensure that the outage is captured AND rectified.

Scalability

Outsourcing should allow investment managers to scale their operations in tandem with the investment climate. As your fund grows, your operational capacity should evolve with it; it should not be a limiting factor to your growth. Initiatives like to adding a second strategy to your fund, securing a new large ticket, or a separately managed account (SMA) should be a sweet uplifting melody for your business, not incur operational alarm bells.

Ensuring that your selected service provider can handle both your current operations and your future operations as well is crucial. It also applies to the downsizing of your fund. Should a Portfolio Manager spin off or you downsize your fund, can your service provider accommodate your evolving needs? This was highlighted during the pandemic, where many managers looked to expand via SMA structures, or were forced to downsize dramatically due to investor redemptions.

Security

One is bound to contemplate third-party cybersecurity exposures. According to eSentire, “44% of firms had experienced a significant, business altering data breach caused by a vendor in 2019.” Imagine the situation now, with a large percentage of the workforce working from home. Since a lot of highly critical information changes hands between both parties, be sure to fully assess the outsourcing service provider’s information security measures.

Comparing apples with apples

When comparing the actual cost of internal vs. external staffing options, a straight salary-to-cost comparison is like comparing apples and oranges. To see the actual staffing cost internally vs. externally, you need to net the actual internal costs to give an apples-to-apples comparison.

table

*Staff estimate based on 75th-95th percentile, junior staff members (Analyst or similar), Robert Half 2020 Salary guide

**Office share based on average Tier 3 Grade A/B per sqft cost * recommended 150 sqft/employee.

Ultimately, pricing will be part of your consideration; this is a business, after all. For best results however, don’t start with the price. Make sure points listed above are covered, and then find the provider that can give you the best value for money in terms of covering them.

Matthew Jarvis manages the sales and marketing function for Linedata Global Services in Hong Kong. He has a solid understanding and extensive relationships throughout the hedge fund industry in Asia-Pacific, working with hedge funds, hedge fund investors, and other hedge fund service providers.

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