NEW YORK-Outsourcing isn't just for the back office anymore. As the practice of contracting out certain middle and even front-office operations becomes increasingly common among asset management companies, it's not getting any simpler, said speakers at the second annual FSO Knowledge Exchange Asset Management Industry Outsourcing Forum here last week.

"It will cost money. It will take energy. It will be difficult. Period," said Adam Schneider, a principal with New York-based Deloitte Consulting.

In the past five years, speakers said, outsourcing has morphed from a cost-cutting cheap fix to a long-term partnership.

Like any partnership, that means when dealing with service providers, investment companies must negotiate clear terms, hammer out clear agreements, and, over time, be willing to tweak both as needed.

"Understand, this is not a contract; this is a relationship," said Sean Kelley, operations and technology global head for Deutsche Asset Management in New York.

Echoing others throughout the day, Kelley used the metaphor of marriage to describe the union between an investment company and service provider.

"Like a courtship, before you put the ring on, you have to know what you're getting into because the luster can come off the ring," he said, adding, "To get out is more painful than to get in."

Although complicated, a well-designed outsourcing relationship can add significant value and help money managers focus on what they do best, Kelley said.

Decisions about what to outsource should be strategic. "Focus on your uniqueness," he said. Those things that distinguish companies among their competitors are what generally provide alpha, or push returns above the benchmark, Kelley noted.

"Partner away your beta," he advised.

Such strategies have helped traditional corporations such as Ford Motor in Detroit and IBM in Armonk, N.Y., go from 20th century powerhouses where the business model was to control and own each part of the operation, to leaders of the 21st century economy. Today, those industrial titans operate networks comprised of independent suppliers, rather than chain-of-command models. "Their alpha is putting it all together," he said.

The question for many mid-size companies is determining what work can be entrusted to others. "The real question is: what can't you outsource?" said Paul J. N. Roy, a partner at Mayer Brown Rowe & Maw in New York. "The answer is: very little."

Valley Forge, Pa.-based Vanguard, for example, contracts out its investment management and stock picking. But most companies are still skittish when it comes to passing the reins, even when the tasks are more minor. "It depends on whether you're ready," Roy said.

Three things no company should relinquish are policy, strategy and compliance, he said. Perhaps that's because getting ready to outsource a task requires first developing a strategy.

"How do we use outsourcing as leverage?" he said. "Develop a road map."

The easiest map to follow will be the one that leads to a common goal, both for the asset manager and the vendor.

William F. Gibson, chief operating officer for New York Life Investment Management, advised looking at the relationship like a traditional business partnership. "The way you got into a partnership agreement is that you went into business with someone, you had your hand in his pocket, and he had his hand in yours, and you worked together," he said.

"Service providers want to partner to help their customers do better," Roy said. After all, it's not just good customer relations, it's good advertising, he added.

Once the map has been drawn, it's important to ensure all parties have copies, in the form of a service level agreement (SLA).

"Going into these things saying, We'll work it out,' is a recipe for disaster," Roy said. Both the customer and the provider should have a clear understanding of expectations and responsibilities.

"It's important to lay out the expectation, because we're going to make some mistakes," said Paul Schaeffer, managing director for vendor-side business development and innovation at SEI Investments in Oaks, Pa.

Vendors can likewise use the agreement as a baseline to justify commanding extra fees when customers ask for extra customization or services not previously discussed.

Finally, the SLA can bolster compliance. Although the customer is ultimately responsible for the vendor's operations, an SLA can specify in what form and how frequently data is reported and help establish regular communication standards, Roy said.

"The SLA should really be a scorecard," Schaeffer said.

It should also be flexible. "If you take an SLA and put it in a drawer, that's not a best practice. It's a living, breathing document," Schaeffer said.

Just as the markets change, so, too, might the products and the needs of the asset manager, or the capabilities of the vendor. Consequently, the SLA terms. "You've got to have the flexibility to allow you to grapple," Gibson said.

"An SLA is absolutely essential, but it's not sufficient," Roy added. "You have to actively manage these relationships."

Companies that outsource functions must remember that they are-to a degree-giving up control. The people doing the work are not captive employees and, therefore, might not be motivated by the same incentives-or punishments-as in-house workers. And because the work might be in another city, state or country, it's easy to forget to link the vendor into the communications loop. Finally, outside partners are not permanent, and in the case of emergency, it might be necessary to suddenly change course, or provider.

As important as it is to know one's provider, it is important to know their competition well, too, Schneider advised.

"You have to know when you can go to plan B, and plan C, D and E," he said.

(c) 2006 Money Management Executive and SourceMedia, Inc. All Rights Reserved.

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