The investment management industry is always looking to make business more efficient, cut costs and comply with regulations. More firms are recognizing the key to helping with those issues might be outsourcing.

Thirty-one percent of investment management firms said they plan to increase their outsourcing arrangements with third-party providers over the next two years, according to a PricewaterhouseCoopers survey of 150 finance executives from mutual funds, hedge funds and other asset management firms at two PwC forums in Boston and New York last month.

"Outsourcing has become an attractive option, as investment management firms have to deal with sophisticated new products, regulatory and investor demands, and a talent shortage," said Kevin O'Connell, a partner with PwC.

By outsourcing, investment management firms are able to focus on their core competencies, and avoid the costly pursuit of keeping their infrastructure and systems current to meet the demands of greater investment complexities, he said.

Forty percent of executives said their primary reason to expand outsourcing is to be able to focus on core competencies, while 31% believe outsourcing is a way to improve the quality of functions their finance teams do not have adequate time or resources to handle on their own.

Companies are starting to delegate areas that are no longer proprietary functions or considered a competitive advantage, said Dennis Gallant, president of Gallant Distribution Consulting of Sherborn, Mass. This allows companies to assess what their core competencies are and focus their time and effort on those parts of the business, Gallant said.

Twenty-nine percent of executives deem cutting costs as the reason to outsource. As firms become increasingly worried about costs, outsourcing is a viable option to help reduce them, said Geoff Bobroff, president of Bobroff Consulting of East Greenwich, R.I.

"Firms are looking at their budget and trying to expand capabilities," said Paul J.N. Roy, a partner at Mayer Brown Rowe in Chicago. "If firms can pay less for the same service, then that frees up some money," he said.

Sixty-two percent of executives said they will continue with their current third-party service arrangements, while a mere 7% said they intend to bring certain currently outsourced operations back in-house. Several firms are looking into re-bidding providers to help bring costs down, Bobroff noted.

While companies are able to outsource most functions, the portfolio management function is a core competency that companies will not outsource because it differentiates them from their competition, O'Connell noted.

There is a growing dependency on technologically advanced, cost-efficient and functionally capable middle-office and back-office servicing organizations, according to PwC's report, "Looking Ahead: Strengthening the Structural Foundation of the U.S. Investment Management Industry."

"The back office is now the new front office," said Paul Schaeffer, managing director of strategy and innovation at Oaks, Pa.-based SEI Investments.

The growth of outsourcing will likely be significant among firms offering alternative investments, many of which had performed most back-office function in-house, the report states.

As mutual funds continue to become more complex, there might be a resurgence of outsourcing in the area, Schaeffer said. More funds are using esoteric instruments and searching for alpha, and clients are demanding more products, he said.

Additionally, investors are demanding more transparency, and clients are now telling firms how they want their investment products packaged, Schaeffer noted. There are key issues to think of when outsourcing, the least not of which is due diligence. Outsourcing is driving increased focus on internal controls, including oversight of third-party service arrangements, the report states.

Management and directors should have a common understanding of strategic and operational goals underlying existing and proposed outsourced or third-party services arrangements, according to the PwC report.

Companies need to make sure they maintain effective oversight of their outsourced functions, O'Connell said. "There has to be a clear, robust process of managing third-party service providers that incorporates matters relating to responsibility tasks, resources, reporting and most importantly accountability," he said.

There also has to be frequent visits and contacts between the parties, he noted.

Also, management should monitor performance and use technology to confirm accuracy of information and be able to recognize abnormalities, the report states. "Outsourcing to third parties is about delegation, not abdication of accountability and responsibilities," commented Barry Benjamin, PwC's U.S. investment management practice leader.

(c) 2007 Money Management Executive and SourceMedia, Inc. All Rights Reserved.

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