Many small hedge funds, financial services and wealth management firms are seeing big returns from outsourcing their back office, reconciliation, reporting and compliance functions. Read on to learn how to generate the best return on your partnership with an outsourcing provider.
By Stephen Van de Wetering, Founder of Empaxis Data Management
Many investment organizations are now partnering with an external organization to help manage their back-office operations like reporting, reconciliation and compliance functions. Outsourcing all or part of your back-office functions offers the potential to both improve the quality of your firm’s operations as well as to support the growth and scalability of your business.
Many hedge funds, wealth management and asset managers are benefiting from partnerships with specialized investment operations outsourcing organizations. The fundamental reason to outsource all or part of your operations is to allow you and your key team to focus on those areas you truly shine: serving the client. The return you experience in working with an outsourcing provider, however, is dependent on which partner you select and how the relationship is managed.
First, what is the expected financial return on investment?
For smaller firms, outsourcing all or part of your back-office operations can deliver instant additional capacity and better controls around your growth. Outsourcing also avoids redundancy of staff and frees you to focus on client support and your firm’s profitable growth.
Accurately calculating all of your costs is the key component is determining ROI. For each firm this will be different as there are a number of factors to determine all of the hard costs, soft costs and opportunity costs. As George E.P. Box quipped, “Essentially all models are wrong, but some are useful.” A good place to start though is to consider the fully loaded costs of your people; this includes the salary, of course, but also any expected bonus, payroll taxes, healthcare and other benefits, as well as paid time off. A rule of thumb for many managers is to estimate 120% – 130% of base salary in calculating your staffing costs.
Include management costs
Be sure to include management costs in your calculation. Remember, people don’t work in a vacuum so it’s essential to consider the supervisory costs of the back-office or operational teams. Management is the most expensive element of a business, since it is not directly producing a good or service. Even if it is just 5% of a leader’s time, it adds up.
Consider a manager who spends two hours a week coordinating and meeting with his or her direct reports. If the fully loaded salary of the team member is $100,000, then you need to allocate $5,000 to the staffer’s total cost.
Who is currently assigned to these operational roles?
Consider the type of people you have assigned to these tasks. Often, the cost of the back office work is high relative to your work. Sometimes these folks are not specialists in the operational systems and therefore don’t perform at their highest efficiency. Further, you may be paying a full-time person for what should be a part-time function.
How is your turnover in these positions? Be sure to consider the cost of hiring and training new people periodically.
Don’t forget opportunity cost…
This leads to considering opportunity cost. Every minute spent hiring or managing an operational person is a minute which cannot be spent supporting clients and growing your business. This has to be balanced against the time invested in managing the outsourcing partner. Opportunity costs are a big reason why smaller firms have much to gain from outsourcing. They have the ability to re-purpose people from operations to work on serving clients.
…or, your clients’ quality expectations
Quality control is also a big factor. Accuracy is essential in successfully supporting financial services clients. If you are finding that key items are missed in client reports or if breaks are causing trading errors, it is likely a sign that you may not have adequate controls in place. This is often due to staff members wearing too many hats or working in areas outside their strengths. It is difficult to invest the requisite amounts to build a world-class operation when this happens. Giving this work to specialists can improve the quality of the reporting while freeing people to spend more time with clients.
What about the benefits? Small to medium-sized firms get greater ROI…
Most people jump right to the difference between an estimate of direct cost of labor and the cost of an outsourcing contract. This is a mistake, especially with small to medium-sized firms. Given their budgets, larger firms already have access to expertise, redundancy, good controls and ability to pay for growth incrementally given their size, so it makes sense for them to focus mainly on cost. Small to medium-sized firms don’t, so the combination of all of the benefits provide small and medium firms is a great advantage.
It’s just harder to calculate
Small to medium-sized hedge funds, asset managers and wealth managers have small teams that are wearing multiple hats. As it relates to their operations, they are jacks of all trades, but masters of none; they generally don’t have time, expertise or the ability to focus on proper documentation, squeezing out the most from their operations software, developing automated systems for quality control or developing other team members who can be solid back-ups. Management for these firms is rightfully focused on bringing in more clients or managing assets.
When a firm of this size leverages outsourcing for their operations, they benefit not just from a potential direct cost savings, but more importantly from also getting better controls, better redundancy, more consistent work product and a simpler environment for management to deal with. When small to medium sized investment managers outsource, they are in a better position redeploy their labor to higher value opportunities.
In summary, outsourcing all or part of your back-office functions offers the potential to both improve the quality of your firm’s operations and also to support the growth and scalability of your business.
However, an accurate ROI calculation is the key component in the decision whether or not to outsource all or part of your operation. Work with someone you trust in evaluating the real financial and operational benefits of an outsourcing partnership.
One last note: Outsourcing needn’t be an all-or-nothing proposition. Depending on your firm’s current needs, you can choose to outsource only a portion of the operation. In one instance, a firm I worked with lost two of their five-member operational team in the same week. They wanted to keep the remaining team members, but were quickly able to add capacity to backfill the employees who left the organization. The firm was able to move toward a solution that incorporated the best of both worlds.
Stephen Van de Wetering is the Founder and CEO of Empaxis Data Management, a premier provider of back-office services to small and medium-sized financial services firms, hedge funds and wealth management organizations in North America and Europe. You can reach him at 310-356-5831 or via email at Stephen@empaxis.com.