Fuel alpha creation with the help of MOBO managed services
As a portfolio manager, you may encounter operational limits and experience systemic frustrations that hamper your ability to make and quickly act on portfolio decisions, but see the responsibility for optimizing operations as someone else’s. It is the COO who handles the way a firm delivers on middle- and back-office (MOBO) processes.
While that may be true, it is still a worthwhile use of your time and effort to pay attention to MOBO operations, particularly when the potential to outsource becomes part of the discussion. Why? Optimizing MOBO can actually help fuel alpha creation by improving data accuracy while stripping out unnecessary costs and complexity
Although operations are not your primary focus, the impact of optimizing processes can affect investment results. As such, you can be a proactive advocate for operational solutions that drive alpha by augmenting investment visibility and reach, or you can leave someone else at your firm in the driver’s seat, at the risk of limiting the potential of your strategies.
Following is a quick primer on what portfolio managers need to know about outsourcing in order to ensure your needs are met, and your returns are not compromised.
“Outsourcing” versus “managed services”
Looking at outsourcing from the portfolio manager’s perspective can help identify the optimal service model for your firm. The distinction between “outsourcing” and “managed services” is a fundamental concept for this thinking. They may appear similar at a superficial level, but a quick overview reveals that each functions differently.
Traditional outsourcing may be the more familiar model after many decades in practice. The term commonly refers to hiring an outside third party to complete tasks or perform services previously undertaken by internal staff. However, unlike an outsourcing provider, a managed services team can sit alongside your internal staff and perform functions by acting as an extension of your organization, providing outside expertise as well as operations support.
As you consider the two approaches, there are three core considerations for optimizing MOBO tasks: accountability, accuracy, and alignment.
With outsourcing, the service provider typically takes full responsibility for delivery, staff, methods, and platforms (i.e., data and software). However, you, the outsourced provider’s client, still have fiduciary responsibility and are accountable for the outcomes.
With managed services approaches, you maintain full responsibility. The benefit is that you control the functions for which you are accountable—the delivery team works more collaboratively with you and your COO and operations team members. As a result, managed services can make accountability easier to fulfill.
Portfolio managers can expect their managed services provider to fulfill all their assigned functions. However, since the ultimate responsibility rests with your team, you should ask three essential questions:
- Does your provider give your firm transparency into its processes throughout the investment lifecycle?
- Will your provider proactively bring your ops team’s attention to issues and problems that may affect you?
- Does your ops team have access to your provider’s expertise and capabilities when you need them?
As a portfolio manager, you need accurate, real-time data to make the most informed investment decisions so that you don’t lose opportunities to create alpha. In most outsourcing scenarios, data moves back and forth between your systems and your providers, which may introduce delays and risks. The risk of failed trades and errors increases because data can easily degrade or be delayed when moving from one system to another.
With outsourcing, using third parties who operate separately from your team can mean more handoffs. Just as when two people are trying to speak with each other through an interpreter, information can get lost in translation between you, your operations team, and your service provider. It means your firm needs to devote additional effort to detecting and resolving data issues.
Managed services can potentially reduce these risks by working within the same investment management systems as you and your operations team.
Questions portfolio managers should ask:
- How often does data pass back and forth from one system to another before you see it in the Portfolio Management System (PMS) or other internal decision support applications?
- Will you have real-time/intraday visibility and control in critical areas such as the amount of cash you have on hand and the value of your positions?
- What are the potential costs and risks of using a third party that could constrain your strategy or erode alpha?
Outsourced providers use their own systems as well as their own processes. A Service Level Agreement (SLA) sets tight parameters for what they will and won’t do and by when.
In practical terms, this means that portfolio managers may have to wait for operations staff to toggle to the outsourced provider’s dashboard or portals, call an API, or in many cases run a report, and then copy and paste data into the PMS to see the impact on their portfolio. In smaller organizations, portfolio managers may even need to do this work themselves. In either case, the time spent on the mechanics of creating a report can jeopardize investment opportunities.
By contrast, managed services can offer greater flexibility. You and your provider have more opportunities to collaborate as a team with a shared workflow in addition to potentially using a shared system. With fewer SLA constraints, a managed service provider can operate with a wider range of motion, allowing you to focus on alpha. Finally, as your needs ebb and flow, you always have access to the necessary expertise and resources—you can scale without needing to hire your own staff during peak periods and then scale back down afterward.
Questions portfolio managers should ask:
- What exactly happens when you trigger orders from your PMS?
- How do trade issues and exceptions get resolved, and by whom?
- How do you know everyone involved is working from the same “source of truth” at each step of your workflow?
Shadow accounting: a case in point
Shadow accounting and shadow NAV creation help illustrate the contrast between outsourcing and managed services. Commonly, investment managers outsource NAV creation to a third-party administrator that uses its own systems to create official books and records. Doing so takes advantage of the arm’s length relationship between outsourcer and client because it validates accounting from the outside. The practice has been developed in response to demand for transparency and accountability in firms’ official books and records, corroborating accuracy for the firm and its portfolio managers.
However, outsourced accounting entails the same risks of errors, mismatches, and time lags we have already highlighted. Discrepancies between the official external Accounting Book of Record (ABOR) and the Investment Book of Record (IBOR) require reconciliation on one side or the other.
To help with this process, investment managers with sufficient resources may carry out shadow accounting as a cross-check, either in-house or with additional outside resources. Fully outsourcing to an additional external provider adds both cost and complexity to the process.
However, seam-free managed services and a secure, shared investment management platform create continuity between the IBOR and your own shadow records. When discrepancies emerge, a managed services team can reconcile and make necessary adjustments in your data or facilitate changes before closing the official month-end ABOR. This approach can deliver some of the same benefits as outsourced shadow accounting without adding yet another third party into the mix.
As a result, having an internal shadow view of ABOR allows the front office to be more responsive to client queries about assets in their investment without waiting for a third-party administrator to validate finalized end-of-month books. Portfolio managers can also make decisions and manage performance with confidence, based on an up-todate, consolidated data store rather than requesting data from the administrator to get an accurate view of cash or other data points.
Conclusion: Get the pros and skip the cons
If MOBO managed services teams use the same golden data and operate as an extension of your team, you can synchronize your entire front-to-back process. You work with pros who take care of the operational ins and outs of your investment management system—freeing you to focus exclusively on your portfolios and the execution of your strategy. You also skip the cons that may come with a pure outsourcing model that can lead to frustrating disconnects, delays, and lack of confidence in your data.
In other words, managed services keep you, as a portfolio manager, in the driver’s seat. You aren’t hopping into the back of a rideshare. Instead, you focus on driving where you want to go, with an expert pit crew handling the operational mechanics that might get in your way.