For years, the fund industry has been looking for ways to manage costs while continuing to provide competitive products to the increasingly complex marketplace.
Ironically, we have done little to look in the mirror and realize how diametrically opposed those two concepts are. As traders continue to invent and then trade in new derivatives, and regulators subsequently try to catch up with them, the pressure is on the back office to find a way to account and to report. As Beacon Consulting Group noted in a recent paper, “Constant stress has been put on technology as the front office continues to seek new investment opportunities and strategies. This pressure, accompanied with changing regulations and tighter budgets, has left the middle and back offices scrambling to meet the needs of the organization, often through work-arounds and offline processing.”
As reported by the ICI in March 2016, mutual fund expense ratios have been declining for many years and in 2015, average expense ratios for equity, hybrid, and bond mutual funds were at a 20 year low. As the front office chases beta and stronger returns for shareholders, there is still an expectation that the trend of lower expense ratios will continue. Back offices pay the price for all the front office innovation and are challenged with managing the inevitable cost of service increases that result. It’s a game of tail-chasing that has gone on for years and only with the recent regulatory onslaught of rules and reporting requirements has the industry truly widened its eyes.
While asset managers and administrators have invested countless dollars into custody and accounting platforms over the years, automation investment for fund administration and reporting has been comparatively meek. In fact, in a survey Confluence conducted in 2014, respondents said their most important back-office goal over the coming two years was to replace manual processes with automated technology (61%). However, that was also reported as the most important goal for the prior six years in three different surveys Confluence conducted. It appears that, while back offices at asset managers and fund administrators recognize the need for investments in automation, they haven’t executed on their goal to replace manual processes. Finally, as a result of the requirements placed on funds across all asset classes by the increase in global regulation, as well as the recognition of the wide gap between front- and back-office investments in automation, asset managers and fund administrators are making automated technology investments a priority.
Historically, when looking around the back office, instead of automation, we have seen that many functions have been offshored simply to keep up with the growing cost pressures on the market. In the past ten years, an increasing number of jobs have been moved to lower cost, non-US locations like Mumbai, Manilla, Pune, Gurgaon, and Krakow to take advantage of the obvious salary arbitrage.
Only now that we have exhausted all other resources, are we all coming to the table to make it happen. Indeed, we are entering the final frontier of true back-office automation. Yet even as the fund industry begins to focus on cost-cutting through automation, I sit across the table from my own financial planner and wonder if he understands the work that is done by those in the back office to manage funds’ costs. As he casually mentions the expense ratio of one fund compared to that of another, I can’t help but wonder how little he knows about what is included in those critical numbers. As he makes recommendations to move from one fund to another because the costs imbedded in the former are “too high”, I can’t help but wonder if he realizes the ripple effect that those decisions have on the marketplace.
Demands for lower cost, cost-competitive investment products that provide a high rate of return are nothing new and will continue in eternity. The ability to deliver automation and services with value pricing has never been higher and the time for delivery is now.