Banks stand to reap rapidly growing revenues from outsourcing services to money managers that offer separately managed accounts, industry observers say, and several big banking companies have entered the nascent business in recent years.
Managed account administration fees will rise to $170.1 million by 2009, which would be a 56.7% compound annual growth rate from the $18 million collected in 2004, according to a recent study by TowerGroup, a MasterCard Inc. subsidiary. And Alois Pirker, an analyst at Celent LLC, a Boston research firm, agreed that administrative fees for outsourced separately managed accounts would reach roughly $170 million by 2009.
"Asset managers have a core competency of buying and selling securities. Operations is just a byproduct of something they have to do, and they want to keep those costs down," said Stephen Boyle, the director of managed account outsourcing at JPMorgan Worldwide Securities Services, a division of New York-based JPMorgan Chase & Co. "It's a natural progression for the industry. The same thing happened with mutual funds - accounting and administration were outsourced."
Mr. Pirker noted that managed account assets are growing exponentially; many investment managers are likely to outsource as account volume rises, he said.
A decline in management fees has compelled many asset managers to look for ways to reduce operating costs, TowerGroup senior analyst Matt Schott said in a report released last year. Technology and operations costs can consume as much as 45% of a manager's managed account revenues, he wrote.
JPMorgan has been offering outsourcing services to asset managers for the past year and half, Mr. Boyle said. It has two clients - Gartmore Global Investments Inc., a unit of Nationwide Financial Services Inc., the big Columbus, Ohio, insurer, and Boston-based Lee Munder Capital Group LP - and is close to announcing an agreement with a third, he said.
Gartmore, which had $81 billion in all assets under management at June 30, decided in October to outsource managed account administration to JPMorgan, said Tim Grugeon, a vice president of business unit support and outsourcing at the Philadelphia company.
"From our perspective, when you're employing multiple strategies with multiple managers and a significant inflow of funds, outsourcing makes scaleability a lot easier," he said.
With less than 10% of the $645.6 billion separately managed account market (at Sept. 30) outsourced and managed account assets accumulating rapidly, ample room exists for growth in outsourcing, according to Mr. Schott.
TowerGroup predicted in October that managed account assets would grow at a compound annual rate of 16.6%, from $400 billion in 2001 to $1.7 trillion in 2011. A Money Management Institute report last year projected that separately managed account assets would reach $1.6 trillion to $2 trillion by 2011.
The product's growth should spark greater demand for outsourcing services, said Steve M. Papulak, a first vice president and business development manager for Mellon Financial Corp.'s investment manager solutions division. Mellon, which has been in the managed account outsourcing business since 1995, has five outsourcing clients, he said, including investment managers, sponsors, and providers of open-architecture wealth management platforms.
"There are a number of managers moving into the space because it is a popular and growing segment," he said. "They want to leverage their investment discipline, and managed accounts are one way to do that."
But the managed account outsourcing business remains in its infancy. Only 23 managed account outsourcing deals have been signed thus far, including Citigroup Inc.'s agreement last week to supply administrative services to Pacific Income Advisers Inc., a Santa Monica, Calif., fixed-income asset manager, Mr. Schott said.
Citigroup's fixed-income servicing capabilities helped it secure the deal with Pacific Income Advisers, said Andrew Clipper, the director of asset manager solutions in the banking company's global transaction services group. Citigroup is to administer 7,000 retail accounts for Pacific Income, with $2.5 billion of assets under management. It has offered separately managed account outsourcing since 2004.
"There's been a tremendous growth in the fixed-income marketplace as the baby boomer generation ages," Mr. Clipper said. "Investors are rolling over 401(k) accounts into fixed-income on an increasing basis." Processing fixed-income trades is typically a more complex process than administering equity trades, he added.
"We had to go with the firm that had the financial and human resources to pull it off," said Tim Tarpening, an executive vice president and portfolio manager at Pacific Income Advisers. "We wanted a firm that had a long-term commitment to this line of business. Five years down the road, some people might get out of the SMA outsourcing business."
Because fixed-income managers typically receive less fee income than equity managers do, they need to keep operating costs low to generate profits, Mr. Tarpening said. "We needed to improve on the operational side of the business to deliver a market-leading product," he said.
Six banking companies outsource separately managed account administration, according to TowerGroup: Citigroup; JPMorgan Chase; Bank of New York Co. Inc.; Mellon; State Street Corp.; and PNC Financial Services Group Inc., which provides the service through a subsidiary, PFPC Worldwide Inc. Many of these vendors were already involved in outsourcing for mutual funds and institutional accounts.
Back-office outsourcing companies like Bisys Group Inc. and SEI Investments Co. also administer managed accounts. A few companies like Vestmark Corp. and Checkfree Corp. supply technology platforms for managed account outsourcing but do not offer comprehensive services, Mr. Schott said.
Banks are uniquely positioned to capture share in the managed account outsourcing business because they offer services to both money managers and account sponsors, allowing for shared technology and operational scale, Mr. Schott wrote in his report. Many money managers want a single technology platform that can be customized for different business lines, such as institutional and retail accounts, the report said.
Separately managed accounts are unprofitable for many asset managers because each account sponsor, such as a 401(k) plan, has different investment requirements, processes, and technology, making it difficult to achieve economies of scale, according to the report.
"Money managers who are successful need to manage large numbers of relatively small accounts," said Stephen DeAngelis, a PFPC senior vice president and head of its Advisor Port managed account division. "They need to do trading and administration of accounts on an array of systems. It's a very large operational burden on money managers."
CFA Institute standards that took effect Jan. 1 on performance reporting for managed accounts may prompt some asset managers to turn to outsourcing, TowerGroup's Mr. Schott said. The industry also expects the National Association of Securities Dealers to heighten its scrutiny of managed account trading practices, his report said.
But despite the forces tending toward growth in this outsourcing business, some considerations point the other way.
"The question is, can the industry support eight providers chasing after 23 deals?" Mr. Schott said in an interview Thursday.
Moreover, the rapid progression of the managed account outsourcing business, which has seen several new vendors and technologies in recent years, may lead some asset managers to defer an outsourcing decision until the situation stabilizes, Mr. Schott wrote in October.
"Elements of standardization across platforms are still being vetted and understood by the industry," Mellon's Mr. Papulak said.
Still, outsourcing separately managed account services to banks lets money managers focus on what they do best, Mr. DeAngelis said.
"Money managers' true value in the marketplace [is] their intellectual capital and ability to manage investment portfolios," he said. "It makes sense for them to outsource administration and focus their resources on investment management, sales, and marketing."
Asset managers may be more likely to outsource after seeing companies like Neuberger Berman Inc., a PFPC client, take the leap, Mr. DeAngelis said.
"In the last year and a half, we've seen a market increase in firms that are actually inking deals and turning over their operational systems to firms like PFPC," he said. "When asset managers see the big boys and girls doing it, they'll say, 'It's probably something we should look at.' "
