Exploring Outsourcing Trends in Alts: Outsource the Task, not Responsibility

In the not-so-distant past, fund managers and their service providers would discuss outsourcing almost as an afterthought, and always focus on back-office functions such as accounting, reconciliations or trade settlement.

Not anymore.

“The whole marketplace for alternatives is changing,” said Daniel Trentacosta, Global Head of Private Markets & Change for MUFG Investor Services, during our NY Alts & Private Markets Forum on June 5. “Now outsourcing is just in every single conversation that we have.”

Danny moderated a forum panel discussion, “Operational Crossroads: Outsourcing, Co-Sourcing, Lift-Outs” with panelists Kara Paulsak, Global Head of Alternative Client Services and Head of Business Management & Strategy for Alternative Operations at BlackRock; Jennifer Santangelo, COO, AB Arya at AllianceBernstein; and Joseph Fisher, Senior Lead Partner at KPMG.

The discussion focused on the scope and scale of outsourcing in the global alternatives industry—the role of service providers and technology, the rationale for outsourcing vs. handling functions internally, when and where “lift-outs” are effective, as well as investor preferences regarding outsourcing.

Fund managers are increasingly seeking service providers for comprehensive, “front-to back” solutions or technology that begins as close to a trade as possible and carries through the process, Danny said.

Firms that trade in private equity, private credit and real estate often use different systems, which can pose “challenges finding those vendors that can handle front-to-back, from investor onboarding through trading and fund accounting, across those different products,” Kara said, adding that her team outsources fund accounting and transfer agency work, as well as middle- office work in private credit and data-related functions.
 
To attract retail investors, Kara said BlackRock is introducing semi-liquid products in private equity and private credit and “as we’re seeing that retail market pick up, [we need] vendors that can support that “front-to-back” as retail investors come in.”

While continuing to focus on developing specialized, proprietary systems. Jennifer said her team is outsourcing hedge fund work, particularly middle- and back-office tasks, as well as fund of funds shadow accounting. She recalled how her firm purchased two hedge funds and was “able to easily lift them into our ecosystem because we stripped out the complexity of the workflow for the hedge fund platform,” she said. Tapping third-party outsource providers helped her team to “do some things quickly and bring us to market more quickly than we could if we were just relying on things solely in-house.”

Outsourcing tax issues is on the rise, especially for funds with complex structures, and there are growth opportunities in private equity fund accounting, Joe said, adding that integrating technology remains a key point for the industry to address.  

“Technology is complex and fragmented, and there’s no one-size-fits-all,” Joe said, “The evolution of the public cloud versus private servers is a conversation that that comes up a lot. Digitization of data has been the hot topic: Where is it stored, how is it accumulated, how is it accessed, who controls it.”

Retaining ownership and control of data is a critical issue, especially for larger clients, Danny noted. In those co-sourcing instances, service providers typically log in to a client’s system and work within that environment or use a hybrid mix of technologies from both firms.

Balancing control of data and outsourcing helps to streamline operations, Kara said. “We have a couple of [private credit] firms that we’ve acquired, but also homegrown private credit funds and businesses” she said. “Having all of that outsourced to one provider within one system to get all of that data back in a standardized way has definitely allowed us to scale in a much better way than we would have with a halved outsourced and sourced model.”

Fund managers also are considering “lift-out” models, where fund teams are shifted to become employees of service providers.

“That’s the hot topic right now,” Joe said. “We’ve been seeing the tax function being lifted out. Say, if you have a tax compliance department of a hundred people, it gets lifted out. There are certain people that are going to stay behind with the [fund] to help manage the people.”

The fund benefit by keeping teams intact, but moving them off their payroll, he said. The service providers benefit because they have brought on knowledgeable staff that can be used to help other clients as well.

Investors, many of whom are used to greater disclosure and transparency than the alternatives industry has provided in the past, have come to expect outsourcing as a normal part of the business.

Several years ago, investors challenged the idea of shadow accounting for a multi-manager hedge fund, asking “why are you spending the extra money to do that? Why don’t you have a team in-house?” Jennifer recalled. “Now, clients really do expect to see some level of independence with the oversight on the shadow accounting side of things.”

Kara agreed, saying investors are “more open to having that third party doing the work, and having us doing that additional control. We explain to them what our additional control and oversight is over the providers. They like having two sets of people actually looking at the work.”

“You might outsource the task, but you don’t outsource the responsibility,” Danny added. “And you don’t outsource the ownership since you are the ones that have to answer to your investors at the end of the day.”