FUNDS PROCESSING – UNLOCKING HIDDEN EFFICIENCIES

By Geoff Hodge, CEO Milestone Group

Geoff Hodge
Geoff Hodge

Efficiency has been at the top of the funds industry agenda for more than a decade. Technology vendors and outsourced service providers have flourished on the back of efforts to improve output while reducing costs.

Naturally, much of this effort has been directed at core processes and competencies such as fund accounting, transfer agency and investment operations or ‘middle office’. But this has left an important group of activities that are not serviced by core platforms. These are the activities that can be collectively referred to as fund processing, also known as fund administration in the US, and which have been left to fragmented and often chronically inefficient spread sheets or manual processing.
But as the industry matures, the margins are no longer there to pay for inefficient practices or to cover the costs of operational risk. With regulators becoming increasingly aggressive about robust and transparent infrastructure, and placing a premium on fiduciary responsibilities and investor protection, a growing number of funds and administration businesses are starting to look again at these remaining pools of inefficiency.

And with good reason. Fund processing is an emerging focus area for business transformation, with the potential to yield the highest immediate return on technology investment. Milestone Group’s own analysis shows that these functions tie up approximately 40 per cent of all middle and back-office staff effort, and represent about 70 per cent of the operational risk. As these figures demonstrate, the potential of the opportunity is significant.

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A problem of definition
One of the reasons that fund processing has evaded the efficiency spotlight for so long is that it is something of a grab-bag of processes, with no real agreement about what it consists of. Often, the way these types of activities are defined crosses over with fund accounting and transfer agency activities, further hindering clear focus on the opportunity. More recently, these functions are often best identified as the key functions that are ‘left over’ after a firm has outsourced a portion of its operations.

However, it is possible to view fund processing as a distinct area of activity, in which a number of key functions can be identified. The list can be lengthy, but includes NAV validation, often striking NAVs or unit prices across more complex fund of fund or investment structures, cash allocation and rebalancing for multi-tiered investment structures, tax and fund expense forecasting and expense cap management and more. As this list alone indicates, fund processing is often a breeding ground for fragmentation, inefficiency and operational risk.

Fund processing

  • Validating the daily net asset value (NAV) and often striking NAVs or unit prices across more complex fund of fund or investment structures.
  • Cash allocation and rebalancing for multi-tiered investment structures.
  • Processing fund distributions and settling distributed income within multi-tiered investment structures.
  • Reconciliation of holdings, transactions and cash between internal systems and external service providers and IBOR/ABOR reconciliations.
  • Managing data connectivity both within the client environment and to industry-wide counterparties and service providers.
  • Tax and fund expense forecasting and expense cap management.
  • Fee and rebate management to support recovery of fund distributor’s fees from asset managers.
  • Production of financial statements.
  • Regulatory reporting.

The second problem is the widely held, but erroneous, belief that automating this array of functions will require either a series of point solutions that will then need to be connected, or constructing a new all-encompassing enterprise-level platform, with all the attendant disruption that this inevitably incurs. Understandably, neither of these options is popular.

But firms increasingly recognise that there is a third way. These disparate functions can be viewed as a single set of fund-related activities with a common set of challenges and opportunities. They often share common data and require an understanding of the same fund structure; they may also be interdependent in their operational execution. If thought about in the right way, these processes are not as diverse as first appears, and can therefore be automated on a single platform that exploits their common features, and allows functions to be added sequentially over time but – critically – offers a much simplified operational design. From there it is a short step to finding solutions that have the appropriate set of characteristics to achieve this.

Process vs. production management
If identifying fund processing is the first step to making it more efficient, the next step is a little less obvious. Not least because part of the solution can be found in the archives. In the 1970s, Bank of America hired an executive from Chrysler, the car-manufacturing giant. The reason was that he knew how to design processing systems when bankers and fund managers didn’t. By importing the latest thinking about process design and quality management from manufacturing, the banks themselves saw improvements to their own workflow.

Fast-forward to the 21st Century, and banks and other financial institutions habitually apply Six Sigma principals and other techniques to improve their process management. But in the intervening years, manufacturers have continued to push down the real costs of finished goods year on year through effective production management – which offers a different perspective on efficiency, and requires a step change in thinking about technology and its deployment.

To date, financial institutions have delivered efficiency through effective process management. They have constructed logical sequential processes – like Chrysler’s production line – along which various functions will be performed. By looking at one area of their workflow, and cutting the fat from that, before moving on to the next area and the next, each individual process in the workflow has become as efficient and streamlined as possible.

But this method has maxed out. For the vast majority of firms, the piecemeal approach of best-of-breed process management has been stretched to its elastic limit – and it isn’t going to deliver any more.

This is where production management comes into play. Rather than taking this incremental approach and looking at individual processes, production management looks at all those processes together and how they interact with each other. Where process management develops an efficient workflow, production management zooms out to see what else is going on. Rather than attempting to fine tune the production line for ever-diminishing returns on effort, it looks at the interaction of a variety of processes to unlock significant new efficiencies.

In our car manufacturing plant, process management originally delivered a carefully calibrated series of sequential and simultaneous activities. But production-management thinking has encouraged the development of a single production line that can be tooled up such that it can produce a convertible one day, a station wagon the next and an SUV the next.

When translated to fund processing, a production management mind-set offers the same flexibility: a single platform that can value funds, allocate cash, and process income according to demand. Where process management says, “Build me the cheapest tool to handle allocations”, production management says, “Get me the cheapest portfolio of tools to process all potential fund activity”.

Thinking straight, thinking strategic
In other words, unlocking the efficiency gains from fund processing and its varied functions is very much about getting the right mind-set and then making sure that technology supports that approach.

A production management mind-set enables a firm to set out on a more strategic path towards its ideal operating model and make better decisions even within the same budget parameters, resource constraints and short-term priorities. The difference is that even as change is rolled out in manageable increments, short-term decisions will not limit the firm’s ability to meet its long-term strategy, or divert it from its chosen path.  It gives the firm the confidence of knowing that any processes that may need to be re-engineered, added or automated in the future can be dealt with in the same platform.

That opens up a much wider pool of opportunities for generating efficiencies. It also means that the firm is no longer constrained by the need to join up numerous point solutions or ‘stage’ data between different systems – the equivalent of pouring concrete over a production line.

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