A new whitepaper from Northern Trust — one of the world’s largest custodian banks, with $11.6 trillion in assets under custody and administration — notes:

“Across the globe, investors are bringing their asset management in-house in order to reduce fees, enhance control, gain efficiencies and drive overall investment performance.”

Dan Houlihan, Head of Asset Servicing, Americas at Northern Trust, contributed to the report and took time to discuss "The Changing Tide: The Evolution of the Asset Owner Investment Model."

Funny, the reasons Northern Trust gives for insourcing investment management — greater efficiency, improved operations — sound much like the reasons for outsourcing.

It’s interesting because yes, on one hand, outsourcing generally happens as a result of cost, fees, and economies of scale. The initial trend we saw in outsourcing was the technology function. We don't view technology as a core competency for an asset owner. However, you could argue that investment is a core competency, fundamental to whoever the stakeholders are, such as pension beneficiaries or not-for-profit organizations.

Why is this happening now?

If you look in our industry, there have been three big waves of outsourcing. The first was in the 1980s, when the asset managers outsourced their custody operations to independent providers. Then as we got into 2000, middle-office outsourcing started globally, and when the global financial crisis hit in 2008, we saw a spike in demand for mid-office outsourcing. It is a recession business that happens at the tail end of a long bull run.

Isn’t that a bit contradictory, that a bull run leads to concerns about costs?

No. The bull runs and rising investment returns either hide or enable growth in fixed costs, and then when the cycle turns, we see a big push for outsourcing. I think we are heading into a third wave where the front office, which has historically been immune to cost-cutting, is coming under pressure from fees and regulatory demands.

In the last two years or so, we have gotten 50 or more clients who have outsourced their trading operations to us. I think that trend will continue, in part because as a large-scale provider, we have access to liquidity that a single asset manager wouldn’t.

What does this mean for Northern Trust’s role?

More opportunity for us, because if an asset owner is bringing the investment management in-house, the investment decision-making component is their core competency. But the mid- and back-office — do you want to outsource that to a scale provider like Northern Trust? 

We see a large opportunity for us to continue to provide services, and we are expanding into front office capabilities for asset owners as well.

That’s new territory, isn’t it?

Last year we launched Front Office Solutions, a new business line, which provides actual front office decision support for the chief investment officer (CIO) as it relates to their alternate investment book. 

We have a set of technologies and an operational position that allow us to source and support all the underlying data for those positions, such as limited partnerships, private equity, hedge funds, and real estate. 

All in one place?

We provide the CIO with dashboards where he or she can see the portfolio versus their policy, risk, and attribution. That is a newer capability, something clients are very much looking for. The CIOs have historically done that through a number of different systems — a document management system to track all the prospectuses, a separate performance and analytics system, and a record-keeping system. This capability consolidates all that in one place. 

So you become the tech provider?

They don't just want the tech; they also want the operational expertise to ensure that the quality of the data is there. Data is their raw material, so if the data isn’t accurate, the outcome is flawed. That is our differentiator — the expertise and the technology. It is a lot of expertise to bring in-house.

Does the demand differ by asset owner?

We see two models:

1. The asset owners who outsource 100% and don’t have the experience to comprehend the operational and tech components and the costs and timelines to get that plugged in. 

2. The asset owners who already manage an asset class and sub-advise the rest. They are more in the know, so it’s probably easier in that context to bring more and more strategies back in-house for the cost savings — knowing the advantages they will get from governance and transparency.

What’s the difference in technologies between what asset managers have and what asset owners deploy?

What we saw in the asset owner community was that, whilst very sophisticated investors and allocators, they are — and here I am generalizing —they are a decade or so behind the asset managers for ability to manage data in real time and getting sophisticated analytics. 

In September 2018, we combined the asset management and the asset owner business, and now I lead both sides.

How are asset managers and owners responding to the more demanding regulatory requirements in Europe, like MiFID II and data privacy rules?

Among our large global clients, which operate in the U.S., Europe and Asia, many are globalizing the MiFID II and GDPR standards — the most stringent set of regulations around the world. They have to implement them in Europe, so they are adhering to the same standards here too. I hope at some point there will be more and better harmonization of global regulations, but that is an aspiration, not a destination. 

Where I don’t know if it will play is if you have a small active manager in the U.S. — $10 billion — implementing MiFID II is no small feat, and it is not cheap.

Your whitepaper says the cost of investment management is 8 bps in-house and 46 bps when outsourced. Why aren’t asset owners flooding to do their own investment management?

That fee pressure is consistent, and that is part of the challenge for the asset management side. There has been a lot of fee pressure on the active side, and we believe it will continue, and you will likely see more performance-based fees. 

As the investment insourcing trend develops, asset owners are increasingly outsourcing non-core functions to focus on the activities that add the most value. Accordingly, they are reconsidering their operational, technological, risk, governance, and compliance responsibilities.