Normal 0 false false false EN-AU X-NONE X-NONE MicrosoftInternetExplorer4The stereotype is familiar: two gun portfolio managers leave an institution, ‘hang a shingle’ outside a small office, begin running money and living their entrepreneurial dream. But like all stereotypes, this is far too convenient and masks the complexity of some boutiques’ operations. There is no standard model for boutiques. “It could be as simple as a guy with a spreadsheet and a phone, trading Australian equities through IRESS,” says Bruce Russell, a former Morse consultant who now contracts for Victorian Funds Management Corporation. Sometimes the start-ups form when an entire product team at an institution walks – recall how the nine-person domestic equities team at Suncorp became Solaris Investment Management, almost overnight, in 2007. But as new business ventures, boutiques must come to terms with institutional demands for operational strength, and most have no choice but to outsource their back-office functions.
Many have a unique set of needs, such as different methods of performance attribution or after-tax reporting, and all are cost-conscious. “Boutiques are always looking for the lowest cost solution, and need to find partners who are willing to go with them and price at an appropriate level,” says Martin Carpenter, director of Citi’s securities and fund services division. The big custodians are too expensive, and so is building or acquiring an internal operations infrastructure: “You can’t buy a SimCorp-lite or HiPort-lite” to reconcile trades and report positions, he says. Custodians have invested in these systems, and since boutiques are founded by fund managers, they “need a little hand-holding” when learning about back-office operations.
Citi accommodates boutique budgets by allowing clients to choose which service they want to use – accounting, cash and foreign exchange management or brokerage – and packaging the service so that “each product team is not saying they need to make ‘X’ amount of revenue. If Citi is getting an appropriate amount of revenue we step back from the product-byproduct view,” Carpenter says. After initially providing custody, back-office service providers like RBC Dexia Investor Services have grown to offer fund accounting, unit pricing and registry. This is largely because “boutiques want everything – custody, fund accounting, performance attribution,” says David Travers, managing director of RBC Dexia Investor Services in Australia. Many boutiques outsource everything but their investment decisions. And while it’s important for managers to pick the right outsourcing partners to help grow their business, it is equally important for custodians to choose good boutiques.
“Some providers won’t entertain boutiques because they won’t get enough revenue. So there’s a disaggregation happening when you look at the boutique market. Everyone wants big investment managers because they’re an opportunity to earn high revenue. When it comes to boutiques, you’re backing a few individuals to be successful. And if you’re going to provide a service to boutiques when they’re small, you want to provide a service to them when they’re big because that’s when you earn revenue. You have to be there when they emerge,” Travers says. Carpenter agrees: “The names behind the boutiques are important. All custodians try to pick the winners,” he says.
The FI X is in David Paradice’s move to run global small-caps by staffing a new office in Denver shows how worldly Australian boutiques can become. Most boutiques now have some allowance to invest part of their mandates offshore: “They may be 90 per cent Australian equities but have capacity to trade that other 10 per cent in Asia,” says Sam Marshall, manager of wholesale portfolio solutions at IRESS. This has spurred the IRESS portfolio system (IPS), which has long been the dominant order management system (OMS) among domestic boutiques, to use its connectivity with the Financial Information Exchange (FIX) protocol to plug managers into Asian, North American and European stock exchanges. IRESS began connecting with offshore exchanges in the last two years, Marshall says, but the process was hastened in late 2009 when ConvergEX established an office in Sydney to offer its EzeOMS – a global, multi-asset class OMS that is popular in the US and Europe – to Australian boutiques.
To source global market data, IRESS has connected to exchanges in Singapore, Hong Kong, Indonesia and Thailand, and is in the process of linking to exchanges in North America and Europe. IRESS has only approached offshore exchanges nominated by clients – hence the absence of Tokyo. But its new competitor, the EzeOMS, is fully global, connecting with 450 brokers worldwide, says Chris O’Connor, head of the vendor’s domestic office. Both companies are preparing for the end of the Australian Stock Exchange’s monopoly on the domestic market, saying the provisional licence granted to pan- European trading facility Chi-X is a sign that another exchange will arrive soon, if not imminently.
To take advantage of multiple trading venues, the broker network accessed by the EzeOMS offers 600 algorithmic trading programs designed to execute orders in one or multiple exchanges. They can be as simple as the VWAP, or volumeweighted average price algorithm, or as abstract as the ‘Night Owl’, which scans dark pools as well as public exchanges for the best prices. Meanwhile, IRESS is seeking a cornerstone client for its best market radar tool, which was developed by the company’s Canadian operation and helps brokers achieve best execution across multiple exchanges by comparing the available prices and liquidity, and also implementing customised rules to prevent users being front-run by traders who might predict their next move. “Algos will predict which exchange an investor will go to next, so it’s good to get around it,” Marshall says. He is confident the product will appeal to brokers, and expects they will buy a readily available system rather than build or import proprietary tools.
“A lot of the bigger brokers will look at us versus which proprietary systems they have overseas in their business, and the cost for them of bringing it into Australia will probably be more than the cost of using our system.” Nothing is certain but death and corporate actions IRESS was a provider of market data to managers before it developed an OMS. This enables the system to “go deeper into the back office” to provide full tax reporting and notification about corporate actions than other trading systems, Marshall says. But like the EzeOMS, it must tap into a ‘start-of-day’ information feed from custodians to display clients’ complete holdings. If this feed is delayed, the EzeOMS provides a theoretical start-of-day portfolio so managers are not “flying blind” until custodian data arrives.
This is possible because the OMS remembers each transaction that managers have executed, but is unaware of some other positions, such as cash holdings, which a fund accountant or custodian can only be certain of. Without an internal fund accounting system, such as DST Global Solutions’ HiPortfolio or the back-office component of SimCorp’s Dimension, managers must rely on data from custodians. Russell says managers often complain that custodians are too focused on post-trade information at the expense of pre-trade data, such as corporate actions. Although Citi automatically notifies clients of corporate actions through the SWIFT network and CitiDirect platform, Carpenter says it is sometimes difficult to assess the implications of corporate actions because they carry different nuances.
The spate of capital raisings in 2009, for instance, introduced some permutations about investor eligibility in share purchase plans. “It’s a bit of a moving target. But getting the information as quickly as possible and documenting it to clients electronically and allowing them to make a decision – for example, if it’s a voluntary event like a dividend re-investment plan – is really important,” Carpenter says. “Corporate actions carry a lot of risk. It’s probably the highest risk and where you can lose most in custody operations. The time delay between making an incorrect election and subsequently reversing the position can expose you to large share price movements if you choose stock and not cash in a dividend re-investment plan. “And it is manual in nature. There’s a greater chance of making a mistake and potentially more losses, whereas day-to-day settling of trades on the ASX is highly automated. Even if a trade fails, it’s not the end of the world – you cop some fail fees but are not necessarily impacted by share price movements.”
Delays in processing corporate actions are often caused when custodians need to pursue companies to gain further details so the full implications for clients are apparent, he says. But such lags, however justified, can be frustrating for hedge fund clients running event-driven strategies. To maintain more pre-trade information close to hand, some managers have bought enterprise data management products, from vendors such as GoldenSource and Eagle Pace, so they are not completely dependent on the startof- day feed from custodians. Expansion into this market is “something everyone’s looking at” in the OMS space, says EzeOMS’ O’Connor. But the uncertainty surrounding some portfolio positions – like cash holdings – tempers the vendors’ enthusiasm. At IRESS, Marshall is keen to work with custodians on using SWIFT to automate trade reconciliations reconcile between the back-office and OMS. Travers of RBC Dexia says OMS providers aiming to provide data management services “would still need to get the information from somewhere, unless they’re going to get into the administration business”.
He says there is a natural limit to how much pre-trade information a custodian can provide. “Boutiques have outsourced the investment accounting function to support portfolio management. The custodian has to provide an element of data to assist with pre-trade processing. Can you help with pretrade compliance? It’s really tough. A lot of that involves the portfolio manager looking at it and saying, ‘Can I do this within regulatory limits?’ Unless you’re sitting in the manager’s office it’s hard to tell them if they’re going to breach a mandate or not.” Fair fees Nor are managers without fault in the outsourcing relationship. “Managers squeeze custodians to the full on price to the point where it’s almost uncommercial,” says Russell. “They’ve squeezed the rate card, and then pulled securities lending, forex and cash – the things that make custodians money.
Service expectations are going up while revenues are going down.” Travers says custodians need to carefully assess the changes the superannuation industry will undergo following the Cooper Review, and how their workloads will be affected. The IFRS accounting standards, introduced in 2001, resulted in two-to-three times more work for custodians, but this change wasn’t necessarily reflected in the fees they received, he says. “So we need to ask: how do we price these changes? The systems capability needs to be there, but when it creates more effort, which needs to be reflected in fees.” Because an outsourcing arrangement is a partnership, no side should be treated unfairly.
“You need to have the ability to add additional services as and when they’re required. It’s not just about fixing a fee. An outsourcing relationship is very much a partnership, because you need to provide services as and when they’re needed. “The definition of a partnership is that both parties benefit from the organisations working together. You don’t want a situation where either side feels disadvantaged.” In this relationship, system upgrades do not warrant a renegotiation of a custodians’ fee, but more work does. “Look at the balance sheets of many custodians. It’s a mixture of revenue that they receive. A lot of it is from fees, and then other services – securities lending, trading currency or cash. You need to be careful. If you take away a stream of revenue from a provider, that provider will need to find that revenue from another place in the relationship.”