OPINION | The question of whether or not a superannuation fund is better off outsourcing its back-office investment operations is not as straightforward as it used to be. Increasingly, funds can get better value by picking and choosing which functions to keep in-house and which to contract out to specialist third-party providers.
A recent Parametric research project on how the superannuation fund industry is changing examined large insourcing and outsourcing decisions by superannuation funds, which are having a dramatic impact on the sector’s value chain; that is, the way the sector invests and spends each member dollar in the effort to build retirement savings for members.
This value chain captures the journey of each contributed member dollar through the distribution, product and infrastructure functions within each fund, through outsourcing arrangements, into investment markets and back through these channels into the member account.
The ‘value’ in the value chain is the multiple on the member dollar deposited back in member accounts. The ‘bogey’ for the industry to beat is what a self-managed super fund investor would have earned on the same dollar.
How the elements of the value chain are configured is important to the experience of the member and to the reputation of our industry as a whole.
The decisions funds make around important functions such as member servicing, investment management, marketing, insurance and technology are called ‘capability sourcing’ and our report included a ‘how-to’ tool to guide funds as they make these important decisions.
Borrowing from corporate literature, we asked funds to apply three key pieces of information to the following decision-making framework (see the chart below) for each capability: real costs, notional costs, and the fit-for-mission standard required for the capability.
“Real costs” are the measurable costs of a third-party outsourcing arrangement. “Notional costs” are the costs of the fund producing the output itself, derived in a similar way to corporations attributing their production costs between internal business units. A fit-for-mission capability is the standard to which the particular function must be produced to deliver on the fund’s mission – not sub-standard and not over-engineered. Funds should develop their own specific sense of what standard they require FOR each capability and should not assume that each fund will have similar standards.
A structured decision-making tool can help funds be clever about where (and where not) to pursue savings and where the quality of the capability and provider are more important to the fund’s mission. The tool highlights potential ‘low-hanging fruit’ cost savings, where current arrangements to source capabilities may exceed what a particular fund needs to deliver on its core mission to members.
The superannuation value chain is unbundling. A fund can now apply ‘make or buy’ strategies in a granular way for a close fit with what it wants to insource, what it wants to outsource, and with whom it wants to partner. This should leave room for funds to sponsor innovative, niche third-party entrants in the value chain with specific consulting or analytical skills or product solutions.
How will funds know they are applying good “make or buy” strategy?
When their sourcing increases the return multiple on the member dollar and the gap over the outcomes of the self-managed superannuation investor who chooses to bypass the Australian Prudential Regulation Authority-regulated super fund sector altogether.
Raewyn Williams is managing director of research at Parametric Australia, a subsidiary of the Seattle-based funds management and portfolio services firm Parametric Portfolio Associates.