Authored by Professor Amin Rajan and Barbara Martin, and backed by Citi and Legg Mason, the report* looks at the challenges and opportunities presented by the globalisation of the funds industry. In a section on operating models, the report notes that outsourcing has been used as a way to integrate back offices in global businesses.

The degree of outsourcing depends on the model of the asset management business, but a poll for the report indicates that the centralised activities that have changed most are marketing to global clients, brand promotion and product development (within marketing).

Within the investment process, the most activities undergoing change are risk and quant analysis, asset allocation dealing and trading, and derivatives management, with more of these being outsourced. The least centralised activities were to do with distribution. Sales via intermediaries, fund supermarkets, direct and open architecture were all decentralised.

"At the start of this decade, outsourcing was used to kill two birds with one stone: tackling the cost spiral and exporting 'problem children'," the report finds. "However, as product complexity has increased, outsourcing has been used to perform a variety of functions in the back and more recently, the middle office."

"The next generation of outsourcing will impact on high value added activities such as derivatives pricing, independent valuation of illiquid investments, performance measurement and performance attribution."

Asset managers have discovered that relentless ingenuity going into product innovation at the front end is only as good as the infrastructure that supports it at the back end, the report said.

"Operations and technology are notorious for derailing client service and senior executive attention. Hence top executives in asset management firms want to create structures within which complexity and exceptions are dealt with by outside experts with a credible track record."

Of functions that have already been outsourced by asset managers, custody and settlement featured at the top, with around 70% of those questioned in a poll to accompany the report already outsourcing, and another 8-10% suggesting more could be outsourced in this area.

The other three functions that have been most widely outsourced already are independent valuation of investments, shareholder services and proxy voting. Functions where 50% or more remains in-house include derivatives pricing and processing, performance measurement, risk management services, performance attribution analysis, tax planning, financial reporting and regulatory compliance.

Functions most likely to be outsourced in the future are independent valuation of investments, performance measurement and risk management services, the poll found.

Winners among asset managers will be those "smart enough to develop solutions that chime with client needs at the front end and operational excellence at the back end."

An executive at a continental European asset management firm, interviewed for the report, commented: "The phenomenal growth in global asset management since 2003 has transformed the nature of the relationship between asset managers and their administrators, whose old image as commodity merchants doing nickel and dime business is now confined to the dustbin of history... Administrators are increasingly viewed as strategic partners adding value in three specific areas of the asset business."

He identifies these as operational excellence, delivering back office functions through a single hub with close proximity to clients, who are becoming increasingly demanding of reporting facilities. The second area is operating leverage, where the back and middle office helps create a scaleable business model. In fact, back office outsourcing, often using local hubs, is being regarded as a way to heal fault lines created by the complexity of globalised businesses.

The third area where value is being created is product innovation, as administrators carve out a niche in the middle office by moving into vendor management, trade reconciliations, performance reporting, performance attribution analysis, data management, complex analytics and simulation models.

However, as the back and middle office functions add value, they also provide one side of increasing friction with other parts of the business. Shared distribution is often a source of tension, as each business line wants priority and to claim revenue. Likewise, along the trading chain, fee sharing requires sophisticated systems, and those providing those systems want recognition for their input.