Today, many asset management companies are

January 2006 Offshore Insights Market Report Series Volume 4, Issue 1 www.neoit.com RESEARCH SUMMARY: Leveraging Services Globalization SM in the Asset Industry Today, many asset management companies are willing to leverage services globalization for operational improvement. However, an up-close look at the landscape reveals that both suppliers and clients have to scale significant obstacles to achieve their objectives in current outsourcing arrangements. Indeed, while services globalization is a popular discussion topic, there have been few attempts to understand its potential in specific verticals. This white paper aims to explain the potential of services globalization for the asset management industry and to provide recommendations to clients and suppliers for a more optimal approach to global services sourcing. How can asset management companies optimally leverage services globalization SM? Key Topics Covered The drivers of services globalization in the asset management industry The types of functions that are being sourced globally Actions vendors could take to specifically address the asset management sector Actions asset management organizations could take to reap the benefits of services globalization

Page 2 of 18 Overview In 2004, the asset management industry had $14.4 trillion in assets, with 53 percent in the U.S.; 33 percent in Europe; and 10 percent in Asia. Figure 1: Geographic Distribution of the Asset Industry s Assets 10% 33% 53% Source: Deloitte Yet despite historic records of solid growth and strong profit margins, the asset management industry is currently struggling with the increasing costs associated with new products and new geographies; a wildly fluctuating equity market; and increasingly stringent regulations. The industry is looking to alleviate the strain from these pressures. Could services globalization be the industry s means to that end? Could it be more? Understanding the Asset Industry Asset management (also known as investment management) is the art and science of choosing investments such as stocks, bonds and derivatives. It combines those investment vehicles to maximize client gains according to client s specific risk-to-reward needs. There are three different groups within the industry that interact with each other: the buy side, the sell side, and the market makers. BUY SIDE The buy side refers to the asset managers who represent individual and institutional investors. Asset managers purchase investment products with the goal of increasing the assets in their clients portfolios. They make specific buy and sell decisions on behalf of their clients (according to the clients risk-to-reward needs). And they have a legal responsibility to manage clients assets prudently in accordance with their established goals and guidelines.

Page 3 of 18 Asset managers on the sell side act as a facilitators of buy-side investments. They make money not through growth in value of their investments, but through fees and commissions for these facilitating investment services. Asset management clients include institutions (corporations, governments, foundations, endowments and other investment vehicles such as mutual funds) on one hand and ultra high-net-worth individuals on the other. We call the institutional segment of the buy side asset management and the individual segment private banking (in the ultra-high-net-worth market). Figure 2: The Asset Industry Ecosystem Sell Side Market Makers Buy Side Investment Banks Lead Managers, Underwriters, Dealers, Research Issuer Services Trustees, Transfer & Paying Agents Brokers Retail & Institutional Liquidity Providers Exchanges, ECN s Asset Mutual Funds, Private Banking, Private Equity Funds, Plan Administration, Hedge Funds, Wealth Customers Support Investors Corporations Asset Administration Individual Governments Custodian HNI Institutional Source: neoit

Page 4 of 18 SELL SIDE The sell side of the asset management industry includes investment bankers, traders and research analysts. Sell-side professionals issue, recommend, trade and sell securities for investors on the buy side. MARKET MAKERS, SPECIALISTS, TRADE CLEARING AND TRADE SETTLEMENT Market makers, specialists, trade clearing and trade settlement are the companies that facilitate securities trading by providing services such as trade clearing, trade settlement, and creating an orderly market for companies' securities on stock exchanges by acting as an intermediary between buyers and sellers. Examples of market markers include brokers, traders, liquidity providers and exchanges. SUPPORT SERVICES In addition to the buy-side, sell-side, and market-maker segments, the asset management industry also includes specialized companies that provide support services to the other industry segments. There are two sets of support services: custodians and asset administrators. Custodians are responsible for the possession, handling and safekeeping of all securities purchased by a fund. The asset administration companies provide services and technologies to businesses engaged in the sale and management of investment products. Services Globalization SM Drivers in the Asset Industry We ve highlighted the fact that asset management companies are facing increasing pressures: including pressure from the increasing costs associated with new products and new geographies; a wildly fluctuating equity market; and increasingly stringent regulations. In this section we ll look in more detail at the pressures that asset management companies face pressures that could become drivers for services globalization. SLOWER GROWTH Investments activity is slower in today s asset management industry than it was in the late 1990s due in part to the prolonged bearishness of the market overall. For example, net assets in mutual funds have fallen significantly during the last three years. At the same time, the pace of growth in the number of funds has also slowed.

Page 5 of 18 Figure 3: Number of Funds by Type of Fund 2004 2003 2002 2001 2000 1999 1998 1997 1996 0 1000 2000 3000 4000 5000 6000 7000 8000 9000 Stock Funds Bond & Hybrid Funds Money Market Funds Source: ICI The money market funds have declined in number as assets have flown out of them. The number of equity funds has also dropped. In fact, sub-par performance led to the merger and shutting down of some funds. Historically, cost control has not been a high priority in the asset management industry. During its boom years of rising asset levels, asset managers added staff, increased product breadth and channel coverage, and ventured into new geographies. The result was a collapse in average operating margins: percentages have dropped from the mid-30s to the low-20s (which means that a significant portion of the industry is no longer profitable). Asset management firms have traditionally had relatively high operating costs, but many firms are now working to change that. Improving efficiency is one way to increase the numbers on the bottom line. In fact, the ability to increase efficiency is rapidly becoming a key to sustaining profits as well as a potential source of competitive advantage.

Page 6 of 18 MOVING INTO NEW GEOGRAPHIES FOR GROWTH The relatively limited potential for growth in the U.S. mutual fund market has led major firms to look to other geographies. Although in Europe fund market growth has also been relatively flat, the ability to create pan-european funds under the UCITS III directive bodes well for the industry s long-term prospects and thus continues to attract interest. But for most firms with global ambitions, current efforts are focused on the Asia-Pacific region. Asset managers see this region as a land of opportunity. Across Asia, internationally-managed assets grew from $827 billion to $1.1 trillion between 2003 and 2004. On the demand side, top global equity clients are continuing to consolidate and gather assets. They are increasingly demanding global products and services such as global research, global assets, and global IPO s. But asset management firms will need persistence and a long-term horizon to succeed in new regions because of the intrinsic cost and complexity involved. For one, having a global business means different regulatory regimes and many sign-offs. Today, many asset management firms are focusing on attaining global cost leadership and increasing global market share to enhance revenues, returns, and maximize shareholder value as the costs associated with achieving global scale in any equities platform have increased. The winners will be the ones who are able to combine deep resources and expertise with patience and staying power. MOVING INTO NEW PRODUCTS/ ASSET CLASSES Both institutional and individual investors are showing a greater inclination towards alternative investments: allocation to alternate investments has gone up from 1-2% in 2000 to 6-10% in 2005. Alternate investments include hedge funds, funds of hedge funds, real estate, private equity, venture capital, structured finance and a variety of hybrid instruments. Asset management firms will need to prepare to offer a wider variety of options to investors to meet this increasingly diverse demand. But existing infrastructure systems are not capable of providing adequate support for new asset types. So the proliferation of new products will raise back-office costs. To take advantage of the demand for new products, then, asset management firms will have to build technology infrastructures that are more flexible and efficient. They will also have to develop robust financial models to understand the economics of the new products. INCREASING COMPLEXITY OF THE BUSINESS The primary goal of most asset management firms is to gather more assets, but as funds grow larger and increasingly complex, their management becomes increasingly more costly. Ideally, funds would be able to nimbly buy and sell stocks, but as the funds come to own larger portions of the shares of a company, they find it increasingly difficult to buy or sell without moving the share price against them. And as funds increase the number of stocks in their portfolio, they begin to more closely resemble their benchmark. As a fund gets bigger, it gets tougher for it to beat its benchmark.

Page 7 of 18 Further, globally commission rates have also come under pressure. In this scenario, it is best for large funds to concentrate more on investment than on operations as operations does not constitute their core business. INCREASING REGULATORY PRESSURE We ve seen several cases of misconduct in the asset management industry over the last few years. Such cases have led to greater regulatory pressure on the industry worldwide. The United States Securities and Exchange Commission (SEC); Canada s Ontario Securities Commission; the Netherlands Authority for Financial Markets; the Committee of European Securities Regulator (CESR); the UK s Financial Services Authority (FSA); the Australian Securities and Investment Commission; and the Association of the Luxembourg Fund Industry (ALFI) are all advocating for more stringent disclosure requirements. Indeed, corporate governance standards have been on the rise around the world. Presently more than 40 countries have corporate governance codes or laws. For example, the U.S. Sarbanes-Oxley Act requires companies with U.S. listings to tighten financial reporting, improve transparency, and upgrade risk management. Europe has also tightened its corporate governance standards in the wake of major corporate scandals. At least 21 European countries have implemented governance codes. Emerging markets in Asia are ratifying similar standards. Figure 4: Disciplinary Fines Collected by the U.S. National Assoc. of Securities Dealers 2004 2003 2002 2001 0 20 40 60 80 100 120 Disciplinary Fines (Millions of US$) Source: U.S. National Association of Securities Dealers Many firms are even voluntarily instituting more stringent practices as a means of positively differentiating themselves in the marketplace. But these moves significantly increase compliance costs for asset management firms.

Page 8 of 18 DEMANDING INTERNAL CUSTOMERS WITH VERY LOW TOLERANCES FOR ERROR Asset management companies possess demanding internal customers with very low tolerances for error. Asset managers begin every day with a clear view of the market. They track activity with alerts and targeted news, evaluate companies with real-time and historical information about fundamentals, ownership, filings, and more. They perform in-depth peer analysis, track major economic indicators and then drill to analyze specific securities. These managers need timely, accurate information and the tools to track market activity, analyze risk, evaluate the companies behind the securities, and cut through the clutter to make informed decisions faster. They need to process complex trading data, understand pricing and execute on positions with unprecedented speed. They need systems and processes with very high reliability, robustness, speed, security and quality. Services globalization (including onshore, nearshore, and offshore outsourcing) could be a solution for the above mentioned challenges faced by asset management industry as detailed in the table below: Table 1: Services Globalization as a Fix for Asset Industry Challenges Industry Challenge Business Objective Outsourcing as a Solution? Offshoring as a Solution? Slower growth Improving operating margin by reducing cost No Moving into new geographies for growth 24/7 coverage No Moving into new products/asset classes Cyclic nature of technology requirements demands operational flexibility Growing complexity of the business Reduce complexity by using service providers who are experts in their field Demanding internal customers with very low tolerances for error Improve quality by using service providers who have well-defined quality processes Regulatory pressure Improve compliance and reduce compliance cost by using capable service providers Source: neoit Which Services Can Be Sourced Globally?

Page 9 of 18 This section analyzes the processes, applications, and functions of the asset management industry and recommends global sourcing opportunities. Broadly, the asset management industry has three types of services that may be globally sourced, including: Business processes IT services IT infrastructure ASSET MANAGEMENT INDUSTRY PROCESSES The segregation of a generic, high-level business process model of an asset management business into front-office, middle-office and back-office functional areas is shown in the table below. The model applies to various types of asset managers, including private banks, fund managers and insurers. Table 2: Key Processes in the Asset Industry Front Office Middle Office Back Office Research & Analysis Sales & Distribution Portfolio Trade & Transaction Services & Control Clearance & Settlement Fund Accounting Research Pricing Analytics Relationship / CRM Sales Pipeline Coverage & Contact Client Reporting Billing Performance Analysis Limits & Key Ratios Compliance Check & Portfolio Reporting Fund Analytics Portfolio Optimization Trading Transaction Brokerage Risk and P&L Calculations Limit Monitoring & Reporting Cash Desk Connectivity Data Warehousing Data Trade Control Performance Rebalancing Accounting Control & Verification Group Risk Calculations Group Reporting & Control Regulatory Compliance Corporate Compliance Deadline Surveillance Back-Office Transactions Confirmation Settlements Payments Clearing Securities Transfer Transfer Agent Custody Corporate Actions Accounting Position Generation Ledger Functions Tax Rules Maintenance Source: neoit OFFSHOREABILITY In addition to working with traditional vendors to source back-office processes, asset management firms are also looking for vendors to handle middle-office and front-office functions such as research, analytics, data management, transaction processing, and other post-trade services. The functional areas currently being offshored are highlighted in beige in Table 2 (above). The fact asset management firms are looking to source middle-office and front-office processes as well as the more traditionally sourced back-office processes does not negate the fact that offshore supplier maturity in different functional areas can vary by asset classes, as shown in the table below.

Page 10 of 18 Table 3: Offshore Business Process Maturity by Asset Classes Equity Fixed Income Derivatives Credit Other Securities Front Office High High High High High Middle Office High High Medium Medium Medium Back Office High Medium Medium Low Low Source: neoit IT SERVICES In some cases, a process may have a standard solution that can be delivered in a packaged form by an offshore supplier; in other cases, an asset management firm must develop an in-house solution to a unique process need. Some of the functional areas that can be well-suited to packaged standard solutions and the companies that have used those solutions are listed in the table below. Table 4: Key Asset Package Solutions FO MO BO CRM Decision Support Order Compliance Performance Measurement Client Reporting Back Office Corporate Actions Fund Accounting Advent Y Y Y Y Y Y Y Y Y Charles River Y Y Eagle Y Y Y Misys Y Y Y Y Y Y Y Y Thomson Y Y Y Y Y Y ERI Bancaire Y Y Y Y Y Y Y Y Y Source: neoit

Page 11 of 18 IT service work involves developing and supporting IT applications for varying business needs, including (specifically) supporting applications (both third-party and in-house), system integration, package implementation, and interface development. Many asset management firms face inconsistent processes and disparate technologies across various functions that lead to duplication, inaccuracies, and friction. In attempts to assuage those problems, firms will continue to invest in integration, automation and consolidation services in addition to regular IT maintenance services. Among those IT services that asset management firms may invest in, opportunities for global sourcing exist in application development, application management, migration and testing. Table 5: Areas of Opportunity in Global IT Sourcing Application Development Application Migration Testing New Development Production Support Application Migration Test Analysis Web Enabling Maintenance Data Migration Unit Testing EAI Performance Tuning Upgrade Functional Testing Package Implementation Porting Performance Testing Application Audit Source: neoit IT INFRASTRUCTURE IT infrastructure work involves the provision of IT-infrastructure-related services to the various IT organizations aligned to business units in an asset management company. The following table highlights the specific processes that make up IT infrastructure services. Table 6: IT Infrastructure Processes Application Hosting Information Security Solutions Networking Desktop Support Architecture Source: neoit Among an asset management firm s steps toward cost reduction is the identification of its fixed and variable IT infrastructure costs. Asset management firms may find opportunities to save on variable costs in particular by globalizing services. The functional areas currently being offshored are highlighted in beige in Table 6 (above).

Page 12 of 18 Case Studies This section highlights how pioneers have leveraged services globalization in the asset management industry. Figure 5: IT Services Globalization in the Asset Industry Case Studies Client: Asset management division of large investment bank Supplier: Tier-I vendor Project: Development and maintenance of a custody technology application infrastructure, custody technology operational engineering, securities clearance, and reconciliation system. Also included the provision of maintenance and enhancement support to the asset management system of PCS (private client services). Client: Large global bank Supplier: Tier-II vendor Project: Provide level-1 operational support for settlement system for international fixed income securities business that interfaces to more than 80 other systems including price feeds, trade feeds, and GL reporting. Also included functional query resolution, rectification and report handling; job monitoring; configuration management; and the provision of bug fixes. Client: Leading U.S. money manager Supplier: Tier-II vendor Project: Replace 20- year-old legacy system with an open-architecture solution while retaining the functional richness of the existing system. Application Migration Application Development & Maintenance Web Enabling Asset Production Support Package Implementation Application Audit Client: Leading U.S. mutual fund Supplier: Tier-II vendor Project: Re-architected the web-based institutional mutual fund trading system to ensure a robust, scalable and secure environment. Client: Global Money Group Supplier: Tier-II vendor Project: Developed a portal for product delivery and sales and marketing information for domiciled retail funds to financial consultants of different distribution channels across 7 countries and 9 languages. Client: Investment arm of U.S.-based insurance company Supplier: Tier-I vendor Project: Evaluation, selection and implementation of securities portfolio accounting package. Managed environment change and data migration from the current system to the new system. Source: neoit

Page 13 of 18 Figure 6: Business Process Globalization in the Asset Industry Case Studies Asset Client: Leading global custodian Supplier: Tier-I vendor Project: Perform reconciliations, including cash and stock reconciliation and pre-settlement reconciliation with exchange data. Client: Global investment bank Supplier: Tier-I vendor Project: Includes limit/compliance monitoring, reports, and NAV calculation. Client: UK-based investment management firm Supplier: Niche player Project: Analyze the level of disclosures pertaining to non-core assets, goodwill, and accounting standards undertaken by the FTSE companies. Analytics Reconciliation & Settlement Data Asset Portfolio Billing, Taxation, Corporate Actions Research Client: Large global investment bank Supplier: Niche player Project: Perform credit risk analysis including country analysis, sector analysis and industry analysis. Conduct global markets research covering credit, economics and quantitative research. Client: U.S.-based investment management firm Supplier: Niche player Project: Data cleansing performed by a dedicated data cleansing team in India acting as a one-stop shop for client s data cleansing needs across all divisions globally. Client: Global custodian Supplier: Tier-I vendor Project: Includes sub-custodian fee billing, corporate actions (involuntary), tax reclaims, income processing, and redemption. Source: neoit

Page 14 of 18 Actions Vendors Can Take To Address the Asset Industry s Needs BUILD CREDIBILITY Many investment companies believe that there are no credible offshore service providers in the marketplace. In other words, they don t believe that they can reduce costs by globalizing services without sacrificing quality an enormous risk to the brand that looms larger than any perceived potential gains. Vendors can work to change this perception by building and highlighting their competency and maturity in asset management services. BRIDGE CAPABILITY GAP IN FOLLOWING AREAS In some cases offshore service suppliers need to increase their ability to adequately meet the needs of asset management firms. Specifically, suppliers need to increase capability in the following areas: Asset management domain knowledge Expertise in multiple applications Knowledge of relevant industry protocols Access to high-quality technology infrastructure INCREASE BREADTH OF SERVICES Suppliers could also attract business from the asset management industry by widening their range of services, including ADM, BPO, and infrastructure to become one-stop shops for clients who aren t interested in maintaining numerous relationships with different niche service providers. DEMONSTRATE HIGHER MATURITY In addition to increasing capability in key areas and widening their range of services, services suppliers in the asset management industry must also demonstrate higher levels of process maturity to attract clients in large numbers. Specifically, firms should: Move away from staff augmentation and time and material and offer fixed-cost or SLA-based relationships Offer a mix of onsite and offsite services according to each client s specific needs and desires.

Page 15 of 18 Actions Asset Firms Can Take to Benefit from Services Globalization SM Asset management firms can capture more of the benefits offered by services globalization by increasing their knowledge of the process of services globalization and the services offered by global vendors; by engaging executive managers in sponsorship of globalization initiatives; by engaging due diligence in selecting a location and service provider to which they will source; by practicing due diligence in contracting; and by engaging best practices in governance and change management. Knowledge Executive Sponsorship Strategic Objectives Organization Readiness Portfolio Assessment Location Selection Vendor Due Diligence Draw a services globalization roadmap. Start by answering the questions: What is services globalization? Why is services globalization right for my company? Where is my ideal service provider? How will we engage services globalization (what are the best practices)? When is the best time for us to globalize our services? Get buy-in and active sponsorship for globalization initiatives from key management executives. The probability that a globalization initiative will fail rises substantially if there is no visible executive management support and sponsorship for the initiative. Articulate what you plan to accomplish by globalizing your services. In other words, answer the question: Why are we globalizing this service? Determine your company s strategic objectives against which you can measure the success of a globalization initiative. Ensure that your organization is ready for services globalization. Readiness areas to look for are documentation, clear process definitions and reengineered workflow suitable for working in a distributed work environment. Determine which processes you will offshore. Engage a detailed portfolio assessment to determine the optimal location for each process (for example: in-house, with an onshore service provider, or with an offshore service provider). Determine where you will have each process performed. Some processes are best performed in an established center of excellence, which others would do well in an emerging location. To optimize your location use a portfolio approach, considering how each location ranks on people, infrastructure, financial, and catalyst factors. Apply due diligence when selecting a service provider. Make onsite visits to vendor delivery centers before you select a vendor and engage detailed due diligence covering operations, security, compliance, quality, finance, and human resources. Many companies have found it helpful to hire a third-party consultant with relevant location knowledge to aid in the vendor selection process.

Page 16 of 18 Contracting Change Governance Before beginning the services engagement, ensure that you have a proper contract in place that includes provisions for SLA s, performance metrics, and key terms and conditions (including termination, reverse transitioning, benchmarking and pricing). Organizational change management is critical. Executive buy-in and proper communication are keys to a smooth organizational transition and the successful redeployment of resources. Developing a thorough governance framework that clearly defines roles and responsibilities for the management of global services engagements is essential, especially if you re engaging a multivendor/multi-country sourcing model. Your governance framework should provide for a program management office that executes performance management, contract management, relationship management, resource management and financial management for the sourcing engagements.

Page 17 of 18 Conclusion Asset management companies face many challenges: slower growth, a desire to move into new geographies and products/asset classes to take advantage of growth opportunities there, increasingly complex businesses, increasing regulatory pressure, and demanding internal customers with high quality expectations. But those challenges present the asset management industry with a unique opportunity to alleviate cost pressures and realize new growth potential. That opportunity is services globalization. But to benefit from the opportunity before them, asset management companies need to understand that commitment and vision are critical elements of a successfully leveraged services globalization initiative. They should take a more disciplined approach to the management of globalization projects monitoring those projects more closely and improving their understanding of the potential benefits of services globalization. They should look at services globalization as not only a short-term costreduction strategy to abandon if equity prices once again begin to generate healthy returns but as a long-term growth strategy as well. Andrew Grove, the chairman of Intel once said There is at least one point in the history of any company when you have to change dramatically to rise to the next performance level. Miss the moment and you start to decline. For the asset management industry, the moment is now and the opportunity is services globalization.

Page 18 of 18 More information about the offshore outsourcing industry can be found within neoit s research center at www.neooffshore.com. For more details about neoit s offshore advisory and management services, please contact: Juliana Gidwani Marketing Manager San Ramon, California juliana@neoit.com 925-355-0557 www.neoit.com No part of this report may be reprinted/reproduced without prior permission from neoit. Contributors Pareekh Jain Analyst Sabyasachi Satpathy Research Director Nishant Verma Manager Editors Atul Vashistha CEO Avinash Vashistha Managing Partner Eugene M. Kublanov Vice President neoit Global Offices neoit Global Headquarters 2603 Camino Ramon Ste. 200 San Ramon, CA 94583 Telephone: 925.355.0557 Facsimile: 925.355.0558 Asia Headquarters 210, Bellary Road Upper Palace Orchards Bangalore 560080 India Telephone: +91 80 23610371 Facsimile: +91 80 23610375 neoit Philippines 8/F Pacific Star Building Senator Gil Puyat Ave. cor Makati Ave. Makati City, Metro Manila, 1200, Philippines Telephone: +63 (2) 811-5519 Facsimile: +63 (2) 811-5545