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Asset Managers’ Middle and Back Office: A New Focus for Investors

By Benjamin Gunnee
While Madoff maybe a dirty word for many investors, the scandal at the end of 2008 certainly helped propel the often forgotten operational departments of an asset manager into the limelight.
Never before had so many institutional investors got caught up in such heavy losses caused directly by the lack of internal controls and oversight at an asset management firm. Historically, losses had been mainly driven by poor performance from asset classes, for example the equity markets after the tech bubble burst. The Madoff scandal highlighted investors’ need to understand much more than the team running money on their behalf.
Pre-Madoff most institutional investors focussed the vast majority of their efforts selecting an asset manager based on investment process and portfolio strategy. In the new world the selection process for identifying asset managers has become more rigorous, with many more investors focusing on the quality of the operations, control and support functions, in addition to the portfolio management team. An institutional investor study carried out by Mercer in 2009 found 41% of respondents carried out some sort of operational due diligence in 2009, up from 13% in 2008.
As investors start to embrace operational due diligence, it is having a material impact on the way asset managers position themselves during the selection process, and more importantly, the actual controls and processes applied behind the scenes. For the first time, asset managers are being asked questions about their audit process, their compliance department, valuation methodologies and pricing sources.
On top of a strong investment process, investors are looking for:

  • A strong organisational structure promoting good corporate governance
  • Formal segregation of duties between front and back office activities
  • Infrastructure and systems to match the size and complexity of assets under management
  • Appropriately experienced and qualified staff
  • Documented policies and procedures
  • Reputable service providers including lawyers, auditors, custodians and administrators
  • Robust back-up plans in case of disruptions due to power failures or other disruptive events

In order to find answers to the points listed above, many investors are attending meetings on-site or appointing a specialist operational due diligence provider to review an asset manager’s operations, control and support functions. Again this is a major change from existing behaviour where most of the selection process took place at the investor’s or a consultant’s office.
The informal feedback Mercer has gathered indicates that many investors are surprised by some of the findings at asset managers. There have been instances of asset managers running their whole technology infrastructure using spreadsheets, and fax machines heavily used for asset confirmation. Whilst these types of processes were acceptable in the 1990s they are not sufficiently robust for current day asset managers with many employees running complex products, managing millions or billions of investor’s money. Both of these examples show a lack of investment in infrastructure and the reliance on manual processes, which increase the probability of losses through mistakes or fraud.


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