Growth in fund complexity and managing assets in-house has triggered intensive efforts by pension funds to beef up their operational and support functions.
JANA principal consultant and head of operational consulting, Jo Leaper, says there is a growing awareness that the investment value chain must work more efficiently to maximise returns to beneficiaries.
Put simply, super funds can up their game when it comes to identifying new sources of alpha, including reducing implementation complexity.
While boosting returns by squeezing every possible ounce of value from the investment process is a goal for most asset owners, it's not always a reality, given the growing complexity of operations.
Says Leaper: "Funds are doing a pretty good job with operations. Yet being better than 'good' and achieving 'best practice' - so they can find operational alpha - is much harder."
The JANA head of operational consulting said when running money in-house, super funds have to be conscious of an increasing range of factors that could interfere with the investment process.
"Funds should aim to understand that when they invest, the process by which that dollar gets to where it's invested is now much more complex and requires broader thought," she adds.
"And preventing money seeping out of the value chain to reduce costs is increasingly important."
There are a lot of hidden costs to target.
"Funds need to reduce foreign exchange costs, monitor trading costs, ensure that tax leakage is as low as possible and that the way strategies interact together works well. It's about ensuring that you've got the right processes and practices but equally, that they are not a drain on the business."
Unlike asset managers who have long run a full in-house operations team, super funds have historically run operations predominantly on the member side of the business.
The introduction of internalisation to a business that is already exposed to heightened complexity, and then adding complex asset classes to in-house portfolios, further complicates the operational structure.
Leaper goes on to say that funds need systems, risk management and compliance, governance, decision-making forums, and many more delegations from the board to support these changes. They need to hire more risk people, more ops people, more data, more people, and more reporting people.
"Further, the role of the superannuation trustee will expand as well because they're suddenly monitoring a far broader remit than what they were previously."
"When outsourcing to an external manager", she says, "funds do their due diligence, but the external managers largely do the operational work."
Internalisation is attractive to funds because it gives them more levers to pull when chasing alpha. But the peripheral service support that enables internal investment management also comes down to how many people and resources are involved in investing that dollar."
Leaper warns that the real cost impact of internalisation is unknown in the industry because funds are constantly impacted by changing regulations and the growing complexity.
"Funds mostly look at the reduction of fees paid to external managers. They save money on the headline fees, but they need to understand where they're saving money across the entire value chain" she states.
"It's the cost of all the additional employees hired and the time involved with oversight and monitoring. And in addition to this, there are different audit requirements.
"There is a much broader cost to investment than putting systems and teams in place, and funds need to consider whether they understand the ongoing cost of internal investing at best practice."
Leaper's view is that the industry's assessment of this has been challenging given the rapidly changing and evolving landscape.
"You've got to look at the entire benefit or detriment to members of internalising investment strategies. And that is a hard equation to solve"
For a start, there is the question of the remuneration structure and changes to culture.
Leaper says the industry has started questioning why incentive programs for those running money differ from those implementing money, causing cultural challenges in the industry more broadly.
This new realisation that operational specialists are the glue that holds everything together has ignited a massive demand for their skills.
"The idea that these people in the background who make sure nothing breaks are valuable was a real penny-drop moment," says Leaper.
Making spidey sense
What's interesting is that the skills for this job are often taught rather than learned in a CFA or master's degree in finance which is not to say that an undergraduate degree isn't helpful in the corporate world.
"The challenge is that you want a generalist for the most part. You want them to have expertise in particular areas, but you do not necessarily need them to have worked on a derivatives portfolio for 15 years,' she notes.
"Understanding how investments works is a good solid grounding for operational specialists. Younger generations can do well in this career because they can come in, learn on the ground and then find their specialty later.
"Sometimes I think specialisation is occurring very, very early."
The main requirement is curiosity, having that 'spidey' sense of how things fit together.
"If you think of it like a jigsaw puzzle, knowing your investment inside out is the basis of putting all the pieces of the puzzle together."
There is a reason for the demand. Operations typically hired from the big custody banks - typically the best possible training ground for ops people coming into the industry. However, given most of their operations have gone offshore, there are fewer opportunities and options onshore.
And understandably, as an operations guru, Leaper thinks outsourcing is often smart for several reasons.
First, the title of APRA's outsourcing standard has been changed to operational risk, and according to Leaper, that makes a big difference.
The pace of regulatory change has not slowed down in the industry, and the more superannuation funds internalise, the more they must keep pace with increasingly onerous regulations and day-to-day practices.
Before, super funds could rely heavily on their asset manager for investment management operations in partnership with the custodian. Now, they must also oversee the outsourced operations of the middle office (or its insourced equivalent),
"You can't just give it to the managers' middle office and tell them to run with it. You also need to ensure that they do the role to the standard expected and that is monitored appropriately."
Many funds that choose not to outsource their operations do so because they want to control the process.
But Leaper argues that goes back to how much money they save by not using an external manager - the cost-benefit analysis of whether or not to outsource is a big part of this decision.
As Leaper sees it, it can be hard for funds to prove an advantage, although assessing the full value chain makes this possible.
Some clients outsource all bar the buy/sell decision, not dissimilar to some asset managers. Other clients do all functions themselves, including custody. "They've built the support structure and the risk and control environment that provides rigour, so it is a fund-by-fund question."
Still, some choose to outsource a much larger portion of assets, which Leaper argues is often a logical approach for their member base.
"If super funds have expert traders and support staff in every asset class, the investment will get expensive.
"Concentration and key man risk would become quite challenging, as would finding talent."
Leaper regularly reviews global operational processes for asset managers and custodians and would love investors and operations specialists to sit back, take a blank sheet of paper and re-design the investment process from scratch.
However, she concedes that a tough one for funds to achieve where the luxury of time is not possible, especially with mergers which means bringing processes and practices together swiftly to achieve synergies.
"I'd love to see the pressure come off a bit so asset owners can take some time to step back and go right back to the start. I think that could lead to a better outcome as the industry continues to increase in complexity."