Outsourcing and Pension Funds
The past couple of decades has seen a rapid increase in the rate at which outsourcing is being used by businesses. Almost all types of organizations have been using outsourcing to increase the profitability of their business. Organizations providing financial services have been at the forefront of this activity. However, pension funds have not been early adopters when it comes to outsourcing. Pension funds have been cautious when it comes to outsourcing.
In this article, we will have a look at the various reasons which make outsourcing a viable proposition for pension funds and also the concerns that need to be addressed before outsourcing can be done.
Advantages of Outsourcing
Outsourcing has several advantages which are why it has become a preferred model of operation for global companies. Some of the advantages have been listed below:
- Cost Advantage: Outsourcing has been primarily adopted by companies because of the cost advantage that it offers. The cost advantage has been the result of offshoring the work to countries where the labor cost is very low. Pension funds are under tremendous pressure to earn higher returns. This is because the interest rates are at historic lows and hence the debt markets are not offering much respite.
At the same time, the valuations in equity markets are already sky-high and hence there is very little chance to make a long-term investment. Since pension funds are not able to earn high returns, they want to cut down on costs aggressively so that they can present a better return to their stakeholders. It is for this reason that outsourcing is now being used as a strategic tool by pension funds.
- Focus on Core Activities: As mentioned above, investing in financial markets has become quite complex. Straightforward investments in debt and equity are no longer providing the requisite returns. As a result, pension funds are under pressure to become creative.
Pension funds are investing in alternate assets as well as directly in private limited companies. However, such investments need to be carefully monitored because of the high risk that results from investing in them. Pension funds have realized that they can perform better if they continue to do their core tasks instead of spending a large amount of time doing administrative tasks.
- Talent Shortage: The middle and back offices of the pension fund have a requirement to perform a lot of complicated tasks. The reporting requirements of pension funds are far more complex and granular as compared to other industries. Hence, pension funds require skilled personnel such as accountants and technology professionals to perform such tasks. However, there is often a shortage of such personnel in the market.
Hence, recruiting, training, and retaining such employees is a full-time challenge that pension funds do not have the time to deal with. Outsourcing of middle and back-office activities allows pension funds to receive the services of personnel on demand. Since there is also a cost advantage involved, pension funds find this model to be incredibly convenient.
- Lower Capital Investment: Traditionally, the costs related to middle office and back-office activities have been more or less fixed for pension funds. This is because most of these costs are related to technology and personnel expenses and hence do not vary.
Pension funds do not lay off people if their trading volume is lowered. However, when a pension fund moves to an outsourcing model, it can make the costs variable. The pension fund can pay a lower middle and back-office cost when its trading volume is lowered. The personnel and costs can be quickly scaled back up when a higher trading volume is expected. The end result is that pension funds do not need to lock in their money as capital investment for long durations of time.
Disadvantages of Outsourcing
Pension funds have been reluctant to get on the outsourcing bandwagon because of several disadvantages which are associated with it. The important ones are listed below:
- Data Protection: Pension funds have access to sensitive personal and financial data relating to individuals. Hence, if a pension fund outsources its activities to a third party, they have to share sensitive data as well. This drastically increases the chances of data theft. Since a breach of data security could have a colossal impact on their business, pension funds avoid outsourcing their activities to third-party companies.
- Regulatory Hurdles: A lot of the time, outsourcing also involves offshoring. This is where regulatory concerns come into play. Government bodies regulating pension funds are wary of data being shared with third parties in other countries. This is because they do not have jurisdiction over the activities which take place in these countries. Hence, if a data breach were to take place, the local pension fund investors would be affected. However, regulatory bodies will not be able to penalize the offshore third-party company.
Pension funds and offshoring companies are finding ways and means to overcome this problem. For example, outsourcing companies are setting up offices onshore so that they can also be in the geographical purview of regulatory bodies.
- Increased Complexity: The middle office and back-office activities of pension funds can be quite complex. Pension funds often find that the service quality provided by the third-party outsourcing companies does not fully match their requirement. Since the service quality is not up to the mark, many pension funds avoid outsourcing their activities despite the cost advantage.
The fact of the matter is that the outsourcing decision is more complex for pension funds than it is for other companies. This is because of the fact that their business has certain unique regulatory issues.
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