This article was originally published in the #32 addition of the LPEA’s Insight/Out Magazine, which you can view here.

By Gregorio Pupino and Thomas Erichsen

Introduction

In the increasingly complex landscape of fund administration, fund managers are under growing pressure to provide precise, timely reports while keeping costs in check and complying with extensive regulatory demands.

One solution to these pressures that is gaining traction across the sector is co-sourcing – a hybrid solution that blends in-house capabilities with external expertise. Co-sourcing allows fund managers to maintain control over key activities while leveraging external expertise and resources.

What is co-sourcing

Co-sourcing is becoming a buzzword in the fund industry now, but it was born in the 90s. The first examples of co-sourcing can be traced back to 1994 when this practice of collaborative outsourcing was implemented in the chemical sector to help maintain competitiveness (Tattum, Lyn. Cosourcing: A Relationship Based on Trust. vol. 158. Englewood: IHS Markit Ltd, 1996).

At that time, C-executives were struggling with a rapidly changing world and business models that did not evolve at the same pace as the IT solutions available on the market to support them. In this specific case, the knowledge gap between those who knew the chemical business (BASF) and the IT experts proposing their innovative solutions (EDS) prevented business owners from using the available information technology to innovate and disrupt as they would have liked.

EDS became a pioneer of co-sourcing by enabling BASF and other chemical and pharmaceutical companies to align IT resources with business objectives, reducing the time to market for new products and enhancing the customer experience.

The 90s marked a tipping point in the classical make-or-buy decision as this new trend began to take hold: rather than fully contracting out a problem, it is better to bring in-house the expertise needed to solve it. This approach helps the entire organization progress better by increasing value and retaining control over key processes.

The main difference between external consultants and co-sourcing services is that the latter foresee the expert pool/co-sourcing provider mingling with and virtually extending the receiver team. This boosts the team’s capabilities with additional knowledge and expertise that would take time and resources to develop in-house. It is the combination of the two human resource pools (provider and receiver) with technology that differentiates co-sourcing from classical consultancy services.

Why is co-sourcing rising now in the Private Market Funds Industry?

“Co-sourcing has helped many companies that don’t have the staff capability to deploy new systems”

(Thomas, C. William, and John T Parish. Co-Sourcing: What’s in It for Me? vol. 187. New York: American Institute of CPA’s, 1999.)

The rise of co-sourcing in the alternative fund industry is linked to its evolution into a more mature stage of its lifecycle, where various phenomena are impacting this business model:

• Increased competition from new market players is decreasing margins and adding pressure on costs.
• The ad-hoc nature of each investment strategy has made it difficult to completely standardize tech solutions for certain fund operations, such as accounting and investor reporting.
• Non-standardization of operations has kept many manual processes alive, currently relying on email exchanges, Word documents, and Excel files.
• The business pace and increased complexity no longer leave room for improvisation. The innovation required to compete is a core competence that cannot be outsourced; therefore, every other process needs to be improved with the help of experts.

If we define outsourcing as the decision to decrease control and involvement in a process to a minimum (linked to a low value-added categorization), and in-housing a process as the willingness to identify it as a core competency/high value-added, the natural consequence is that co-sourcing lies in the middle. It involves collaborating in value-added processes where retaining control is key in the value creation chain, but where the specific competency lies in another company.

Based on this assumption, we have mapped the activities in our impact assessment on the value chain of an asset manager and the competencies brought by their out-sourcing and co-sourcing partners.

Key benefits of co-sourcing 

“Co-sourcing combines an in-house department with resources of a dedicated outside pool of experts”

(French, D. (2003) The co-sourcing solution, Best’s Review 104 (6), 85.)

A co-sourcing solution is particularly valuable in the complex world of fund administration, where regulatory compliance, reporting standards and operational demands are constantly evolving. Some of the key benefits include:

• Operational efficiency – co-sourcing allows fund managers to tap into the operational expertise of specialised providers while retaining oversight of core activities. This helps streamline back-office functions like accounting, NAV calculations, compliance and investor reporting.
• Cost-effectiveness – by co-sourcing, firms can reduce the overhead of building full in-house teams, while still benefiting from a shared service model.
• Regulatory expertise – with regulations becoming more stringent (such as ESG/SFDR, FATCA, CRS, and AIFMD), co-sourcing partners offer specialised knowledge and expertise to ensure compliance. Firms can benefit from a co-sourcing partner’s familiarity with complex reporting and filing requirements across different jurisdictions.
• Scalability – co-sourcing offers flexibility, enabling fund managers to scale their operations as needed. This is particularly useful in periods of growth or market expansion, where having an adaptable partner can reduce the friction of adjusting internal processes.
• Focus on core competencies – fund managers can focus on investment strategies and portfolio management, leaving administrative tasks to the co-sourcing partner. This can lead to improved performance by allowing managers to concentrate on what they do best.

Co-sourcing vs outsourcing

While outsourcing involves handing over entire processes to a third party, co-sourcing involves a shared responsibility where both the fund manager and the service provider work in tandem. Co-sourcing offers more control and collaboration compared to traditional outsourcing models, providing greater transparency and adaptability.

Examples of co-sourced services include:

• Fund accounting and reporting
• Regulatory compliance and risk management
• Investor relations and reporting
• Transfer agency services
• Tax compliance and structuring

The co-sourcing model is increasingly being adopted by managers within Private Markets where the complexity of operations and regulations demands both in-house control and external expertise.

How to implement a co-sourcing strategy

To successfully implement a co-sourcing model in fund administration, firms should firstly identify core vs non-core functions. Determine which functions can be effectively managed in-house and which should be co-sourced.  A consultative approach is vital as everyone’s needs will be different, a blend of tasks in each function is also possible.

It is then important to select the right co-sourcing partner. Focus on providers with a proven track record, relevant expertise and a strong understanding of your company’s specific needs. After choosing a partner, effective communication is essential. Establish regular reporting methods to ensure alignment between internal teams and external partners.

Ongoing monitoring of performance and compliance is also essential. Continuous monitoring helps identify areas for improvement and reinforces accountability. Co-sourcing strategies should be flexible and easily adaptable to change as the business needs change or new opportunities for efficiency and innovation arise.