Fund Selection from an Outsourcing Perspective

Fund Selection from an Outsourcing Perspective

Fund selection is a relatively niche research function as compared to Equity/Fixed Income Research as well as investment banking and remains relatively underexplored from the perspective of outsourcing. Let's use outsourcing with a dual connotation, one traditional we are all well aware off and second in a broader sense of a centralized fund selection unit as compared to each wealth business of say a large financial services organization having its own independent fund selection world.

Why Outsource and/or consider a centralized fund selection capability?

Highly Manual

In spite of the one of the most vital functions of any wealth management, multi manager firms as well as for pension funds and family offices, Fund research continues to be highly manual intensive right from short listing of the funds through some sort of quant screens for narrowing down the opportunity set, to receiving the filled in Due Diligence questionnaires from the fund managers, to conducting the calls/meetings with the portfolio managers to ascertain the possible competitive edge as well scenario dependencies of the product.

Unlikely to be Completely Automated

Off late we have seen extensive use of algorithms to select funds as part of Robo Advisory platforms. Fintechs are attempting to modernize various parts of the fund selection value chain with their technology driven solutions. For example, Fintechs like DiligenceVault ( and "Door" ( are trying to digitize and streamline the due diligence needs between the asset managers and fund investors. Then you have others like 'FundInfo' who are trying to quantify qualitative due diligence information for short listing and ranking funds which can used as a narrowed down universe for in-depth research. These solutions are more likely to make life easier for fund selectors by providing them with tech driven tools rather than replacing them because human judgment remains the key to choosing the right products. Two products may look exactly similar say in terms of positioning at a given point of time but may behave totally different based on the manager biases and preferred habitat which can only be ascertained based on qualitative due diligence. That is why most of the fund selection solutions are hybrid i.e. quantitative approach combined with a human and it is often said that Fund selection is more of an Art than Science.

Managing Potential Conflicts of Interest

Adhering to open architecture and maintaining a robust governance framework can address the potential conflicts of interest especially in cases where a financial services company has its own asset management company. It is not in distant past that JP Morgan was fined $307 million by SEC and US commodity futures trading commission for preferring its own expensive mutual fund products when investing client assets. While investing in your own products is not something bad per se if you adhere to either of the below:

  1. Wealth managers maintain a closed architecture so that clients know that only what they are going to get are the own products of the firm.
  2. Or you maintain a complete open architecture and also take your products to same degree of scrutiny and governance as third party funds before they make it to investor buy lists.

Wealth Management functions which don't have proprietary products have a slight edge in addressing the potential conflicts of interest provided they are selecting funds in best interest of investors complying with best fiduciary standards and not based on what is most profitable for them. I have often heard that firms arguing that they have a better control over the products managed in-house as compared to third party funds and that is why they are more comfortable advising own proprietary products. While the notion may be well intended but as an end investor who is paying an advisory fee what matters is which product is best suited for his/her needs irrespective if it is manufactured by the firm in-house or not. I will treat passives and ETFs separately here and will not expect a wealth management firm to advise a third-party ETF if the total cost of ownership (considering management fees, bid-ask spread, tracking error etc) of in-house product is not materially different from external provider.

In summary a truly independent and empowered centralized fund selection unit can be helpful in addressing the above conflict of interest as well as any questions coming from the regulators.

Consistent House View

Centralized fund selection also helps to a great extent in better governance and control apart from a consistent client experience. Uniform approach across different parts of the business is important and allowing certain businesses to do their own way can be a risky preposition as one part of the business may be selling a fund while another part recommending a buy on the same.

Breadth of Fund Choices and Regulations

With increasing margin pressures and quest for the next winning idea, the available pool of funds (active as well as ETFs) has increased exponentially and with it has also increased the complexity of selection. MiFID II regulations requirements related to Target Market require much closer scrutiny of the products offered by manufacturers as well as distributors.

  1. While manufacturers are required to identify and disclose the target market for their products and satisfy themselves that products is actually being sold to customers within their TM.
  2. Distributors need to ensure the funds offered are compatible with the type of customers they are offered to.

To comply with above, it is given that you require high quality qualified manpower in addition to technology driven solutions.

Availability of Competitive High-Quality Talent Pool

Having worked in Equity research, fixed income research as well as corporate advisory, in my personal experience fund research is first order derivative of security level research and can be highly intellectually stimulating where one gets an opportunity to speak to industry veterans which helps in developing a broader and holistic perspective. As mentioned in my opening remark professional fund selection does not have that well developed ecosystem like other research functions in India, nevertheless my experience in past have shown that the analytical mindset required is transversal and available in marketplace. Some of the research analysts from other capital markets businesses have performed very well with fund research too.

Being close to the Fund Managers: There is no doubt that being closer to the fund managers in an additional advantage for fund selection teams as you are closer to a well-established ecosystem and potentially have more touch points to validate your investment thesis. But that is not a challenge that can't be surmounted in an era of technology, for example speaking to the fund managers over a VC and a little liberal travel budget can fill the gap. Even after budgeting for this, one is likely to save 50-70% in costs.

Future Prospects

It's not a question of "IF" but "WHEN", sooner than later its logical for global wealth management firms to explore this opportunity given some of the benefits listed above. There are many fund selection related activities like performance commentary write-ups, production of due diligence questionnaires, liaising with the internal fund managers to answer investor queries etc which are already extensively outsourced to either in-house captives or third party professional service providers. It is only a matter of time that 'Fund Selection' establishes itself as one of the mainstream research function among the high-end outsourcing activities.

Note the views expressed on this article are mine and do not necessarily reflect the views, strategies or opinions of anyone else, including my employer.