Portfolio management is a task most often associated with the front office, although this relationship is not exclusive. Certain elements of portfolio management, in particular accounting and administration, have long been the domain of the back office. Today, more so than ever before, the custodian’s role is gradually encroaching on the traditional turf of fund managers and other front office players, begging the question; where will it all end? Like Jack, slowly ascending the beanstalk, will the custodians’ come away clutching a golden egg, or will the front office giant eventually tire of this creeping nemesis and batter it back down to earth?
Few doubt that the role of the custodians in portfolio management is going to increase as time goes by, although the day when the custodian becomes the key provider of this service seems to be a long way off.
Portfolio management has evolved like all financial services, as a greater diversity of instruments and increased cross-border volumes have come into play. Recently, some of the larger custodians have attempted to penetrate the market further, diversifying their product suites through a series of acquisitions and mergers. The boom in alternative investments for example, has seen some big names take a closer look at hedge funds, seeking to buy up specialist firms in the sector. This has unsurprisingly triggered a swing in the traditional relationship between the fund manager’s and the custodians. As the custodians’ remit has evolved from mere sub-custody to global custody, so it has also incorporated services that were at one time considered value-addeds – fund servicing, accounting and performance measurement for example. Naturally, say some commentators, this progression will continue, eventually embracing the strongholds of the middle and, possibly, front office, where portfolio management has traditionally resided.
However, it would be unfair to paint the custodians’ as insatiable monsters, greedily consuming all before them. They themselves would claim that their current position is largely a result of certain sectors turning to them for support and infrastructural assistance. In an effort to integrate their own systems, many organisations have turned to custodians and other third party providers for help. Consequently, the custodians have had to transfer their expertise to activities further up the value chain. Mathew Ives, Head of electronic trading at Brown Brothers Harriman, elaborates: “The custodians were, and still are, very much involved in the back office side of portfolio management, but are also migrating up the value chain and getting involved in investment support services in the front office arena, which clearly embodies portfolio management.”
Market forces too, have played their part in shunting the custodians up the ladder, and Ives agrees that the focus on cost has never been greater. Hence the custodians are being called upon to provide transaction cost analysis and management. “All players recognise the increasing significance that a basis point or two on their entire transaction cost process can have on their overall performance,” says Ives.
Indeed, he is not alone in the belief that the traditional ‘custody’ business is now taken for granted. Customers are seeking a custodian which can provide an across-the-board array of services embodying both front, middle and back office roles.
Mark Austin, strategy, marketing and communications executive at JP Morgan Investor Services, feels that with the growth of outsourcing as a strategic product, the custodians’ will find themselves ever-more in the spotlight: “Looking at the value chain, it is gradually tilting and the sub-custody end is disappearing into utility status. As that happens, you will see services that were previously core to asset managers, being utilitised and parcelled out.”
He continues: “The custodian is now being asked to take up trades on a post decision, pre-execution basis. We are now picking up the trades and sending them through to execution, moving to a higher level on the value chain. With the onset of ECNs and the utilitisation of equity trading, you can now say that a fund manager’s job stops when they have decided to buy. In the near future, the fund manager could conceivably just make decisions on purchase and sale.” Indeed, Austin believes the custodians are now so far into the back, middle and even front office, that there is nowhere else for them to go but into the distribution arena. “The direction the business has taken means that we have less to do with principal custody services and that our activities have now evolved into what is best described as an ‘Integrated securities services business’,” he explains.
Perhaps the most damaging explanation for the custodians’ onslaught on the front-office has been the recent scares over efficiencies in the investment management sector. The halo around this lucrative business has tarnished over recent years as some headline grabbing exposés have revealed a number of high profile slippage’s. Tom Abraham, global head of strategy solutions group, Citibank Global Securities Services, comments: “There is clearly scope for fund managers to improve their efficiencies and, in the past, there has been too much separation between front and back office. At times there have been inconsistencies between the front and back offices of asset managers. That has created a lot of inefficiencies and a lot of needless costs. There is a tremendous opportunity there to gain efficiencies.”
Yet despite the scope for improvement, Abraham’s is not convinced that the custodians will ever become one stop front to back shops. “There will always be some distinction between portfolio management and portfolio administration, simply because the needs vary. A portfolio manager’s needs depend very much on the investment strategy. An index manager for example, will have specific information requirements and these are very different from the needs of the back office. I don’t think that the two sets of functions (front and back) will merge into a single core set. There will always be some separation.”
So, to what extent are the custodians going to become the key providers and controllers of portfolio data? Most would argue that the big banks are unlikely to ever assume complete control of this task. Despite the merging of front and back offices, the roles have too much historical baggage to allow them to ever truly combine. Citibank’s Abraham shares this belief: “Looking at the back office, there is clearly an opportunity for the custodians to expand their role into the middle office to ensure greater consistency between front and back. However, I don’t see the custodians moving into the role of providing portfolio management services directly to the portfolio managers to help them make better investment decisions.”
Some however, are not so sure. BBH’s Ives remains on the fence, but his comments suggest he would not be surprised if, at some point in the distant future, the big custodians grew to encompass all elements of portfolio management: “Will they be masters of the portfolio management universe? I don’t know, but they are well positioned to play a major role.”

Should the custodians move even further up the value chain, recent investments in automation and straight-through processing (STP) can only benefit the portfolio management sphere. Now that T+1 has been laid to rest, those who invested millions in the project will be looking to recoup their expenditure somehow, and the infrastructure refurbishments made by the big name banks are well suited to bolstering efficiency in this area. As JPMorgan’s Austin explains: “There is no one corner of the business that technology can’t help”. He continues: “Looking forward, people are becoming more aware of the hidden costs involved in asset management – the costs of trading, fails, and the inherent value of analysis. That has been brought into the daylight and technology is really helping people analyse trading costs and the effectiveness of broker recommendations.”
It’s perhaps unsurprising that the custodians are keen to extol their own virtues and the benefits they can bring to the front office and portfolio management, however, when one considers their unique position in the value chain, this confidence is better understood. As the entity administering the assets, custodians have a major role to play and a sound view of the overall picture. As BBH’s Ives concludes: “That is why custodians have recently moved towards the front end. The custodian’s position allows them to have a very good view of the whole process.”
London literary figure Samuel Johnson claimed that, “the future is purchased by the present”, and with that in mind, the custodians should be ruling the world by 2004. Hopefully, Johnson was not speaking literally, however, the recent IT and infrastructural expenditure of the big names will undoubtedly commit them to seek ever greater product suites in an ever wider sphere. How much this will be at the expense of the front office, only time will tell, but don’t be surprised if, in five years time, your custodian’s lobby has a sign saying, ‘portfolio management, this way’.