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Operational due diligence - in or out (sourced)
There’s a debate amongst some allocators about whether to outsource ODD, manage it in-house, or combine the two.
Effective and robust ODD ensures that a portfolio is well-run and that the underlying investments are being managed in accordance with agreed guidelines and best practices.
In, out, in, out, shake it all about
But, there’s a debate amongst some allocators about whether to outsource this function, manage it in-house, or a bit of both. We decided to do some research into the pros and cons of in versus out and to see if there was a correlation between AUM, size of team, location or investment portfolio composition and how a firm performs ODD.
Why do some allocators choose to outsource ODD?
One of the most obvious advantages of outsourcing ODD is that it can save time and resources. Conducting ODD in-house can be a very resource-intensive process, requiring significant time and manpower. With a real variance in due diligence and research team sizes, ranging from a single person to full teams, for allocators that are already stretched thin, outsourcing ODD exercises that take hours per manager, can be a viable way to free up some much-needed time and effort.
Experienced ODD professionals are like gold dust
Outsourcing can provide access to a wider range of skills and expertise too. ODD professionals are hard to find and may not always have the cross-asset class experience that firms would benefit from. Institutional inflows into asset classes like crypto and alternatives, and allocations made to emerging managers require a different approach, with specific knowledge. By outsourcing, allocators can tap into a pool of ODD expert resources that can provide a more comprehensive and effective, practitioner-led review.
Outsourcing is not a silver bullet
There are some perceived disadvantages to outsourcing ODD. I say perceived because a good consultant would allow full transparency into the process beforehand and resulting reports, post review. Some allocators fear a loss of control. When another party is conducting the due diligence, there may be less visibility into and control over the process. This can be a concern for some investors who prefer to keep a closer eye on this function.
Don't focus on cost reductions
Depending on the level of engagement, outsourcing may work out more expensive than conducting due diligence in-house, however, economies of scale may come into play if allocators can access ODD reports outside the scope of their specific engagement.
Is outsourcing for smaller allocators?
Does it make a difference how large a firm is, whether they should outsource or keep ODD in house? Honestly, not really. We have found that small organizations can benefit from outsourcing, to as great a degree as larger businesses. Conversely, firms with assets of over $1bn are just as likely to outsource ODD, as smaller firms. Despite the fact that large businesses have greater capacity to conduct ODD in house many often understand the benefits that outsourcing can bring.
The main reasons that firms choose to outsource ODD
- To save time – whether it’s mobilizing an investment quickly, or saving recruitment time
- To access specialist ODD expertise
- To improve efficiency
Trends come and go
In some sectors, where it has been common practice to use outsourced ODD, firms are switching to in-sourced teams to reduce costs and get greater control. We've noticed this happening across the superannuation sector in Australia and New Zealand as firms seek to rationalize their costs in a low-growth environment. This shift is also being seen across sovereign wealth funds, endowments and family offices.
In-house ODD benefits
- Greater control over the process
- Better consistency
- More transparency
- Better alignment with firm culture
- Increased understanding of the investment process and risks.
There are two sides to every story and the challenges of in-sourcing reflect the reasons for outsourcing originally. ODD is a specialist function and can be hard to staff. There can be a lack of objectivity from an in-house team. And conducting ODD in-house can be resource intensive, particularly with a small team, or as portfolios grow and evolve.
Questions to ask before making any "In v Out" decisions
- What is the size and scope of your manager universe?
- How often do you need to conduct ODD, is it a one off exercise or will there be regular monitoring?
- What is your budget for ODD?
- What are your internal resources like?
- Do you have the expertise required for in-depth reviews?
- Are you comfortable with relinquishing a level of control over the process?
Selecting an ODD consultant
If you do decide to outsource ODD, what type of consultant should you look for?
When selecting an ODD consultant to undertake the reviews, you should consider a number of factors, such as:
- The consultant’s experience and expertise
- The consultant’s resources and staff
- The quality of the consultant’s ODD reports
- The flexibility of the consultant’s approach
- The value for money offered by the consultant.
Again, there's no one-size fits all - some firms have a preference for working with larger ODD consultancies, while others prefer smaller, more nimble firms.
Quentin Thom, co-founder of perfORM Due Diligence Services, provides liberated ODD services to asset allocators, service providers and investment managers. He believes his team of senior allocator pedigree ODD practitioners are ideally placed to meet the exacting needs of clients, and the firmly falls into the "nimble" category.
"We pride ourselves on being practitioners and working within clear industry best-practice frameworks, but being flexible enough to also ensure clients' unique needs are met properly." Whilst we are unwavering in our quest for facts, if a client requires a deeper dive into certain areas, then we will absolutely accommodate that."
How can tech help?
If bringing the ODD function in house, asset allocators can use technology to help. Asset allocators said in a study that they would consider automating their ODD processes if the technology was available. Technology can help firms to:
- Reduce the time taken to conduct ODD
- Improve the accuracy and consistency of reviews
- Increase transparency and accountability
- Enable real-time monitoring of the ODD process.
Firms that are considering automating their ODD processes should consider the following factors:
- The level of expertise required to use the technology - look for intuitive, easy to use systems
- The impact on staff roles and responsibilities - will your team be more effective with a system in place?
- The potential for disruption to the ODD process - how long will it take to onboard onto the new system and can existing workflows be replicated or improved using technology?
If you are considering whether to bring ODD in our out, it doesn’t have to be black or white. You could consider both options. An in-house ODD team could benefit from outsourcing particular reviews, bringing in specialist expertise when needed, or just having some extra resource at times of growth.