BOSTON -- State Street Corp. just grabbed an early advantage in a fledgling niche of the investment management business.
State Street will assume full responsibility for all of the investment processing operations of one of its massive money manager clients -- Pacific Investment Management Co., with $190 billion under management -- as part of a new service known as Investment Manager Solutions.
PIMCO is just the first of what State Street hopes will be a client list of 10 to 15 large money managers, said Ronald A. Logue, State Street's chief operating officer.
Consultants said back-office outsourcing -- ranging from more typical mutual fund administration and accounting to the transfer of a money manager's entire back office, including separate account and commingled fund processing -- is a hot topic among money managers seeking to shed non-core functions.
As part of the deal, which will happen later this summer, State Street will take over the settlement and administrative processes of all of PIMCO's mutual fund, commingled fund and separate accounts; the physical assets of the investment operations unit; and the office space in PIMCO's Newport Beach, Calif., headquarters.
State Street also will hire as many of the 300 PIMCO processing operations employees as are willing to stay on. Those former PIMCO employees eventually will service other State Street clients on the West Coast. State Street has been the custodian, accounting agent and valuation agent for the PIMCO family of mutual funds for 10 years.
PIMCO will pay State Street a fee for the outsourced services, after State Street cuts a check for the depreciated value of PIMCO's physical assets. Officials at State Street and PIMCO would not discuss pricing.
After PIMCO's operations have been fully integrated, State Street hopes to find a few more money managers that will adopt its Investment Manager Solutions service. But not too many, said Mr. Logue.
"If we do PIMCO well, we'll have first-mover advantage," said Mr. Logue.
"The other custodians are all looking at this business, but this takes a lot of resources. Maybe they'll be able to pull off one or two, but not 10 or 15 like we will."
Focusing on PIMCO
Targeting the 143 money managers with between $40 billion and $450 billion, excluding the 10 largest managers, Mr. Logue said State Street "has no plan to do a lot of these. Our major goal is to do the PIMCO deal very, very well."
When asked whether such outsourcing makes sense, Peter Starr, managing director at consultant Cerulli Associates Inc., Boston, said: "You need to do the cost-benefit analysis, but for a firm the size of PIMCO, you can see that the slight downside risk (of execution problems) will be outweighed. They change a variable cost of investment operations -- people, technology, processes -- to a fixed cost for a much diminished risk. It's both economical and feasible."
State Street's new service has been a long time in the planning. One observer said it's been on the drawing board since 1994.
State Street is bringing the new service to market with a gigantic competitive advantage: The bank already has $6.2 trillion in custody assets, with about 50% directly handled for money management firms; it long has been engaged in cross-selling various investment management and administrative services to its huge base of custody clients; and it is one of the world's largest mutual fund services providers.
"When you think about their linkage into the custody and clearance of so many money managers, this is so logical a move for State Street, it makes you wonder why they didn't do it sooner," said Mr. Starr.
The best mousetrap
"Efficiency is going to become such a big issue with money managers going forward. Managers have to maximize the true value-added they provide to clients, and except for perhaps the 10 largest money managers, no one else is going to be able to build a better mousetrap than State Street for administrative services like this,"said Christopher J. Acito, managing director at BARRA Strategic Consulting Group Inc., Darien, Conn. (See related story on page 3.)
"I'm just surprised that more big players aren't coming in with PIMCO on this deal, insisting that they're part of the rollout."
From PIMCO's standpoint, being the only player right now is probably comforting. "We have commitment from the top management of State Street. PIMCO is one of the their top priorities as a firm," said Wes Burns, managing director and head of PIMCO's investment operations. He is one of the few investment operations employees who will remain a PIMCO employee, as liaison with State Street.
About a year ago, PIMCO reviewed all of the company's processes and determined that if its current rate of growth continued, it would hit $500 billion under management sooner rather than later, said Mr. Burns. Staff now numbers about 600, with about half of those in investment operations. To cope with growth, globalization, a move to global straight-through processing and T+1 settlement, PIMCO would have had to add operations staff.
"Hiring even more people to cope with our additional technology needs would dilute our focus from being the best investment management company," he said.
"Now we have the best of all worlds."
As Mr. Logue indicated, State Street doesn't have any serious competitors among the other large custodian banks. Most of the competition on the fund administration side is also not making so-called "liftouts" of entire investment operations of money managers, said Charles Mohr, president of BISYS Investment Service Group, New York.
BISYS has made 30 such liftout acquisitions in the past five years, mainly of money management companies much smaller than PIMCO. One of BISYS' largest liftouts was that of the investment processing area of Nationwide Life Insurance Co., Columbus, Ohio, in August 1999, in which 125 people were transferred from the investment processing operations unit of the then $14 billion manager.
Manager interest in more typical fund administration outsourcing in general and liftouts in particular has picked up in the past six to 12 months, said Mr. Mohr. Only last week, BISYS signed an agreement for a liftout of the 25 number of people, systems and all back-office services for the $4 billion in mutual fund assets managed or administered by Paris-based Credit Lyonnais Asset Management.
BISYS has three more similar liftouts in the pipeline, Mr. Mohr said. But even with 30 liftouts under his belt, Mr. Mohr had to swallow hard at the thought of State Street entering the field.
"PIMCO is a massive operation, and State Street got it because of the custody relationship it has with them. Having these custody relationships is a very big advantage for State Street. It's something we can't compete with them on," he said.