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Are Proprietary Buy-Side Investment Management Systems Worth Building?

James Baxter

One of the questions that inevitably rises for buy-side investment management start-ups is whether to build a proprietary system to handle operations. Aite Group estimates that financial institutions will spend more than USD800 million on trade surveillance and compliance technology with vendors by 2020. That figure doesn’t include the full cost of building proprietary systems, which would also include development costs and hardware, nor does it include spend on essential functions such as accounting. But is it worth it to build a system in-house? Let’s examine the pros and cons of building vs. buying a system to handle workflows across a buy-side operation.

Pros: At first glance, there are many. Who doesn’t want a system that was built for their firm, by the firm, with the firm’s unique processes, strategies and aspirations in mind? Here are just some reasons we hear for building a proprietary system:

  • You can control the full process. One of the key arguments we hear for building a proprietary system is the firm wants to have a unique, custom offering it can change to suit its needs at any time. Developers are on staff and accessible.
  • Your proprietary system was built for your team, so they know all of the system’s intricacies. There’s virtually no learning curve, because your trading team was part of the build process.
  • Your system was built with your business goals in mind. Plus, you can add functionality any time you want.

Cons: Despite how great a truly custom system can sound, there are several realities that make the build path a challenge for new funds. Here are some of the main ones:

  • Key man risk. This is one of the biggest risks investment managers take by building a system in-house. If your lead developer leaves, he or she will likely take the team, and all of their ideas. Even if you have extensive knowledge sharing frameworks in place to help overcome departure scenarios, any time you need to integrate with third parties such as new administrators, clearing houses, or regulatory systems, you will need to have team members with deep knowledge of the system available to be able to connect to these third parties successfully. Lastly, you will need to ensure you are always in a financial position to maintain a strong developer bench, no matter how your business is doing.
  • Getting new hires up to speed can be a big challenge. Traders, portfolio managers, and operations folks leave, and replacements will be unfamiliar with your proprietary software. On the other hand, if you are using a third-party solution that’s well established in the marketplace, chances are, you can hire talent that’s already familiar with the system from prior experience. Moreover, some vendors have extensive training programs available as part of their service, so you can bring your full team up to speed fairly quickly, and new users will be trained as part of the process. Finally, new users may be able to compare notes with their peers in the industry if the platform in question is widely known. 
  • Time to market will likely be longer than you think – and cost will be greater than forecast. Costs and timing for launches are almost always higher than initially forecast. In addition to having to hire the right personnel to design, build and maintain the system, you will have to factor in the time you’ll need to run testing, and potentially a model portfolio. Operational due diligence teams tend to scrutinize proprietary in-house systems more than known, established vendor solutions, so factor in the time it will take to build up the data to show that the system works. Additionally, factor in the time it will take to establish third-party connections – to brokers, administrators, and others. With all of these issues, in addition to day-to-day tasks and inevitable one-off issues that crop up, building in-house can become lengthy and expensive. 
  • It’s tough to see into the future. Even if you have a good idea for the next few years of which strategies you will be launching, and which markets you want to push into, it’s tough to forecast requirements. Regulations change, and often require firms to scramble to catch up, so they may be forced to build solutions to address one-off situations. Similar issues can crop up with the addition of individual administrators, new unique marketplaces that require special interfaces, and applications designed to manage unique workflows in the investment process. Before you know it, you’ve created what’s come to be known as the “Frankenstein effect” – your system technically works, but is so full of one-off patches that you’re constantly worried about its overall stability.
  • Keeping up with regulations is a full-time job. Every time there is a new rule, it must be incorporated into the compliance library, which means your developers need to think about how to ensure that rule fits in with existing workflows throughout the organization. How will the new rule impact pre-trade workflows? Will it require new records to be kept, or reports to be filed? Who will take care of that? How can you ensure that you’ll be ready in time? All of these issues can create a potential burden upon your tech and operations teams. By contrast, most third-party systems have extensive rule libraries that are constantly updated to meet the latest requirements.

In short, creating an in-house system may seem like a good idea on paper, but it’s tough and expensive to do it well. The biggest problem is in-house systems outlive themselves quickly unless there is a large and active development force that can keep them updated.

By contrast, outsourcing to a reputable, experienced third-party vendor ensures that all you need to keep up with is the latest version of the software. A good third-party provider will ensure you have connectivity to any number of potential sources you may need, that your standards are consistent with your peers, and that your system is stable and secure. Moreover, a solid system will be designed to grow with you, ensuring that whenever you are ready to grow, your system will support it. Most of all, your system provider should be able to become an extension of your operation, working with you to maximize the use of your resources, and ensuring that you can focus on your core business.

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