Researching Big Gains

By Sreejiraj Eluvangal , Dare

With independent outsourcing companies achieving depth and scale, more and more foreign firms are expected to go the outsourcing way.

2007 may be the year when offshoring investment research into India comes of age. Though it did not start quite in the same way as the mainstream BPO or IT outsourcing nor been around for so long, this Rs.600 crore industry is tipping in favour of the Indian companies in the sector. Recent trends in this indicate that the industry, which started off due to regulatory changes in the US in 2003, is increasingly junking its bias in favour of ‘captive centers’ and looking at outsourcing more and more from independent vendors.

Offshoring of independent research involves a chartered account or an MBA-Finance graduate sitting in India and helping another analyst, usually in New York or London, to decide whether or not to buy investment products, such as shares, bonds and bills. While the final decision is still taken by the analyst sitting abroad, Indian professionals, after undergoing training to familiarize themselves with market dynamics, share his work load by studying company fundamentals and even market and economic trends. When the Indian analysts is directly employed by the foreign firm, it is called offshoring or the establishment of a ‘captive centre’ and when the analyst is employed by a different company, usually Indian, it is called outsourcing.

Till now the offshoring model has been favored by most investment banks and brokers (or sell-side firms, so called because they are the agents for companies to sell their equity shares or bonds to the public). However, buy-side firms (Fund) such as hedge funds, mutual funds and pension funds have largely stuck to third-party outsourcing so far. The initial wave of offshoring was started off by Wall Street firms as a result of a landmark $ 1.3 billion agreement with the US securities watch-dog Securities and Exchange Commission (SEC) in April 2003. The agreement was the culmination of a two year inquiry into allegations that all the major Wall Street firms including Citigroup, Goldman Sachs, Morgan Stanley and JP Morgan, were using their research departments to give favorable ratings to equity and bonds issued by them.

A large part of the revenues of these firms came from helping companies sell their equity and other instruments to raise money from the public. It was alleged that a favorable coverage by the firm’s investment research wing was being traded as a part of the overall sales pitch to companies looking to issue new shares. While the 10 firms neither accepted nor denied the charges, they were forced to cut costs on investment researches it was seen as less crucial to their activity of corporate finance. This in turn led a lot of them to explore the option of sending part of their research work to India, which had already become famous as a value-for-money outsourcing destination.

Initially the firm’s trusted only captive centers or offices fully owned and operated by them. Even now, the centers run by the likes of Goldman Sachs and Morgan Stanley are as big as, if not bigger than, any run by the big four outsourcing vendors in the investment research space. A large number of the estimated 2500 or so analysts working with the independent providers work for smaller clients- usually buy-side entities like hedge funds, mutual funds etc.

“We expect the (international financial services) companies to increasingly shift to the outsourcing model and away from the captive research centre model,” says Aditya Bhandari senior financial service industry analyst with the consultant Frost & Sullivan. Bhandari estimates that captive centers run by big Wall Street firms like Goldman Sachs, Lehman Brothers, JP Morgan and UBS employ a total of around 3,500 analysts in India, against around 2,500-3,000 analysts working for around 10 independent KPO players. In terms of revenues, the share of the captive industry will be even higher as the per-employee costs are estimated to be around 20% more compared to third-party outsourcing.

Like most people familiar with the industry, Bhandari too believes that the initial preference for captive centers on the part of the firms is on the vane due to various reasons. “Even from a management bandwidth perspective, choosing outsourcing instead of offshoring can cut down work load on senior management of these firms by 20%-30%,” he says.

Another important reason for the change from offshoring to outsourcing is the increasing expertise and depth of talent of the independent providers of such outsourced services- Gurgaon- based Copal Partners and Evalueserve, the Bangalore-based Amba Research and the Chennai-based Irevna have seen their employee numbers go up by around 50-60% this year. All four will have more than 500 investment analysts by the end of this year.

The service providers attribute this to a shift in work allocation by sell-side firms, besides the usual growth in demand. “The trend is that even the companies who have a fully-owned captive centre in India are outsourcing a part of their work to independent providers,” says Ashutosh Gupta, head of transitions for Evaluserve, one of the biggest providers of third party KPO services in the country. The Gurgaon-based company seen as a leader in the KPO business did not initially offer investment research services when it started out in 2000. Though Evalueserve too started offering investment research services only in 2003, the division accounts for nearly a fourth of its 2,100 employees. Similarly, located a stone’s throw away, Copal Partners, started by former McKinsey employee Joel Perlman and GE capital veteran Rishi Khosla, too has seen its number explode from just 10 employees in 2003 to over 500 now.

Analyst Sudin Apte of Forrester Research sees a pattern behind the increasing traction behind the outsourcing vendors. Apte, lead author of a paper titled “Shattering The Offshore Captive Center Myth” which came out six months ago, is firmly of the opinion that captive centers do not allow the company to take full advantage of the globally distributed sourcing model. Due to this, he expects BPO and KPO industries to gain at the expense of captive centers in future.

“Our research shows that many captives are in trouble. While few will admit it, Forrester believes that more than 60% of captive centers fail to meet expectations. There are several common reasons for failure: a poor delivery track record, operational problems, a lack of scale, poor morale, rampant attrition, and high costs,” Apte points out in his report.

Apte points out that companies who have offshored or outsourced to India across a variety of sectors spend an average of around $4,950 per head while an outsourcing vendor spends around $4,230-a difference he attributes to a variety of factors such as higher expenditure on both salaries and office premises and unexpected expenses such as legal fees, head hunting and marketing expenses etc.

He also points to the monotonous nature of work in captive centres which tends to be less varied compared to what outsourcing provides who cater to a number of clients, as a crucial reason for high employee attrition rates. Attrition has been the Achilles heel for the Indian outsourcing industry dependent almost entirely on its trained human capital. As a result of these realizations he says, companies will increasingly prefer an outsourced model to an offshored model, realizing that the “captive centre is a stage in letting go and companies “ offshore and outsourcing evolution.” The reported moves by Citibank to divest control of its 9000- strong Indian BPO venture, e-serve, due to spiraling costs, seem to underline Apte’s point. Divestments or no-divestments, the outsourcing industry is upbeat, going solely by the growth so far. Dr. Paul Alapat, head of the quantitative services division of Amba Research, a Bangalore based investment research firm and a former chief economist for Asia with the Japanese financial services group Nomura, believes that the industry still has a long way to go. “We have only just started of,” he says. The market is very big. The top 15 sell-side (Investment banks) and buy-side (funds) firms alone employ around 25,000 analysts worldwide,” he points out. In keeping with its focus on providing round the clock specialized research in all investment areas, the company has analysts in Sri Lanka, India, Costa Rica and Singapore, Unlike the others, Amba has tried to go beyond company research and has analysts devoted to high end areas like technical and macro analysis.

The market for outsourced research also has a clutch of small players like the Mumbai-based Netscribes, which cater primarily to small buy-side firms such as hedge funds. Depending on clients wary of going to big outsourced providers who may also be servicing their competitors, some of the smaller firms have fewer than ten analysts.

Sourav Mukherjee, CEO of Netscribes believes that smaller firms will always be there in a market where words like ‘niche’ and ‘intelligence’ carry much prestige. Mukherjee, whose investment research team is 60 member strong says smaller firms can carve out a niche for themselves by being flexible about the work they do. “Even with all the hype, we have never positioned ourselves as a KPO because we believe we are not just process experts.. we are not vendors, but partners and will add value outside any outsourcing arrangement that will add to the client’s growth, strategy in an industry where confidentiality plays a key role.

However like the rest of the export dependent sectors risk factors also abound. Like the IT sectors, the biggest threat is the possibility of a sharp market downturn in the US continued depreciation of the value of the dollar and the high attrition rates in the Indian market are also vexing issues. The extent to which each of these factors can affect the companies will be different as the client distribution varies radically from firm to firm. For example, Copal Partners has a large number of buy-side clients from the listed equity market like hedge funds while Evalueserve gets a lot of its business from private equity firms. “The obvious strategy is to have a well-balanced geographical distribution of clients,” says Ashutosh Gupta of Evalueserve, who is setting up a new work centre in Eastern Europe. “We have balanced it out over the years where only about 40% of our revenues are from the US. About 40% is from Europe and most of the remaining is from the middle-east,” he points out.

Another characteristic that may stand in good stead for the industry is the relatively high share of relationship based work. Industry players say that around 75-80% of their revenue and headcount are generated from ongoing relationships and only the remaining is from ad-hoc projects, sometimes involving merger and acquisition activities.

A complicating factor, when estimating the impact of such risk factors is the mixed effects that a slowdown in the source markets can have. While conventional wisdom dictates that falling share prices and lower levels of activity in the markets abroad will lead to job cuts in the investment research industry, there are also those who argue that it will force companies to outsource a larger share of their work than before. As Dr. Alapat points out, for an industry born out of the need to cut costs without compromising on quality, hard times may not always have the obvious impact.

In the end it is Joel Perlman of Copal Partners-a US citizen who first got a taste of Indian work-ethics when interacting with McKinsey staff in Gurgaon a decade ago-who seemed most confident about the ‘India Story’. Being in India today is like being in the US in the 1940’s. “Perlman who spends ten days every month in Gurgaon, says “Here people get a kick out of working long hours. Unlike in many places I have worked in. I don’t have to worry about making people work hard; hard work and ambition are ingrained,” he says adding with a smile that he wished the ambition would lead employees to switch their jobs so often.