There are now approximately 200 administrators providing services to hedge funds. The number is a reflection of the range of service offerings available to today's hedge funds and can be broken down into several categories:
- Bank-affiliated administrators – that are the fund administration arms of banks which provide prime and custodian services to hedge funds.
- Independent administrators – that offer a suite of services around middle- and back-office support and traditional fund administration services.
- Specialised administrators – that provide limited services beyond traditional fund administration services and who cater to a niche clientele base.
- NAV Lite Shops - that provide accounting services by relying on prime broker reports to create the books and records, performing write-up services for financial statements, NAV calculations and investor allocations.
Blurred Administrator Roles
For years, hedge funds were well-served by these various categories of administrators who were able to co-exist due to the seemingly endless supply of new fund launches and increases in assets. They seldom competed for business among administrators in different categories. Today, the relatively low number of new funds, the liquidation of funds and asset flight to the top hedge funds has resulted in overlapping competition among the administrators at all levels. It is inevitable that we will see a reduction in the number of administrators in the coming years.
With 200 administrators vying for a smaller pool of business, it is only natural to begin by asking whether there will be consolidation in the industry. The largest administrators already account for 80% of the asset under administration. Among this group are the administrators affiliated with banks. For bank-affiliated administrators, the business is a valuable service in attracting and maintaining clients. There is little evidence that banks will change their existing business models to servicing their clients. However, these banks may make acquisitions where there is a specific service offering that they need to have which is not offered by their own administrator. Consolidation may also occur because, like fund managers, the cost to implement and build the necessary infrastructure to manage the business has increased dramatically over prior years (as a result of demands of regulators and investors). Administrators that lack a source of working capital will be limited to the additional services they can offer hedge funds. They will find it difficult to compete with the larger administrators on service and the lower administrators on price. Finally, we are likely to see consolidation due to the critical mass of business required to operate a profitable administration business. These consolidations will likely take place within each category where administrators are compatible in clientele base and service offerings.
The real reduction in the number of administrators may come through attrition which will be the by-product of the failure of administrators to become more client-centric and innovative in their service offerings. For years, administrators enjoyed a never-ending inflow of new funds and assets where providing monthly NAVs and processing subscriptions and redemptions were the only requirements to enter the party. Once in the door, hedge funds were captive so there was little need for administrators to invest in improving their infrastructures. Even during the financial meltdown when the party looked to be over, Bernie Madoff arrived, dressed as Santa Claus, bringing an inflow of new business from hedge funds that were previously self-administered.
Progress is Key
It is no wonder hedge fund CFOs and COOs who struggle with accurate, reliable and timely information from their administrator, sound like characters from Shakespeare's Henry VI: "The first thing we do is kill all the lawyers" (read: administrators). The phrase was not intended to mean lawyers, like administrators, should be removed alltogether, but rather, those who stand in the way of progress need to be removed.
So what is standing in the way of progress for administrators to improve their standing with hedge funds? At the core of the problem is the fact that administrators are plagued by fragmented operations and infrastructure. It is not uncommon to find administrators who are quietly engaged in the process of re-engineering their operations. They recognise that to have a sustainable long-term business, it requires that they integrate their various platforms used in servicing clients, many of which are the result of prior mergers or acquisitions, bolting on applications to existing platforms and never-migrating clients off old antiquated technology. In the best of economic times, this would be a challenge, but when you add in thinning profit margins, one is left asking whether the business has the financial resources, commitment and vision to execute the changes and position their business for sustained long-term growth.
Efficient Back-Office Systems
The administrators who are flourishing have already evolved to keep pace with the changes within the industry. Best practice now dictates funds need to have an integrated back-office operation, devoid of workaround solutions to fill the gaps in processes and technology that previously were piecemeal by reliance of prime broker and administrator reports and data.
Without a fully integrated back office, hedge funds lack the ability to address the formal governance processes needed to manage investors' money in today's environment. Hedge funds need to demonstrate that their back offices are scalable, have the breadth and depth to handle new trading strategies and investment types and can provide the granular level of details that investors and regulatory agencies are demanding. The result is hedge funds are engaging administrators who are focused on daily reconciliation and reporting with the technology and processes which meet the 'proof of concept' by creating value add (such as mitigating operational risk, better collateral management and more accurate, reliable and timely reporting) in the back-office operations of their clients. These administrators have already made the transition from being a traditional fund administrator to becoming an integral part of their clients' back-office operations.
No one knows for certain what the future holds for administrators and who the winners and losers will be, but what we can say is small administrators who cater to funds under $50 million in assets will continue to be viable because the services they perform are an integral part of the overall hedge fund industry and the larger administrators cannot compete on price over the long term. Administrators with specific skill sets (such as fund of funds and private equity funds) will continue to provide high-quality niche services to clients.
Administrators affiliated with banks will continue to be successful because their service is integrated into the overall service offerings of the banks. The real change will come among the remaining administrators. For administrators who held onto the belief that the party would never end, they need to recognise and address the challenges in their business model before they can offer a truly robust solution required of today's hedge funds. The true winners are the ones who have already recognised the needs of hedge funds have changed and who can today offer a client-centric and innovative approach to providing solutions for clients, bring best thinking to best practices.
Francis Rainsford is executive vice-president of Viteos Fund Services. He brings to Viteos over 20 years' experience servicing the alternative investment industry. He oversees the global client-relationship management function, advising clients in areas of fund structuring, valuation of investments, back-office operations, tax compliance and regulatory compliance.
This article first appeared in HFMWeek (US East Coast 2010, Pages 18-19). For more information, please visit www.hfmweek.com