Historically, hedge fund managers in Asia have had few choices when it comes to hedge fund administration and outsourcing. This has resulted in complaints from many hedge funds when it comes to fees and, in particular, capacity to launch new funds. However, while capacity issues have hampered the growth of the Asian hedge fund market, the limited capabilities and offerings of local administrators have impacted the market even more by preventing, or at least slowing, the introduction of new strategies. These limitations have limited the ability of local, Asian based, fund managers to offer their products to foreign investors as well.
The capabilities of nearly all fund administrators in the region tend to mirror the characteristics of the current Asian hedge fund market: they are focused heavily – if not exclusively – on domestic long/short equity and the local investor market. It’s another way of saying that they are not geared to handle complexity with respect to asset classes traded, markets traded or investor base. If you are a manager that trades local exchange-traded equities and has a local investor base then you will have some, albeit few, choices.
The real challenges come if you manage more complex or broader strategies that include investments in other asset classes such as OTC derivatives, fixed income securities or if you trade in certain markets, with any significant volumes. Similar challenges exist if you have a foreign investor base with local needs – for example US investors that require US GAAP accounting. The inability of most administrators to handle complexity has slowed the evolution of the hedge fund market in Asia; you can’t evolve from just offering basic long/short equity offerings to a local investor market if your administrator can’t support more complex strategies and a more diverse investor base.
Equally as challenging is the support of operational activities related to certain functions, asset classes or markets that fund administrators and/or prime brokers do not typically support. This is something that many new managers – in particular those who had previously and exclusively worked for large organisations – don’t fully appreciate until they prepare to launch. The comment often heard is: “I thought I outsourced everything. If I have a prime broker and fund administrator then why do I need to hire operations staff as well?”
In addition to fund administration, there are middle office activities (eg daily P&L/NAV, reconciliations, daily valuations) and other operations activities (eg prime broker communications, trade confirmation, settlement and support of non-prime broker transactions) that need to be supported as well. These activities typically fall outside the scope of traditional administration. The challenges associated with these activities depend upon the complexity of the fund (eg asset classes and markets traded, number of prime brokers/custodians, trade volumes) and fund specific requirements (eg frequency of NAV calculations, unique reporting requirements).
Hiring operations staff is not always an easy undertaking – especially those with the skills and knowledge to support more complex or broader strategies. This situation is exacerbated in Asia, given the ever-increasing demand for these skills from not only hedge funds, but from prime brokers and administrators as well. In addition to people, there are investments in related middle office and operations systems that need to be made.
While these middle and back office activities can be outsourced to an administrator locally in developed markets – such as the US and UK – that has not been the case in Asia. This is particularly true when it comes to complex and diverse funds. While the entrance of new administrators to the Asian market has alleviated some of the region’s general capacity issues, it has done little to address the need in the market for an offering that addresses other important needs: “one-stop shopping” for administration, middle office and operations services; support for the complex and diverse requirements of sophisticated hedge fund managers; and local client service.