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Providing Services to the Alternative Investment Community:
the Evolution of the 'One Stop Shop' Concept
Joost Löbler, Global Director of Sales, Fortis Prime Fund Solutions

March 2004

Introduction

Choosing the right hedge fund administrator is one of the most important decisions that an investment manager can make and failure to do so could be costly to a fund. The administrator plays an invaluable role and will generally provide investment accounting and valuations, shareholder services, corporate secretarial services, domiciliary compliance, and assistance in the preparation of financial statements. A good administrator can remove all administrative headaches allowing the investment manager to focus on its trading activities. It is important to note that time spent on choosing the right administrator may save time in the long run.

In the past there was a distinct separation between the administrators and the large prime brokers: the latter provided typical brokerage services such as execution of trades, stock lending and (leveraged) finance whereas the administrators were the typical 'back office' of the investment managers. This boundary is getting less distinctive. Traditional administrators-such as Fortis in the past-are evolving into full service administrators, custodians and banker/financiers, simply by using their banking divisions. Lately, typical prime brokerage firms are buying administrators in order to be able to offer the same 'one stop shop' concept to their clients.

Changing environment
An administrator essentially performs the duties of a CEO, CFO and Company Secretary and reports to the board of directors of a fund. The administrator will also be the principal point of contact for investors, other service providers and the regulatory authority of the fund. Choosing a professional administrator who has experience in servicing funds of hedge funds and hedge funds will enable the directors and the investment manager to focus on their own tasks, rather than having to get involved in administrative issues.

As hedge funds become more accepted as a recognised asset class, their appeal is extending to a wider range of investors. Traditionally, institutions and sophisticated private investors accounted for the majority of investors in hedge funds. However, increased participation from pension funds, insurance companies, family offices and retail investors, both directly and through funds of hedge funds is more evident now. Institutions and asset allocators who are investing on behalf of their clients apply strict fiduciary responsibilities and investment restrictions whereas retail investors attract higher levels of protection from regulators.

As a result of increased interests of other investors as well as a continuous search for better risk/return rewards, the popularity of funds of hedge funds is growing by the day. Funds of funds account for the largest growth in the entire alternative investment arena. Not surprisingly, this leads to specialist service providers for this particular group. So far, only a small number of banks are able to leverage funds of hedge funds or to provide general financing facilities. However, the number of banks that are developing these techniques is expected to grow.

In recent years there has been a notable growing trend for funds of hedge funds and hedge funds to be domiciled or listed and administered in highly regulated jurisdictions, leading to a burgeoning industry in European offshore locations such as Ireland and Isle of Man or at more "exotic" locations such as the Cayman Islands and BVI.


Traditional Administrative Tasks:

Pre-launch Assistance and Administrative Support
An administrator can provide considerable assistance during the set-up phase of a hedge fund. An experienced administrator will be familiar with, and able to explain, all activities prior to the fund launch as well as the complex structures utilised for hedge funds and funds of hedge funds. Structures can range from plain vanilla stand-alone companies with a single share class to more complex Master/Feeder structures encompassing multi-currency share classes each with different methods of calculating management and performance fees. In addition to understanding complex structures, the administrator operates the fund strictly in accordance with the prospectus and can provide advice from a procedural and operational perspective. The administrator can liaise with the fund's lawyer, review and comment on the prospectus and agree appropriate wording relating to the operation of a fund. Some administrators will employ a new business support team to manage pre-launch operational issues. This can greatly assist in the resolution of any teething problems experienced by a fund.

Calculating the NAV
One of the primary tasks of the administrator is to reconcile the books and records of the fund and ultimately produce the net asset value within the agreed deadline. The timeframe for producing an NAV is becoming increasingly tight and typically ranges from between one to five business days following the NAV date. This is critical as any delays in the release of an NAV can cause concern amongst investors. Hedge funds often require more frequent calculation of estimated net asset valuations that compel the administrator to process trades and cash on a daily basis. In order to meet these deadlines, an administrator must have the ability to interface with the prime broker and fund manager. Without a high quality software interface, an administrator will struggle to meet deadlines and may expose itself to errors through manual intervention. The administrator may also be responsible for instructing payment of all fees and expenses of the fund including management fees, performance fees and other operating expenses.

As the investment manager may enter into complex transactions including short selling of securities and the opening of various short and long positions, it is vital that the administrator can record and report the details accurately. Therefore, it is important that the administrator is in a position to understand the fundamentals behind the hedge fund strategies. In most cases, prices for listed securities are readily available from mainstream pricing sources. However, pricing for some of the more esoteric OTC instruments are more difficult to obtain and can present an onerous and manual task for the administrator. They may require quotes from calculation agents or broker/dealer counter-parties. The administrator must at all times maintain independence in the operation of a fund in respect of the recording, reconciling and pricing of securities.

Communicating with Investors
The administrator is responsible for on-going communication with the funds' investors and for delivering information pertaining to their holdings in a timely and efficient manner. Furthermore, the administrator is required to deal with more complex queries from investors on issues such as performance fee equalisation. The administrator also maintains the fund's share register and investor details, carries out all client identification checks, processes all dealing transactions such as subscriptions, redemptions and transfers to the fund, maintains client subscription accounts of the fund, makes redemption payments, distributes investor statements and investment manager's reports, if required.

Recent trends and changes in regulation has forced the administrator to enhance its systems to track and report on anti-money laundering or 'know your customer' documentation and issues relating to the eligibility of investors to invest in a particular fund. Prospective investors are required to confirm whether they are eligible to invest in the fund, whether they are Qualifying or Professional investors, ERISA plan holders and also whether they are eligible to invest in hot issues. The administrator should ensure that appropriate automated investor systems and procedures are in place to track and monitor the aforementioned issues.

Preparing Financial Statements
As well as providing the core services to the fund, the administrator may prepare the fund's financial statements in accordance with current accounting and regulatory requirements. The administrator liaises closely with the fund's auditors to ensure timely completion and distribution of financial statements to shareholders. In addition, the administrator may also be responsible for the filing of the financial statements with the relevant regulatory bodies and stock exchange, where applicable, on a timely basis. For some clients, the administrator may be required to provide tax reporting for funds in various jurisdictions, under the advice of the fund's tax advisors.

Corporate Secretarial Services
Where requested, the administrator can provide full company secretarial services and will ensure that all companies law and regulatory requirements are met. The specific tasks performed by the administrator in a company secretarial capacity include maintenance of statutory books and records, ensuring required filings are made with the fund's local regulator and companies registration office and the convening and holding of both board and general meetings. Promoting good corporate governance at the fund level is also an objective of the company secretary.

Due Diligence
The quantity of due diligence requests being submitted to the administrator is increasing. Investors want more transparency and, as a result, the administrator needs to fulfill more onerous reporting requirements. In addition to the investment manager, investors are becoming increasingly concerned about how their funds are being administered. Institutional clients, in particular, are focusing much more on compliance and due diligence issues and some may go as far as to ask for biographies of staff involved in the administration of their funds. It is also essential that administrators act independently of the investment manager especially when it comes to the pricing of a portfolio. A well-known and experienced administrator with a global presence can often provide comfort to investors.


Adding value: custody and finance

Those administrators that are capable of providing custody services benefit from the fact that they have an ideal position as financier as well: the collateral that is needed to provide bridge finance or leverage finance is already registered in their name (as nominee). There are only a handful of custodians large enough and with the necessary balance sheet to provide this combination. Some of them are also providing stock lending as a service, based upon their own assets under custody.

Calculating leverage
The percentage of leverage which can be offered to a fund, whether it be a hedge fund or a fund of funds, is determined by the quality of the investment portfolio. Factors such as liquidity and rating of the stocks, diversification of the portfolio and, of course, the investment strategy play an important role. Just as important, however, are 'soft' factors such as the track record of the investment manager and the quality of the underlying administrators. Hedge funds traditionally have been provided leverage by their prime brokers/custodians and for the calculation of this percentage, there are a number of systems on the market. Since funds of hedge funds do not necessarily need a custodian (their holdings are interests in investee funds rather than exchange-traded equities) such systems have not yet been developed widely for the leverage of this type of investment funds. Again, there are only a handful of banks such as Fortis that have developed internal systems in order to be able to provide leverage to funds of hedge funds.

Finance is mostly provided in the form of a current account facility, which can be used for:

  • leverage of the fund on an ongoing basis;

  • bridging of a possible mismatch between incoming subscription money and redemption amounts to be paid out; and

  • margin calls for FOREX and other hedging transactions

Conclusion

In recent years the traditional roles of administrators versus prime brokers and banks have become more diverse. This enables an investment manager to choose the perfect match for his fund, whether he only needs a 'simple' administrator or a high-level investment banker and custodian as well, capable of tailoring complex financial products to his needs. In choosing the right service provider, an investment manager should consider visiting the administrator's office to meet face to face with those responsible for the fund's administration and its meeting its financial requirements. Meeting with the service provider will help the investment manager get a feeling for what he can expect from them on a day-to-day basis. Written or verbal references from existing clients of the service provider are sometimes a useful indicator of the level of service provided.

The investment manager should view the relationship with his service provider as a partnership that can provide flexible solutions as its business grows.


If you have any comments about or contributions to make to this newsletter, please email advisor@eurekahedge.com

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