The Hedgeweek Interview: Paul Smith, Head of Alternative Fund Services (AFS), HSBC: Dropping the 'barbell 'and focusing on the 'beer belly'

Paul Smith outlines the future of the global funds administration industry, and explains how HSBC is positioning itself for the ongoing shift to the mainstream.

HW: What is the management structure of the Alternative Fund Services (AFS) business within HSBC?

PS: I have a global management committee which is constructed along functional and regional lines, so I have heads for each of the USA, Europe and Asia regions, and sitting alongside them, heads of sales, client relationship management, products and technology.

Under the global management committee each location that I run has an AFS country head who is responsible for our business in that location, in turn reporting to their respective regional heads.

HW: What is the global reach of the business?

PS: We now have eleven service locations, namely San Francisco, New York, Bermuda, Dublin, Isle of Man, Guernsey, Luxembourg, Milan, Singapore, Hong Kong and Tokyo.  Plus there's the London office and we have a representative presence in Japan.

The breadth of these locations would indicate that we are still the only truly global alternative fund services provider.

HW: What is the size of the Alternative Fund Services business at HSBC?

PS: We are now at USD 250 billion in terms of assets under administration, including USD 10 billion of private equity. The remaining USD 240 billion is split equally between funds of hedge funds and single strategy hedge funds.

HW: How has growth been over the past 16 months?

PS:  We were about USD 225 billion at I January 2006, USD 160 billion at 1 January 2005.

HW: Where is this growth coming from?

PS: The key factor is the high percentage of growth coming from existing clients, either growing their product or doing repeat business, it's much higher than in previous years.
This reflects the fact that we are taking on fewer relationships - this is a deliberate strategy - and it's also reflective of the fact that although there are some well-publicised mega launches, there are not enough of them, and the bulk of new alternative businesses are finding it harder to get up to speed.
We are concentrating much more on two strategies:

  • Helping our existing clients to grow
  • Looking at the mainstream fund managers as they move into the alternative investment world via products or managed account platforms.

HW: This shift to the mainstream would indicate rapid and continuing growth of assets in the hedge funds space, what is your estimate of the size of the hedge funds industry?

PS: It is striking that when you look at the growth of our business versus the published growth numbers for the hedge funds industry, we appear to be growing faster.

This is of course not accurate - what is really happening is a large part of the alternative investment industry is not being measured, because it is in the form of structured products, managed accounts platforms or even hybrid products that are not being registered by the fund database agencies.

At HSBC we administer somewhere between 10-13 per cent of hedge fund assets under management, this would indicate that total assets for the hedge fund industry are actually already heading towards the USD 2.5 trillion level rather than USD 1.4 trillion level estimated by hedge fund database agencies.

HW: As Head of Alternative Fund Services for HSBC what is your strategic focus for the business?

PS: We are focusing globally on the asset management groups that are attempting to convert themselves to what we would describe as the asset managers of tomorrow - a universal asset manager looking to manage a broad spread of products and asset classes on a coherent wealth management platform.

These managers can come from the hedge funds side, but they are more likely to come from the traditional asset management side. Our challenge over the next five years is to build a platform that will assist both sides as they blend their styles going forward.

HW: Where do you expect to see the biggest growth in 2006, in terms of assets under administration?

PS: Well, if you remember the famous Morgan Stanley 'barbell' model, where you had thick alternative and traditional wings on either side, I believe this is now dated, my current analogy is a 'beer belly' where you have a fattening of the centre, which is comprised of managers who run a broad spread of strategies ranging from traditional to alternatives, all under one roof.

Phase One of the alternative investment management world was manager-led, we are now well into Phase Two, which is product-led and dominated by marketers and structured product experts. This is what happened to the traditional investment industry twenty years ago.

HW: What are the strengths of the alternative fund administration business at HSBC as it positions for this 'beer belly' trend?

PS: The global reach of HSBC is our first strength. Second, the fact that we do have a traditional and an alternative fund administration business, makes us unusually well positioned.

Third, if you use the analogy of the 'beer belly', as the waist thickens, clearly those larger asset managers are going to focus on their counterparty risk - which is not something that alternative managers have hitherto worried about, but it is becoming more of a concern as institutional investors move into the asset class and request to see the larger names they are familiar with - this plays to our strengths.

Finally, we are a universal bank and we can also do custody and we can bring to the table a range of other capital markets and distribution opportunities.

HW: You mentioned the private equity market earlier, what level of growth do you expect to see in this market?

PS: There are two key growth trends. First, The private equity world is exploding. There is a dichotomy between the mega private groups who are finding it hard to deploy capital, and the smaller groups who appear to be more successful. At the investor end of the market, there is increasing disillusionment with the mega funds, and investors are clearly trying to find funds with more focused strategies.

Second, although our published number is USD 10 billion of private equity, the real number is much more than that.  Itt's hidden within the hedge funds business because there are many more hedge funds currently involved in private equity, and many more hybrid structures used by hedge funds.

HW: How is HSBC catering for these strong private equity growth trends?

PS: We have a specialized private equity system called EquiTrak. Our hedge funds system operates on the Advent platform, and we conduct investment servicing on Koger NTAS, a transfer agency system.

It is interesting to note in this respect that there is no one system that caters for all needs, some of the new structures we are seeing have already moved beyond the technology, and one of our challenges is dealing with the ten per cent of issues that are arising around the administration of hybrid private equity/hedge fund structures.

HW: Do you have a specialized private equity team?

PS: Yes, our private equity team is based in San Francisco, given its proximity to Silicon Valley, and we also service private equity out of Bermuda, Guernsey and Hong Kong.

HW: Do you expect to make any acquisitions in the near future?

PS:  We are always in the market for smaller acquisitions that plug gaps, but we are not looking for significant acquisitions, we feel that organic growth is the way forward.

HW: What impact has consolidation among service providers had on hedge fund managers?

PS: In the smaller-mid end of the market the impact is negative. It is becoming a less tailored, more industrialized business, and it is becoming harder for mid-size managers to get quality names as fund administrators.

I'm not sure that the smaller independent administrators are producing a quality tailored service either, so these mid-size managers are getting squeezed at both ends.

In contrast, the large managers have very complex needs and they may have outsourced too much, particularly in the middle office area, to the extent that their administrators may find it difficult to service them.

Certain elements of the middle office, such as trade break management and collateral management, will be taken back by these large managers and they will move to a more traditional back office outsourcing model, on which we are focused.

HW: What trends are you seeing in fund pricing? 

PS: There are two key trends. First, hedge fund managers are steadily moving to a daily pricing model - daily indications of net asset values (NAVs) - rather than the traditional monthly pricing model, and second, they, and their investors, are demanding absolute independence of pricing.

These are both areas we are focused on. Managers are coming up with ever more complex strategies and we have to keep up in terms of our ability to conduct accurate valuations.  I would say we are 90 per cent there, there are still exotic areas that are difficult to price, but we are investing in the right people and technology and one of our strengths is our independent pricing capability.

HW:  The hedge funds industry is preparing to go retail in some of the major European markets, what impact will this have on service providers?

PS: The impact will be felt primarily on the investor servicing side and the speed with which we will need to mark portfolios to market. For example, most funds of funds struggle to get their fund prices out within ten days of the month end, because their underlying fund investments have not produced the numbers.
With the 'retailisation' of hedge funds we will see a speeding up of the administration process that has to start with the single strategy managers and then move up to the funds of funds so that they can issue prices within two or three days of the month end.

HW: What were the high points of 2005 - and what were the lows?

PS: In general the high point was the opening up of continental Europe to onshore alternative investment products. In specific terms, the opening of our Milan office was a high point. The Italian alternative investment industry is very exciting and we are now well placed to participate in its growth. Another high point was the launch of our German product through which we can service both onshore and offshore investments into hedge funds as appetite for alternative investments in Germany grows.

The low point was continued capacity issues. The size and complexity of the alternative industry has outgrown the traditional places where fund administration is conducted and that, in turn, is now impacting service quality.

The challenge for administrators, working with the regulators and jurisdictions, is to develop a new model for fund administration that will better scale the administration business to the marketplace that we are now in.

HW: How are you dealing with these capacity issues?

PS: Our plan over the next two years is to expand our administration facilities into Kolkata, India, to create further capacity for ourselves. We are developing a Global Service Centre there with around 2,000 people working there within seven years.

HW:  Where would you expect the business to be by the end of 2006?

PS: I would expect the business to be at least 40 per cent larger, in terms of assets under administration, and halfway  through the transformation I have outlined in terms of creating fresh capacity. Together with this, I would expect an ongoing drift of the business towards the 'beer belly' asset manager of the future.

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