Administrators cash in as funds turn to third-party providers
The growth in hedge fund assets under management as well as an increase in pension fund allocations to alternatives is fuelling the adoption of third-party fund administration, and the US administration industry is growing by leaps and bounds to meet the challenge. Continuing strong growth in the number of new funds and vigorous expansion in total assets have prompted the launch of a substantial number of new administration providers over the past two years.
'Many investors, especially institutions, require that investment use independent organisations for some or all administrative services - a third-party, independent review that provides a higher comfort level for these investors,' says Christine Waldron, vicepresident and manager of alternative investment products at US Bancorp Fund Services.
The requirements asked of hedge fund administrators by managers, investors and regulators are growing. Calls for greater transparency on the part of funds, more frequent net asset valuations and more extensive and frequent reporting to investors are getting stronger. Firms with the ability to service ever-increasing trade volumes, global capacities and niche strategies are seeing assets under administration grow at a rapid clip.
But at the same time, managers complain that quality of service is slipping, while administrators insist that the margins they enjoy are eroding. Service providers are taking different tacks in order to sustain margins and keep up service. Bermuda-based Fulcrum, which also has offices in Grand Cayman, Toronto and New York, has seen its US assets under administration double over the past three years. 'We have gained market share and are taking in lots of new business,' says chief executive Glenn Henderson. Fulcrum has succeeded so far by investing millions of dollars in its own technology. 'We carved out a niche by leveraging our proprietary technology to administer complex strategies,' Henderson says. 'We're winning large blue-chip mandates on the back of the complex strategies we're able to service.' For example, Texas Pacific Group chose Fulcrum to administer its distressed debt platform, and Swiss Re awarded it its new managed accounts business.
Business growth from over-the-counter heavy funds, derivatives-driven vehicles and credit-based entities has been particularly robust, Henderson says: 'Most administrators don't want to look at these funds, but we're pretty willing to wrap our arms around it.'
He says flexibility has also been critical to Fulcrum's success, including the ability to enhance its offering to meet specific demands. In some instances, it starts from a blank sheet of paper to develop services around needs of a certain manager. Like some of its bigger competitors, it has built a full suite of services, commonly referred to as front-to-back.
The firm prides itself that qualified accountants rather than sales people armed with PowerPoint presentations give clients initial web demonstrations. Last year Fulcrum opened offices in London and Chennai, India, and it is planning to establish new outposts in Ireland and Asia before the end of this year, with headcount set to double to 100. Other players such as Viteos Fund Services in New York are trying to appeal on lower costs. Viteos offers middle-office, accounting and administration services from its Indian locations in Mumbai and Bangalore, where it can draw upon cheaper resources. Its team of 125 employees are extensively trained before deployment on client work.
'There are a lot of hedge funds in the under USD1bn crowd that aren't getting the level of service they need,' says senior manager for business development Marshall Saffer. 'That offers a great opportunity for a firm like ourselves.'
However, he says that there's a 'stigma' associated with 'offshoring' private information to India - a concern addressed by reassuring the firm's clients that sensitive information never leaves its passwordprotected network. Founded by Sreedhar Menon and Shankar Iyer, Viteos opened for business in 2004 and now services around 20 clients in the US and Asia. Last year it also opened a beachhead in the Cayman Islands to service offshore funds. The upsurge in the administration industry is bringing plenty of new business for technology providers. For example, New York-based Paladyne Systems, a fully hosted application services provider, is experiencing such strong demand for its services from managers, prime brokerages and administrators that it expects to have to double its headcount this year.
'A lot of capital is being used to build internal platforms,' says Sameer Shalaby, who founded Paladyne in 2005. 'Our technological solutions provide fund administrators with more competitive service offerings, increased scalability and tighter operational controls.' The rate at which bigger banks and prime brokerages have built administration-related platforms is evidence that it is still a lucrative business, which still has room for growth.
However, the industry is moving very rapidly and participants need to respond quickly in order to stay competitive, Shalaby argues. His company counts among its clients Lighthouse Partners, the USD5.6bn Florida hedge fund manager, GoldenTree Asset Management with USD7bn in assets, and specialist hedge fund administrator Caledonian Fund Services, as well as Viteos. Brian Shapiro, founder and president of CarbonBased Consulting in New York, concurs with Shalaby that the days of respectable margins on plain vanilla administration are numbered. 'The smaller players are already overwhelmed and can't support all asset classes their clients are trading,' he says. 'The costs involved in building out technology are skyrocketing. There's no way they can sustain high margins.'
CarbonBased Consulting's latest yearly survey of asset managers found that administration margins are getting compressed, fuelling an increase in industry consolidation. Giant banks that are custodians and/or prime brokerages, such as State Street, Bank of New York and HSBC, are adding rapidly to their capabilities by buying technology or acquiring minor players, setting themselves up to wrestle market share away from specialist hedge fund administrators.
This will fuel increased industry consolidation, industry members say, by a continuing shortage of skills, demand from managers for corroboration of in-house accounting, an investor push toward greater transparency, and a growing need for collateral and margin management as well more frequent valuations.
At the same time, hedge funds themselves are providing third-party administration. A case in point is New Yorkbased LaCrosse Global Fund Services, which was created by Cargill's Black River Asset Management arm and is building a niche franchise to service hedge funds around the globe.
Led by Stuart Feffer and Christopher Kundro, the outfit can service everything from plain-vanilla long/short equities to hard to value instruments in 11 locations around the globe. The Cargill backing as well as the leading duo's industry expertise are expected to give LaCrosse a definite edge. It was spun out in January.
These factors point toward administrators having to increase their IT spending in order to maintain their competitiveness. Eventually, Shapiro says, the industry globally will see greater commoditisation of administrative services, resulting in a 'culling of the herd' among lesser quality entrants, which will
eventually get priced out.
Business process outsourcing is set to continue during 2007. Multi-billion-dollar funds will tend to keep administration role in-house for the most part, but for smaller funds, thirdparty administration will be a 'necessary evil,' Shapiro says.
Meanwhile, managers are clamouring for better services. 'Clearly, a lot of managers aren't happy with their administrators and are willing to pay more for the right service,' says Fulcrum's Henderson. Demand has so far exceeded supply when it comes to complex strategies.
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