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Independents continue to thrive

Over the course of this decade several big banks have entered the hedge fund administration market by snapping up independent firms. Recent years have seen acquisitions in the sector including those of Hemisphere by Bisys (itself recently acquired by Citigroup), Tranaut by JP Morgan, Bank of Bermuda by HSBC and DPM by Mellon. But paradoxically, the outlook for the remaining independent administrators has never been brighter, not despite but because of the influx of the global institutional players. Their focus on the largest funds is creating a wealth of opportunities for smaller and more flexible administrators to flourish and encouraging start-up businesses to enter the market.

Custom House Administration is enjoying  buoyant growth, in part because existing clients are launching new funds and their existing products continue to grow. But at the same time the firm is receiving more business from medium-sized funds that are being turned away by the large players, a process underway for the past two or three years. Many large administrators have now imposed minimum levels of fund size for new business, usually around USD200m and, it has been reported, in some cases as high as USD500. They are no longer marketing their services to a substantial segment of the market - one that has proved an important source of new business for Custom House and other independent administrators.

But another spur to business growth has come from the increase in daily dealing funds. For an umbrella fund with four underlying funds, a switch from monthly to daily dealing increases the annual number of valuations from 48 to 1,004 - boosting exponentially the administrator's volume of work.

This trend is set to grow because of demand for daily dealing from institutional investors. Many institutions have invested through funds of funds or multistrategy funds, because identifying single-strategy hedge funds for themselves is uneconomic. A USD1 billion pension fund placing 5 per cent of its assets into hedge funds will typically have to invest in tranches of between USD5m and UDS10m.

Rather than employing a researcher to identify five or 10 funds from the entire hedge fund universe, using a fund of funds or multistrategy fund involves only making a decision about the ability of its manager, and the extra fees will almost certainly be a lower cost.

Smaller institutions tend to favour funds of funds while larger ones use managed account-type structures with a multistrategy fund. The latter approach avoids the double fees charged by funds of funds, but both options entail slow liquidity. Fund of funds managers seeking to withdraw money from a fund with monthly liquidity may have a lag of six to eight weeks between giving notice and being able to reinvest the proceeds. Multistrategy funds may also face problems of deployment of resources when a particular strategy drops from favour, if investors become unhappy with one of the portfolio managers, or if losses by one manager have to be met from other portfolios.

A master-feeder fund structure recently created by Custom House in Malta from a portfolio of managed accounts may be a model for the way ahead. The managed accounts have been placed in segregated cells, which are sub-funds of the master fund, each of which has daily valuations and dealing, allowing the manager to rebalance the master fund at will and avoid crosscollateral risk. This structure meets what promises to be a growing demand for managed accounts, organised as an umbrella fund, offering daily dealing.

Dermot Butler is chairman of Custom House Administration and deputy chairman of AIMA

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