According to Mark Hedderman (pictured), CEO of Custom House Fund Services, the hedge fund administration industry needs a moment to reflect and think long and hard about what the preferred model to conduct hedge fund administration should be. It’s time to take a deep breath and look at how the evolution of the hedge fund administration business model has altered.
The genesis of the fund administration business was to function as a fully independent part of the investment management process, separate from prime brokerage and custody to perform a singular role. However, over the course of this century, that core function has become somewhat diluted. This has been caused by the proliferation of investment banks and technology specialists, even law firms, entering the space with a belief that fund administration could be bundled together with other services.
That desire to offer a menu of services was pushed even further by the wave of regulations that emerged post-financial crash in 2008. Investment banks were quick to seize on the opportunity to roll out more of a consolidated model when fund administration could be offered in addition to custodial services, clearing and execution, financing and so on.
"What is ironic is that in the last two years we've seen investment banks washing their hands of their fund administration businesses. My assertion is that at some point the true ethos of what it means to be a fund administrator will return; it was simply lost earlier this century.
"Being inside the eye of the storm, I've seen very little thought and consideration given to determining what is the preferred model to conduct hedge fund administration. Our move away from TMF Group earlier this year is part of a wider discussion that needs to take place within the industry. I can't help but have a degree of Schadenfreude when I hear about investment banks wanting to return to their core attributes.
"That's what the hedge fund administration industry needs to do as well: it needs to return to its core values and re-assess its role as an integral part of the investment management process and what is the best way for firms to position their services, and I say that for two reasons:
"First, the industry needs to take a better look at the landscape. Second, administrators need to reflect what type of a role they want to play," explains Hedderman.
Back in March, Custom House announced that it had agreed with TMF Group – a global provider of business services that merged with Equity Trust in 2011 – to go back to being a fully independent administrator: Custom House Fund Services. The deal, signed at the end of 2014, will allow Custom House to acquire TMF Group's Fund Administration Services business and is, in a way, a reverse M&A deal, giving Custom House the ability to operate unconstrained as a fully independent administrator with no ties to a parent company.
"One of the reasons TMF acquired CHG was because they weren't quite sure what to do with their own fund services business. It became quite clear during 2014 that the better interests of TMF and Custom House were for us to operate independently. That was the genesis of our discussion. We were both heading down different paths and had become different organisations.
"Strategically, and philosophically, we believe that an independent fund administrator is the preferred model to support hedge funds. We strongly believe that the ability to calibrate our entire strategy and internal organisation purely on the provision of hedge fund administration means that we can position ourselves as a viable alternative to incumbent administrators," comments Hedderman.
Hedge fund administration has become a highly commoditised business in recent years. Bank-owned administrators engaged in a race to zero as they competed to win mandates. The net result has been that fee margins have continued to compress. To compete, smaller administrators have aggressively pursued price-driven strategies without necessarily thinking about how they are trying to support clients. It has all become rather myopic and in Hedderman's view, administrators have work to do reclaiming that lost ground.
"This is a significant bug bear of mine. A lot of what we've seen has been self-defeatist activity, and continues to be the case. Administrators are devaluing the perception of our industry by getting involved in a race to the bottom by pushing forward the commoditisation of administration services; offering services for free to attract clients. If you don't respect the role that you play, how do you expect your clients to respect the role that you play?
"We need to reassess the value that we offer managers and change the industry perception of hedge fund administration; it's getting to the point where managers can't see any difference between administrators or the service being offered," states Hedderman.
The reality is, administration is a core component of the hedge fund cycle. It is, in many respects, the lynchpin of the investment process. "We support the manager, we support the investor, we support the fund's directors, and yet that value proposition has been eroded both internally and externally," adds Hedderman.
Being a truly independent administrator that is 100 per cent focused on providing core services, not merely adding them to an extended mix of broader services that only the investment banks are capable of providing, is likely to become a much stronger value proposition moving forward.
This is already evidenced by the fact that managers are increasingly partnering with technology specialists to provide customised solutions, or fund platforms that specialise in structuring and distributing regulated funds: point being, these are pure-play specialists. It's their day-to-day focus. Their bread and butter.
"The industry has become a mishmash of players – some independent, some bank-owned, some technology-owned – that I think it is now beginning to become clear to people that actually, this is not as straightforward a business to be in as they originally thought. It's not without its risks and challenges.
"I'm sure other administrators would echo my opinion that calculating the NAV has now become a small part of an administrator's role. The cost of having the privilege to do that means that you have to do so much more; for a large investment bank, they don't really want the pressure of providing multiple services beyond merely calculating the NAV and keeping on top of what are a significant number of moving parts.
"At Custom House, our aim is to create an administration business that reflects the value of what we do, rather than just offer a service that is part of a broader suite of services," says Hedderman.
This is a brave approach. What Hedderman is saying is that administrators need to move away from offering services at the lowest price and start to re-assert their value. To underscore this, Hedderman confirms that the sales and business development teams at Custom House are instructed to make sure that all client discussions are service-led not price-led.
Small administrators are just cutting each other's throats and that's where the space faces a real challenge: and could ultimately lead to further consolidation as these firms struggle to keep their heads above water.
"It is harder to take a stance like ours but we have a long-term business strategy. We're not looking to prostitute our services to the industry as the lowest bidder.
"Becoming independent was a deliberate strategy to help us win new clients by following a service-driven rather than price-driven model. People see us for what we are; we're up-to-date with all the various technologies, bit we're not a befuddled part of a larger organisation. We're not some outlier.
"We offer straightforward fund administration services. And that has almost had a cathartic effect when entering into discussions with prospective managers. We don't have to explain how our business interacts within a wider business group," concludes Hedderman.
