With a post-Madoff world fixed firmly in the rear-view mirror and new regulations on the horizon, a new report from Tabb Group describes how the role of fund administrators is now among one of the most important of hedge fund counterparties, perhaps second in importance only to prime brokers.
What investors want today, says Tabb, is more transparency and greater asset safety, which requires improvements in infrastructure for middle- and back-office operations, enhanced reporting to stakeholders and independent verification of portfolio values.
This shift in investors’ priorities is significantly altering the role and responsibilities of fund administrators and, by extension, the processes by which administrators are selected.
According to Paul Rowady, senior analyst, and Adam Sussman, director of research, who co-authored the report, administration is no longer centered simply on back-office functions dealing with accounting, valuation and share registration. Fund administration can now be defined as everything after the trade.
Facing high switching costs, fund managers tell Tabb they are keenly aware of how important it is to make the correct administration selection. With managers in Europe as well as the US becoming more sensitive to investor’s increasing demands, Tabb Group estimates that from 2009 to 2010 the frequency of daily net asset value calculations will increase to 56 per cent of hedge funds, up from 46 per cent in 2009.
Operational integrity, says Sussman, is crucial to a fund’s survival, especially when faced with this increase demand in fund performance: “Hedge funds are seeking the best possible resources, including people, processes and technology, so they can meet and exceed the demands of the industry’s changing landscape.”
Prior to 2008, the fund-administrator selection process was straightforward and largely handled by managers, a check-the-box type of exercise that revolved around fund administrators’ brands and fees. The problem with relying too heavily on brand awareness, says Rowady, is that a brand’s quality was often correlated with size.
“But size and brand do not ensure that an administrator deploys the most reliable technology, SAS Level II certified processes, domain expertise and scalability, not only in terms of size but the funds ability to adapt its operation to changing technology, regulations and market conditions.”
Tabb details three administrator models in the report: custodian-owned, broker-owned and independent/hybrid independent. Although the independent model strives to minimize conflicts of interest that could influence the administrator’s asset valuation and verification practices, “the hybrid independent model enjoys arm’s-length operating independence combined with the financial backing of a larger entity and this may represent the best model,” says Rowady.
As firms move to validate their processing and servicing partners, TabbB Group believes that the traditional method of choosing administrators by brand or reputation will be replaced by a selection process that prioritises due diligence.
“This shift should benefit boutique administrators more than many of the traditional providers,” says Rowady.
The authors believe the industry is seeing an end to the era in which funds manage their processing internally with a “trust me” nod to their investors.
“We see more investors pushing hedge funds to migrate their processing and valuation responsibilities to qualified third parties, firms that will need to expand their processing capabilities to be more on demand, more responsive and more global.”
Selecting an administrator is a complex and resource-intensive process, says Sussman: “The good news is, there are clues that investors and managers can use to make well-informed selections based on their needs and the ability of an administrator, regardless of size, to meet those needs.”
