Evidence collected by INDOS Financial Limited (INDOS), a UK independent depositary, has revealed that many hedge funds have chosen not to revisit their administrative and depositary arrangements since the implementation of the AIFMD (Alternative Investment Fund Managers Directive) in July 2014.
Bill Prew (pictured), INDOS CEO, says: “In so doing, some managers are missing the fact that their depositary charges are rising in line with assets under management resulting in unnecessarily high fees. In particular larger funds should demand a more tailored fee model from their depositary which reflects the work and risks involved.”
Indos believes that four factors have combined to bring about this state of affairs. The first is the regulatory burden faced by alternative investment managers following the financial crisis. “No sooner had AIFMD bedded down than work began on preparations for MiFID II,” says Prew. “Once a regulatory hurdle has been negotiated, the papers are often filed away and attention turns to the next issue.”
Separately, 2017 proved a generally profitable year for hedge funds not only in terms of performance but also asset growth. Recent figures from Eurekahedge indicate net asset inflows of some USD94.7 billion into the industry, a dramatic change from 2016 which witnessed net outflows of USD55.1 billion. According to INDOS, this positive reversal resulted in some lessening of the pressure to manage all costs within funds.
The third reflects the fact that the AIFMD depositary requirements in 2014 were new for many funds. The market for AIFMD depositary services was immature and approaches to pricing these services has evolved over time, meaning managers are able to negotiate better pricing when buying services today.
Finally, there has been a tendency for administration and depositary deals to have been negotiated as a bundled package, but whereas administration fee rates decline as assets increase, the same is not necessarily true for depositary fees.
INDOS notes that the fee rate for a typical contract for hedge fund administration will generally scale down as assets grow, perhaps from 12 basis points pa (on fund net assets) down to 8bps. In many cases, however, INDOS has seen evidence of the depositary fee being fixed at around 2bps. Thus a USD250 million fund would be paying USD50,000 pa in depositary fees and a USD1 billion fund would be paying USD200,000 pa It is rarely the case that a USD1 billion fund is four times the complexity, or work involved to service, than a USD250 million fund and a more tailored approach to pricing is required.
“In fact,” says Prew, “the industry standard, set by INDOS back in 2014 and consistently applied since, incrementally lowers the fee rate as assets grow such that the effective basis point charge for a USD1 billion fund could well be around 1.2 basis points depending on the complexity of the fund. Therefore, a fund of that size would be paying USD120,000 not USD200,000 – a significant saving.”
“At this time of the year, investor focus on expenses increases since they want to understand what comprises ‘other expenses’ disclosed in year-end financial statements. The answer is, where possible, for a fund to unbundle administration and depositary contracts and thus to achieve a better deal for the manager and, more importantly, investors. And now, as MiFID II has come into force, there should be time to dust off the old files.”
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