By Shankar Iyer CEO, Viteos – Shadow-accounting has moved beyond the simple verification of Net Asset Value (NAV). Outsourcing the in-house accounting function, in part or full, is increasingly recognised as bringing significant value to the business via automation and best industry practices, which may not be in the purvey of internal teams, principally because the shadow provider performs these practices across various managers and funds.
Indeed, scalability in this context can work two ways: not only does shadow-accounting empower fund managers to freely explore new asset classes or investment strategies, and provide operational flexibility, it allows them to work with partners who have developed wide, deep level multi-asset class expertise. The wisdom a shadow accounting partner brings to one client, it brings to all.
Viteos is one such firm, having seen its shadow-accounting business grow from USD21 billion to USD180 billion in client AUM over the last four years.
Even if a trader wants to begin trading a new asset class, the operations team will have to figure out how to start accounting for it in a post-trade capacity. Viteos has the asset class experience, it understands and knows how to deal with it so the scalability issue is immediately overcome.
Viteos’s clients are some of the world’s most complex hedge funds with USD5 to USD150 billion AUM and it shadows some of the most complex investment strategies and fund structures that exist.
By institutionalising the process and data in the complex ecosystem of the post-trade lifecycle, a hedge fund can turn data into customised information that is integrated in its daily operations.
This is not to suggest that a hedge fund’s own internal team could not achieve this, but in an increasingly complex regulatory environment, along with a need for COOs and CFOs to forensically control operating costs, how a manager optimises his internal resources is crucial. Why, for instance, ought staff to focus on non-core activities that take up precious time? And which will likely require greater capital outlay to acquire accounting systems, data systems and so on.
Often, in-house shadow-accounting relies heavily on Excel and other proprietary workarounds, and although it may involve more sophisticated systems, additional challenges may still exist even when sophisticated accounting platforms are present.
Hedge funds that rely solely on their internal staff are missing the opportunity to make major gains in operational efficiency in addition to delivering their very best to their front office staff, clients, prospects and regulators. With more complete data the value they add is derived from focusing their expertise on higher level tasks rather than on the time consuming production of usable data
With trade and fund data coming to managers from their custodian, prime brokers and fund administrators in myriad forms, in-house shadow-accounting has become a more complex and timely exercise. Moreover, these files might not contain all of the data needed, in a way that is needed. As a result, there are times a manager will have to know where to go to get that missing data; this gap is the difference between expected data and actual data.
If the front-office – or indeed an investor – wants a report at a specific time, the operations team will often have to wait to receive all of the files they need to process everything at the same time.
This time lag can create tension between the front-office and operations.
The value of shadow-accounting comes from understanding where one can get more complete data. This requires domain expertise to produce the report with all necessary information included.
Outsourcing negates the need for the hedge fund to invest in infrastructure and headcount, ongoing integration, and other technology projects, thereby increasing capacity to add new funds, structures, or assets and to overlay business and investment intelligence tools on their proprietary data.
Shadow-accounting is effectively a release valve and gives hedge fund managers the opportunity to think about reporting solutions above and beyond what they previously thought possible.
One of the issues of maintaining in-house accounting teams is capacity. At month-end and quarter-end, the workload becomes significantly higher. As most accounting teams are modest in size, a team of two or three people typically end up doing the work of four or five people. If someone happens to be sick, that workload might treble.
In addition, the work needed to be done peak and troughs throughout the year, depending on the manager’s reporting period. A manager might be right-sized for half the year, but capacity-constrained for the other half due to the volume of reporting work required.
When a hedge fund becomes a shadow accounting client, for the first time they start to see what additional work could be possible once the shadow accounting partner takes over their internal operations
Viteos takes care of all the heavy lifting of the CFO and COO’s office around shadow accounting, checking everything that is coming from the manager’s fund administrator, prime broker, custodian. It works with all the main fund administrators and knows which ones are good in certain areas, and which are better in other areas. This helps Viteos to standardise reports for its clients.
One of the main competitive advantages of shadow-accounting, therefore, is that it allows hedge fund managers to become far more operationally efficient and to scale themselves more efficiently as they seek to grow their AUM.
Having this peace of mind, as the regulatory compliance milieu continues to evolve, can act as a powerful impellent to fund managers. In short, choosing the right shadow-accounting partner can boost a hedge fund’s bottom line.
Here are some key features to consider when looking for an outsourced shadow-accounting firm:
- Knowledge of the major relevant software options
- Familiarity with the ins and outs of trading in markets around the world
- Experience with the most common errors made by prime brokers and fund administrators
- Capacity to bring new clients on board without disrupting operations
- Ability to integrate with the hedge fund’s culture
- Expertise in the valuation of complex, exotic instruments.
As competition has increased for institutional assets, consideration of outsourced shadow-accounting capability is becoming a “must have” especially for the funds between mid-sized and large funds.
The ability to shadow is in fact a necessary capability for firms to attract certain types of capital, to manage ongoing operations, and to secure growth over time.
