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Mid-sized HFAs reduce the size advantage of bank-owned peers

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Over the last 15 years the fund administration industry has been dominated by the big banking behemoths at one end of the scale and small niche players at the other. 

Gradually, some of those smaller entities have been consumed. 

Yet at the same time, those operating in the middle tier of fund administration – those in the USD10 – USD100 billion AuA range for example – have grown organically and taken away some of the size advantage of the bank-owned administrators; remaining flexible, innovative, and able to adapt responsively to managers' ever-changing needs.

"In today's marketplace, you don't have to be the biggest to be successful. Instead, you have to be big enough to have scale, to be efficient, and to offer leverage; the key is to retain an intimate client focus and an ability to constantly innovate, that's where the fund administration model is evolving. 

"'There are always going to be smaller administrators who focus on a niche segment of the market, but our ability to anticipate and evolve with the constantly changing needs of the investment managers we serve has enabled us to achieve substantial growth organically. As a result, we've pretty much taken away one of the advantages of the big banks and that's size," explains Ross Ellis (pictured), Vice President and Managing Director of the Knowledge Partnership in the Investment Manager Services division at SEI.

"As an outsourcer, you need to ask if you are able to align yourself to the manager; do you think like them? Do you talk the same language? Do you operate like them? Or does the manager walk away from the first meeting thinking that you are going to put them into a cookie-cutter solution? For us, it's first about understanding the manager's unique needs and challenges, then offering them customised services atop of a leverageable asset-class agnostic operating platform. 

"We feel we are an extension of their asset management organisation, not a separate add on, and as such, we need to think and act as they do, not provide them with a standard ‘our way or the highway’ solution." 

One of the challenges that bank-owned administrators face is that on the one hand, they've grown into enormous business divisions with hundreds of billions in assets under administration by driving costs down and thinning out their margins. This has been made possible by offering a bundle of additional services such as custody, prime brokerage, securities services etc. But on the other hand, hedge fund administration has grown into a complex animal and managers today need more than cost efficiencies; they want to know that their administrator is on top of every aspect of the industry. 

In Ellis's view, some banks took an approach somewhat akin to the Roman Empire or the early development of the fund supermarkets; a land grabbing exercise, taking on as many managers and funds they could in order to grow as big as possible. Some succeeded for a time, while some failed spectacularly, so the strategy clearly cannot be said to have worked consistently.

Part of the rationale of bank-owned administrators was that they could afford to take a hit on profitability knowing that they could at least make up the shortfall in other parts of the business, such as custody, F/X, and treasury services. 

But is that really a viable business model going forward? That the likes of Goldman Sachs, Credit Suisse and Citigroup have decided to pull out suggests not. 

"I don't really see the fund admin space as one of pure M&A activity; I see it more as consolidation. The economics across the asset management industry have become less favourable, with managers facing top-line fee pressures while operating costs continue to rise. The downstream pressure on providers has also intensified. For entities buying admins that weren't that profitable in the first place, the expectation that they could make it up on volume hasn't come to fruition. 

"When the new and existing client business volume slows down and the regulatory changes kick in and expenses increase, some admins, regardless of whether they are bank-owned or independent, will realise that not only are they getting squeezed on revenues, they are also getting squeezed because the cost of doing business has risen. With increased regulatory oversight, the risks to the firm as a whole, are now far more substantial and these are affecting the whole organisation, not just their fund admin businesses," says Ellis.

Additionally, because of the volumes and the constraints they have from a capital perspective with respect to Basel 3, bank-owned administrators have balance sheet issues independent players don't face, and as such, cannot afford to offer the highly customised and more costly solutions managers seems to be increasingly demanding.

Ellis also senses that the mindset of managers is changing. They no longer want everything done in one place with a single bank entity as their primary counterparty. Increasingly, managers are opting to appoint specialist fund administrators, regardless of size, just as they are partnering with technology specialists to handle a plethora of front- and middle-office services. 

SEI is seeing the benefits of this. 

According to eVestment's 2015 Alternative Fund Administrator Survey, SEI administers over USD320 billion in alternative assets alone, yet acts like a smaller, specialist shop. 

"To date, we've managed to grow by partnering with sophisticated forward-looking managers who understand that turning their operating infrastructure in a source of competitive advantage can enable them to gain economic leverage, better meet the demands of investors and regulators, gather new insight into business dynamics and fuel product development."

"In the first quarter of 2015, we've received more RFPs than we did for the whole of 2014. We're speaking to managers who are looking to pick someone who is of institutional quality yet is nimble, able to quickly customise and have a proven culture of innovation," concludes Ellis. 

Changes in the competitive terrain, whether it be through industry consolidation, M&A, or solution development, will no doubt continue, yet to what end is unclear. 

What is clear, however, is that the administrators who succeed in the years ahead will be those who can best distinguish themselves in terms of customised solution development, client experience and continual innovation. For banks to remain relevant, they must start taking a page from their independent brethren. 

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