On 19 October 2017, Deutsche Bank announced that they had sold their Alternative Fund Services business to Apex Fund Services (`Apex’). It is the latest example of consolidation in the alternative fund industry as organisations decide whether to stick or twist in the fee-based – as opposed to transaction-based – world of asset servicing, where margins are less attractive that investing banking activities.
The transaction will add USD170 billion in AUA, propelling Apex to become the eighth largest administrator in the world and the largest independent administrator.
Peter Hughes, Founder and CEO of Apex, says that the aim is to become a top-five global fund administrator, and confirms that around 10 acquisitions are being targeted over the next 24 months.
“It comes down to making the right acquisitions and properly integrating them,” says Hughes, when asked what it takes to become a leading fund administrator. “Every acquisition should make your business offering stronger. That’s the way we are looking to do it and we are progressing well to reach that target. We expect to be a top-five fund administrator within two years. We have a few other deals in the pipeline which are close to finalisation.”
Apex has the backing of Genstar Capital, a leading middle-market private equity firm and is not alone in joining forces with a PE group to support its expansion plans. Other examples include Conifer Financial Services, which has the backing of private equity behemoth, Carlyle Group.
Some in the fund administration industry feel there are pros and cons to private equity money coming in to support acquisition deals. On the one hand it can inject administrators with capital to broaden their service offering at a time when alternative fund managers are running a wide range of multi-jurisdictional products spanning hedge funds through to PE, private debt and infrastructure funds.
They are no longer `pure play’ managers as it were, diversifying their business models to capture a global investor base.
Administrators are expected to keep pace with this change. As one administrator spokesperson says, asking to remain anonymous: “This is largely a technology play and it means you have to spend a lot of money. We’ve always invested 15 to 18 per cent of our revenues on technology. If you don’t have that capital base, and you have to attract money from a third party – i.e. a PE group – that will invest in your people and technology, that’s fine.”
On the other hand, some argue that private equity groups are potentially creating misalignments of interests between administrators and their investors. These are money managers. They want to make their IRR over six years and get out.
“I believe private equity is playing a greater role in the acquisition of fund administrators with the opportunity of owning them as investments and ultimately flipping them, a number of years later,” comments Christine Waldron, global head of the Alternative Investment Solutions team at U.S. Bancorp Fund Services.
“The level of private equity activity in this space has not been seen historically and it is impacting multiples, but I think there will still be large acquisition deals announced.”
In many ways, U.S. Bancorp has gone out of its way to openly comment on its long-term commitment to fund administration. Like other custodian-backed fund administrators – Northern Trust, BNY Mellon, MUFG Fund Services – U.S. Bancorp has enormous scale and does not see itself as a potential acquisition target. However, clients appreciate hearing the bank’s long-term strategy on a regular basis. It dispels any rumours.
“When someone is selecting an independent administrator, it’s important to understand the management’s strategic view of the business. Is this a long-term endeavour or are they going to be looking for an exit strategy at some point? When it comes to a bank-owned administrator, the questions should centre on the overarching commitment, oversight and management involvement from the top down.
“An administrator’s organic growth is critical to its longevity. If you’re not growing organically it could be a sign that you are facing challenges, maybe not immediately, but in the future. Your acquisition strategy should be a complement to that organic growth and not a detractor from it,” suggests Waldron.
The industry has gone through a period of substantial consolidation in recent years, with many investment bank-owned administration businesses having been sold. Still, there continues to be plenty of room for new entrants. In particular niche independent administrators who are looking to service specific parts of the industry.
One example of this is Socium LLC, a New York-based independent private equity administrator established by Beth Mueller and Michael Von Bevern last year.
“We recognise that in the industry today, PE funds specifically and closed-end funds generally (private debt, VC, real estate), are highly underserved by fund administrators,” says Mueller, Socium’s COO. “If you are a closed-end fund manager looking to outsource your fund accounting, there aren’t many options outside of the biggest fund administration groups; and the large admins are not particularly interested in taking on smaller or emerging managers as clients.
“There are literally hundreds of independent administrators who focus on hedge funds but very few who focus on the closed-end fund market. Historically closed-end managers have done their own accounting and haven’t outsourced as much as hedge fund managers.”
That trend is changing, mostly driven by institutional investors, she says. They want to see someone independent looking at the books and records, as they’ve become accustomed to with their hedge fund allocations.
This could explain why some administrators are actively pursuing an acquisition strategy. They want to be certain that they can tap in to new growth markets, and given that the majority of hedge fund managers already have an administrator, the closed-end fund space is still hugely under-represented.
“We are having a tremendous amount of success in the US private equity market and the European real estate market, not to mention Asia,” says Jay Peller, Head of Citco Fund Services. “There is a lot of room for future growth; only around 25 per cent of private equity managers are currently outsourcing their administration activities.”
This has prompted SS&C Technologies and MUFG to make a series of acquisitions in recent times. MUFG Investor Services, the global asset servicing group of MUFG, announced last year it had completed the acquisition of Rydex Fund Services, a 1940-Act mutual fund administration business, from Guggenheim Investments, adding USD52 billion in AuA to bring the total AuA for MUFG Investor Services to USD422 billion.
In May last year, the group also acquired Capital Analytics, the private equity administration business of Neuberger Berman Group to bring its private equity and real estate AuA to USD 145 billion.
Likewise, SS&C Technologies acquired Wells Fargo Global Fund Services in September 2016 adding an estimated USD42 billion in AuA and the capability to support a wide range of complex strategies traded by global portfolio managers including credit, structured credit, private equity, private debt, real estate and hybrid structures.
On 13th October 2017, SS&C also announced it had expanded its footprint into the Canadian market with the acquisition of CommonWealth Fund Services Ltd. (“CommonWealth”), an award-winning Canadian fund administrator servicing over USD8 billion in assets.
Hughes says that Apex Fund Services is pursuing a similar acquisition strategy but is following its own approach to execute on it.
“With Genstar’s expertise, we will be careful as to which businesses we target in this space. It will be a cohesive approach. We will be appointing third party advisers on legal and accounting due diligence every step of the way so that we avoid falling into any potential compliance risk traps. We won’t be taking any short cuts,” confirms Hughes.
He says that when considering an acquisition target, one of the most important red flags focuses on compliance risk. Administrators that are a bit smaller tend to have higher compliance risk in their book of business, “and that’s something we are very careful of. We did buy the Pinnacle business three years ago, which was a smaller business but it had a lot of good quality clients. The risk with any acquisition is that the book of business you pick up just isn’t of a high enough quality,” adds Hughes.
Buy or build?
There is no right or wrong approach to building a successful fund administration business. For some, it makes perfect sense to buy other businesses and create a `mega administrator’. This gives them access to diverse revenue streams and a roadmap to create economies of scale.
But this is not as easy as it may seem and not without its challenges.
“The way I see it, and the main reason we stay out of doing acquisitions, is that it causes too many operational issues,” comments Peller. “Different accounting processes, different general ledgers, different technology systems and so on. What then ends up happening is you find yourself running six, seven separate administrators on different platform infrastructures, each with different processes and data to manage.”
With complex regulation such as MiFID II coming down the line, coming up with a new product to make sure those clients remain compliant is a tall order. It may well give the administrator access to new lines of business, but as these deals tend to be more acquisitions than mergers, the ability to streamline people and processes into one multi-faceted entity can become arduous.
“The way we look at it is `One team, one dream’; we think that’s how you are able to deliver superior client service,” says Peller. “We look to handle anything in the alternatives space which meets Citco standards; that’s our niche. If a client opens up a hybrid loan fund, we want to be in a position to handle it.
“Ultimately, you have two choices: buy or build. Our philosophy is a simple one. We build it from the ground up. We hire the people with the expertise and we build our own proprietary technology.”
On the mutual fund side, Peller thinks that is out of the firm’s scope.
“A lot of what we previously referred to as our hedge fund clients have become alternative asset managers running a range of strategies using different vehicles. We want to be able to handle any type of trading strategy in the alternatives space. If you try and start supporting non-alternative asset classes you could land in trouble.”
That ability to handle multiple fund products across multiple jurisdictions has always been core to Apex Fund Services and as such is not one of the drivers behind its acquisition strategy. Even before it received new private equity backing, Apex was covering 25 different domiciles for fund structuring.
“What we need to do now is layer in fund-of-funds custody and depositary services in Europe as we evolve to the next stage,” stresses Hughes. “If you look at the number of EU-regulated funds on our books, we have more than most bank-owned administrators. We’ve been doing administration work for a long time in Ireland, Luxembourg, Malta as well as covering the Channel Islands.
“We already had the platform in place. Now, we just want to scale up our services in Europe.”
The point that Citco’s Peller makes about staying focused on core strengths is an important one when one considers the need for any administrator to maintain a high quality client service experience.
Service quality is key
Over at U.S. Bancorp Fund Services, which has a similarly conservative approach to acquisitions as Citco, Waldron believes that the industry needs to get back to focusing on quality of service.
“I truly feel that with the level of M&A activity that has gone on, as well as what the alternative investment industry has faced regarding recent performance issues, we have been focused on the economic and commercial side of transactions for too long and at the expense of quality and service levels.
“We need to make sure the industry doesn’t swing too far in that direction and the quality of fund administration falls to such an extent that it loses its value.
“Nothing concerns me more than when I hear clients say their administrator is not providing them with value because that could become systemic and indicative of a wider problem facing this industry,” warns Waldron.
Jack of all trades?
Socium’s Mueller thinks that there is a tendency in the industry to focus on maximising assets under administration, without necessarily prioritising the client experience. While administration services in the hedge fund industry have become commoditised, there are, she says, still plenty of fund managers who appreciate high-touch client service and consistent coverage on their account.
“You can’t be all things to all people. It’s important for an administrator to be knowledgeable and experienced in the complexities of the funds they’re servicing. Complex waterfall and carried interest calculations can be easily mishandled without the proper systems and controls. The accounting staff should have expertise in the accounting and calculation complexities of the funds they serve.
“I feel that level of expertise gets watered down when an administrator is servicing hundreds or thousands of clients. It gets harder to put the proper controls in place,” states Mueller.
To Peller’s earlier point on the challenges of integrating multiple administrators and IT systems, the complexity and risk of trying to meld cultures and technology can, if done poorly, lead to a distraction in terms of servicing existing clients.
“I’m not saying it can’t be done well, but acquisitions can dilute the quality of the work you are doing. Maintaining quality at the highest possible level – that to me is the most important thing,” extols Mueller.
Organic growth
By focusing on organic growth, Citco has managed to grow its private equity AuA to more than USD275 billion in committed capital. Of Citco’s total USD900 billion in AuA, Peller says that hedge funds continue to grow “but over the last six years, private equity has become a core part of our business. If I look at the pipeline and the deals we are closing, that’s where institutional investors are putting their money right now. We’re either lucky or good; or both!”
“What organic growth does is keep you grounded in terms of what your core business is,” says Waldron. “It’s critical for any manager that they see good organic growth in their administrator. It gives them a good idea of where the administrator’s management team is focused.”
That’s certainly the approach that new entrants like Socium are taking. In fact, given the exacting demands and reassurances that private equity managers need from their appointed administrator – and, by extension, a high-touch level of support – there could well be a large ecosystem of niche administrators servicing the smaller and mid-sized manager community, while at the other end of the AuA spectrum, large administrators focus their efforts on large, established fund management groups.
“Having access to our many years of experience is a value-add to our clients,” says Mueller. “They have a partner to run things by, to ask for advice. We pair that with enterprise technology solutions, which is the same, and in some cases better, than what the largest administrators use.
“We combine those two things (expertise and technology) with high-touch customer service. It’s what drives us. Excellent client service generates client referrals, which will help you grow your business. It’s not just about acquiring other firms. You have to be smart about it, so that you don’t sacrifice the level of client service you offer, just for the sake of growth.”
As far as scalability goes, Mueller hopes that Socium will flourish just by virtue of the fact that outsourcing now makes so much sense to a lot of PE fund managers.
“The outsourcing trend is catching on. If we stick to our knitting and offer great client service then we will continue to grow organically,” she adds.
The role of technology
Peter Sanchez is CEO of Northern Trust Hedge Fund Services, one of the more prominent custodian bank-owned fund administrators. Speaking about technology, Sanchez says that Northern Trust has a technology framework that allows it to handle all types of investment strategies and portfolio complexities.
“Our technology utilises one data set throughout the trade and NAV lifecycles. Trade capture, fund accounting, performance attribution and P&L, investor accounting and investor reporting are all done on the same platform,” comments Sanchez.
This is helping Northern Trust to respond to the convergence in the alternative funds space as hedge fund managers develop more private equity-like structures and PERE managers add hedge fund-like satellite strategies to their core offerings.
“We have been investing into the back end of our system, focusing on sophisticated investor servicing tools as well as leveraging our existing tools to track performance and cash flows at the investment level. For example, private equity firms today ask for the return not only on a Limited Partner, but the return on a specific asset including all the cash flows and expenses and the return on a legal entity that holds that particular investment or portfolio,” adds Sanchez.
More and more capabilities that leverage powerful data tools, such as tagging attribution tools, are becoming an important part of the portfolio and investor services solution set as fund administrators evolve their product offering in line with the changing needs of alternative fund managers.
Looking ahead
As a core competency of an asset servicing business, a trust/custodial bank is going to continually invest in that business because it is their core business. This goes to the `stick or twist’ point made earlier; Deutsche Bank ultimately decided they didn’t want to throw more money at their Alternative Fund Services business and opted to sell to Apex.
“I think the investment banks looked at the administration business as a back-office business that they could make annuity fees on, but once they began facing balance sheet restrictions, they decided to look at what their actual core competency was, and it became quickly apparent that asset servicing was not part of it,” says Sanchez.
Whilst there will likely be fewer independent administrators in future, they will still exist and play an important role (especially in terms of pricing) to smaller fund managers.
“I could see a situation where the biggest managers become so big that they start to move into multi-administrator relationships. Some of the largest traditional asset managers have multiple administrators and I could see that happening in the alternatives industry, perhaps based on strategy, or investors’ requirements,” says Sanchez.
GPs want to select administrators that are a good fit for them. That’s why it’s important, concludes Mueller, “that if you grow through M&A you have to make sure it is the best possible strategic fit for your firm and isn’t going to compromise the service you provide.
“Only owners of administrators who are truly in this for the long haul are going to keep that in the forefront of their minds.”
