Traditional administrators are taking the bold step towards hedge fund administration. Anusha Roy explores whether they can make the grade within a more complex industry
Traditional administrators are willing to make the daunting move towards hedge fund administration. They are putting a lot of effort, in terms of money and training, in order to join the hedge fund administration industry in search for better profit opportunities.
An industry once considered as specialised or catering for a niche market is now becoming part of the mainstream. As hedge funds become more popular and hedge funds administration more in demand, there are some issues that need to be looked at. The commitment of mainstream fund administrators practising alternative fund administration and the quality of service delivered need to be questioned.
Ross Ellis, vice president of SEI Investments, an alternative investments administrator in Dublin and the US, says that owing to the high level of competition in the investment fund industry and the slowdown in this sector, there is less room for profits across the board in the traditional fund sector. However, the hedge fund industry is growing and demand is soaring, thus leaving a door for traditional fund administrators to join the industry.
Similarly, Alain GuÃ©rard, director of business development at Fortis Fund Services, comments on the increasing business for hedge fund administrators: 'The alternative investment market is booming. It is natural for mainstream fund administrators to try to take advantage of the expansion in the alternative investment industry. They also want to increase their position in the value chain.'
It remains to be seen whether mainstream providers, despite their success in the traditional fund administration business, will do well in the hedge fund administration industry.
Ellis warns: 'Traditional fund administrators are fooling themselves if they think they can get into the alternative fund administration industry and do well simply by being there. Success in this marketplace demands extensive investment in technology and specialist staff.'
Mainstream administration has a long way to go before it acquires the same expertise as traditional hedge fund administrators. It is not only a question of investing in staff and technology, but also gaining enough experience of the market. That is one of the reasons why specialist administrators do not feel threatened by the entry of mainstream providers. They believe that before the mainstream administrator can outweigh them it would take learning what they have achieved with 20 to 30 years' experience.
'Specialist hedge fund administrators do not feel threatened in any way from the entry of mainstream providers. Some specialist fund administrators have around 30 years' experience and have extensive experience in handling complex fund structures and all spectrum of financial instruments. They have the appropriate technology and experienced staff. Maybe over time mainstream fund administrators will be able to achieve this, but administering alternative investments is not their core business,' says GuÃ©rard.
John McCann, managing director of Trinity Fund Administration, points out that in a crafted industry such as hedge fund administration, the size of a fund administration business does not automatically denote the market power of the company.
'Hedge fund administration is by nature more complex and requires a bespoke approach, hence mainstream administrators can only cater for certain segments of the market. The threat might increase in the longer term if they decide to get into the industry in a big way and commit the necessary resources and expertise to this. They will then become big players in this market. They might first take away business by servicing their existing clientele who wish to launch hedge funds. However, historical alternative asset managers have until now turned to specialist shops because of their experience and expertise,' says McCann.
A higher number of alternative fund administrators results in mounting competition. This can be beneficial as more competition would mean a greater choice for clients. Specialist alternative fund administrators are normally restricted in the resources and investment they can put back in the business, whereas larger mainstream administrators have the luxury of injecting money into training staff and the business.
However, in view of the competition that is emerging in the sector, there are different standpoints as to whether quality of service is being compromised or not.
Ellis says: 'There is potential for quality to be compromised, especially from the newer shops that have been set up because of manual systems workarounds and a lack of specialised staff. Also, some administrators become the victim of their own success when they take on more and more business but do not adequately increase the number or quality of staff. There is a need to keep up the investment in people and technology with the level of new business; what matters here is how many qualified staff they have per fund, and the cost per portfolio.'
However, McCann disagrees with this view and points out that competition has resulted with businesses having to keep up with competitors which is beneficial for the client.
'Generally, the quality of service is improving. Nothing focuses the mind more than competition. If other players are coming onto the market then you have got to be good at what you are doing. More competition has certainly been good for the industry as it has put pressures of corporate discipline and transparency,' says McCann.
The entry of mainstream administrators might run down the number of specialised staff in the industry and reallocate specialised labour from specialist shops to mainstream providers.
However, John Fitzpatrick, director of product development and technical sales, comments, 'Mainstream administrators are already looking into training their own staff. There is a combination of bringing external expertise into the business and training their own staff in both hedge fund and traditional administration. Ultimately, the industry will comprise people with expertise in hedge fund administration.'
Ellis also points out that the hedge fund industry is not based on an established legal structure. Hence more players in the market might cause confusion to the client. 'While there are movements in this direction, there is minimal standardisation in the hedge fund industry, with no standard legislation that would regulate hedge funds. The only consistency revolves around marketing funds to the masses. The present system operates under a caveat emptor philosophy,' he says.
This reflects upon the fund administrator as there are no standard ways of administering, and a client might need to shop around to find what he is looking for in a fund administrator.
However, GuÃ©rard argues that: 'Fees charged for administration vary from client to client based on the extent of the service required. For example, some administrators provide an NAV 'lite' whereby all the underlying transactions are not processed. In this case, the administrator's main role is to disseminate NAV information to the underlying shareholders. Usually the fees charged for maintaining such records are a lot lower than providing full administration work. Sometimes new entrants try to undercut market prices, but overall, large institutions and reputable independent managers are looking for quality and they have high expectation of service. Therefore they are also willing to pay what it takes.'
With the changes in the alternative fund administration industry, fund administrators are finding it vital to keep the competitive edge and invest massively in technology. Fitzpatrick comments on the type of system that is important for fund administrators: 'Fund administrators need to make sure they have the appropriate technology. This would involve a system that would cater for all types of funds with interfaces for different users. The more systematisation the less the risk of error. Also administrators would normally aim to operate on one platform so that every time there is an enhancement or change in the system, it is carried out only once.'
Funds of hedge funds have proved to be a particularly popular investment vehicle in the industry. Ellis says: 'Investing through a fund of funds is a way of getting people into the market without the concentration of risk, however, conflict may arise when it comes to disclosure of information about the underlying funds.
Unlike traditional funds where it is required, hedge fund information is not readily disclosed. Investors, particularly institutions, tend not to invest in anything opaque, and want to feel comfortable about what they invest in, on the other hand, they are not equipped or qualified to accept and analyse reams of data ' they cannot handle full transparency.'
• A higher number of alternative fund administrators result in mounting competition. This can be beneficial as more competition mean a greater choice for clients.
• The entry of mainstream administrators might run down the number of specialist staff in the industry.
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