The financial crisis and myriad hedge fund frauds have been a wakeup call for investors. Institutional investors have become especially astute when it comes to doing due diligence on every aspect of a fund—including the service providers and the technology that funds employ.
Andy Smith, executive vice president of fund administration firm Butterfield Fulcrum, recently spoke with FINalternatives about how the hedge fund administration business has changed and what investors can expect in the future.
How has the fund administration industry changed recently?
There was a time when hedge funds would perform due diligence, choose an administrator, and report their choice back to investors after the fact. Now, investors are inserting themselves firmly in the process and performing due diligence visits and are coming on-site to see the operations and ask questions. These investors have varying levels of understanding about the complex technology involved to deliver a timely and precise NAV. So the ability to explain complex technological processes in plain language is becoming a real competitive advantage in this industry.
Are today’s hedge fund investors more in tune with the administration of their funds?
Yes. Last spring the AIMA (Alternative Investment Management Association) reported that the majority of hedge fund assets under management are from institutional investors. That means mainstream pension funds are looking to alternative investments to help boost returns and pick up lost ground. Our clients are the alternative investment firms, but our fiduciary responsibility is to the underlying investors in those funds. And we can tell you that we are seeing an increase in due diligence visits to our offices from institutional investors looking for information.
What are the technological abilities required to meet the demands of investors?
Investors want a clear look into the progress of their investments and fund managers want to preserve the confidentiality of their underlying strategy. Technology is needed that bridges that transparency divide and instills confidence among investors who are increasingly becoming institutions responsible for retirement funds. Like FedEx tracks packages, hedge funds will need to track investments continuously and in real time. It has become a good selling point to investors if you can claim to have systems in place which exceed even the most stringent requirements of the law.
So it comes down to the classic “buy vs. build” decision. Hedge funds need to consider a technological infrastructure that provides core fund accounting and reporting that provides transparency right down to the portfolio level. As we all know, this is new territory for many hedge funds. And it can be expensive. Plus, we believe that any regulations will require some level of an independent view in to the books and records, so it is worth considering how much you want to do in-house anyway. As a result, we think more funds will be looking to do more through third parties, which bodes well for technology providers and independent administrators like us.
What do you see in the coming year for hedge fund administrators?
There are a lot of forces coming together that will make the months ahead a very dynamic time in the industry. While proposals from regulators are being debated in Europe and the U.S. that focus on how transparent the hedge fund industry should be, investors and hedge funds are proactively seeking more transparency as a differentiator. This creates a great opportunity for hedge fund administrators to step up and be a great partner for hedge funds looking to attract assets by offering greater clarity into valuation.
Also, this could also be the year managed accounts start to take off. Managed accounts currently represent 3-4% of alternative investment assets. Depending upon which consulting firm you listen to, that figure is predicted to rise up to represent between 10 and 20% of alternative assets in three years.