Building Bridges: Hedge Fund Administrators Prepare For The Future

Jul 6 2007 | 11:00am ET

Institutional investors represent an ever-increasing share of hedge fund assets, bringing about a sea-change in the way hedge funds—and hedge fund administrators—do business. 

“Investors are demanding more frequent reporting and greater transparency, and that’s the biggest change I’ve seen in the industry,” Christine Waldron, vice president of alternative investment products at U.S. Bancorp, says. “Institutions are driving great accountability and frequency of reporting.”

And they have the clout to do it. According to a recent study conducted by Greenwich Associates, institutions on average allocate just over 2% of their total assets to the space, but it has a big impact. Direct investments by endowments, foundations and pension funds now make up some 25% of assets managed by the world’s largest hedge funds, surpassing the share held by high net-worth investors and family offices, which is now 21%.

The study reveals that the institutional footprint is even larger than meets the eye. “The 25% of assets attributed to direct investment by endowments, foundations and pensions actually understates the institutional component of the hedge fund marketplace by a considerable margin,” Greenwich consultant John Feng says, noting that institutions in the fund of funds space account for another quarter of total hedge fund assets.

Institutions are used to certain levels of service previously foreign to hedge funds, but their presence is changing that.

“Institutional investors have increased demands on the manager, with greater demands for independence,” says John Alshefski, head of business development for SEI’s investment manager services division. “They want independent accounting, independent valuation, independent reporting. They are looking for complete independence of administration.”

And fund managers, responding to client demands, aren’t only insisting on greater independence, but a response speed heretofore unheard of in the alternatives industry.

Reporting deadlines used to be monthly or even quarterly, Waldron notes. “Now, there is estimated weekly performance. Even for the monthly numbers, the turnaround has shrunk to just four to seven business days.”

“Ten years ago, daily administration was unheard of,” Joe Holman, CEO of Columbus Avenue Consulting, a New York-based administrator, says. “Today, we have four clients who do it. You’re going to see administrators go much more to daily processing, which means there has to be an increase in technology.”

The growing desire for transparency and the insatiable appetite for new and more lucrative strategies involving complicated financial instruments are forcing administrators to place an ever-greater emphasis on non-human elements.

“Technology requirements and capital requirements are sure to increase and that is going to really force this industry to converge into institutional providers and boutique providers,” explains Alshefski.

Currently, there are almost 100 administrators in the space. But Citi’s recent purchase of BISYS’ administration outsourcing business raises the specter of voracious Wall Street giants gobbling up administrators in an effort to provide one-stop shopping for any and all hedge fund outsourcing needs. But with the flood of new funds and new assets pouring into the alternatives space, the “boutiques” argue that there will be a place for them.

“Inherently, there will be a large number of different providers, though there will be some consolidation,” Waldron says. Her firm, U.S. Bancorp, has $32 billion in alternative assets under administration, specializing in complex fixed-income products.

“Products are becoming more and more complex, so it certainly helps for an administrator to have expertise in a specific market,” she says. But don’t expect the boutiques to pass on multi-strategy funds. “More and more administrators are partnering,” Waldron says. “To assist multi-strategy funds, you find another administrator.”

The need to partner with fellow administrators isn’t just a matter for boutiques. Even the big guns may call for help when they have too much on their plate.

“Big administrators, like Morgan Stanley, Goldman Sachs and UBS are so successful that we get referrals from them because they’ve taken in their quota of work,” explains Holman.

But there is little doubt that some sort of consolidation will come, as the biggest players seek to increase their capacity and capabilities, and the smaller players seek to survive.

“As time goes by and the complexity of the assets within the hedge funds and the reporting tied to it increases, and as the regulatory environment changes, obviously the investment needed to keep up with that is going to be higher,” Northern Trust’s Potter says. “That’s when you’re going to see a little more consolidation.”

“There’s still room for new entrants,” says Holman, “but the barriers are high because there’s a certain level of credibility you need and a certain amount of investment in technology you need to make.”

With almost 30% of large hedge fund managers saying their administrators have poor competence, according to recent FINalternatives survey, not everyone is willing to leave it to the technology.

“My conjecture is that [larger administrators’] processes are not as straight through as they think they are, and there is a bigger human element in the fund administration process than some people would like their to be,” says Kelley Price, a principal at Bellevue, Washington-based fund administrator Price Meadows. “We have that human element and embrace it.”

Technology, says Price, can provide another false sense of security.

“Technology and securitization is permitting more and more investment styles, and I think that our current competitors, in their rush to grow, have taken on more managers who are doing more things that their current technology platforms weren’t made for,” he says.

Whether through people or technology—or, as will certainly be the case, both—hedge fund administrators are going to have to remain nimble to tackle the twin challenges of increasingly complex securities and an increasingly cloudy regulatory picture.

“I’ve seen this business change so dramatically, just in the past four years,” Phil Stapleton, CEO of San Francisco-based Conifer Securities, says. But he says the uncertainty won’t keep his firm from providing the services his clients want in the future.

“As long as we stay true to our objective, our opportunities will continue to present themselves.”

“Servicing the derivatives: Where does that continue to move?” Potter asks. “Which strategies are going to be the ones that will continue to grow? That’s the big question.”

The future is “a tough nut to crack,” he says, adding, “and that’s why we continue to work with our clients and ask, ‘Where are you going next?’"

by Jonathan Shazar

This article appeared in the July 2007 issue of FINalternatives Prime Brokerage & Administration.


In Depth

High Time For A Cannabis Hedge Fund?

Sep 30 2014 | 7:07am ET

Launching a hedge fund is always a gamble, but Leslie Bocskor's decision to launch...

Lifestyle

Griffin Donates $1M To Rauner's Illinois Gov. Campaign

Sep 22 2014 | 9:29am ET

Hedge fund billionaire Kenneth Griffin definitely has a dog in this fight. The Citadel...

Guest Contributor

Appraisal Ratio Key To Evaluating Hedge Funds And Other New Investments

Sep 29 2014 | 3:07pm ET

As a former finance professor Peter Hecht experiences heartburn every time he hears...

 

Videos

Editor's Note

    Must Attend Hedge Fund Charity Events For October

    Sep 30 2014 | 9:29am ET

    The crisp Autumnal days of October are upon us, and so are a few of the hedge fund industry’s favorite charitable events. If you have never been to Rocktoberfest, well, you are missing out. And for a quieter evening of sipping and socializing, stop by HFC’s Wine Soiree. Read more…

 

Futures Magazine

September 2014 Cover

High frequency market making

High frequency trading is not evil, it is not a conspiracy and it really is not new; it is the natural evolution of the professional trading community making markets, providing liquidity and hopefully...

The Alpha Pages

TAP July/August 2014 Cover

The Alpha Pages Interview: Senator Rand Paul

Senator Paul sat down in the debut series of the Alpha Pages Interview to discuss the broken tax code, regulation surrounding Bitcoin, and his plans for the 2016 Presidential election.