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“Yes We Can” —the mantra of the A Obama campaign—is starting to lose its luster. Just as we are realizing that the jingle isn’t enough to solve the current crisis, so too are hedge fund administrators changing their tune. “The time when you could say you could do anything and not have to back it up has passed,” says Jim Kelly, Chairman and Co-Founder of fund administrator HedgeServ.
Post-credit crisis, the fund administration business is more competitive than ever. The past three years have seen many administrators hit by falling asset-based revenues and fewer funds to compete for. Still, despite a shrinking hedge fund industry, with assets under management and leverage at lower levels than just a few years ago, fund administration has become increasingly important in the wake of Lehman, Madoff and other blowups, with clients and end investors demanding much more.
With the increased competition in the industry, administrators need to find a way to stand out from the crowd. As Jonathan White, Business Development Manager at Viteos Fund Services, points out, “Many end investors do not want to hear what a provider can or could do. They want to know providers are already actively doing these things for clients. They want a ‘yes we do’ rather than a ‘yes we can’ provider.”
Moving Up the Value Chain
Until recently, hedge fund administration was a commoditized business. Before the crisis, half the job of administrators was to keep up with demand. After Lehman and Madoff, a few things happened. Hedge fund assets declined significantly, which meant revenues for administrators went down. Administrators also have been forced to invest a lot more in their platforms in order to have a competitive, robust, and global infrastructure. Most notably, perhaps, has been the move away from providing only core administration services to offering more middle-office and add-on services with the industry’s renewed focus on risk management, regulation, transparency, and delivery of information. Thus, we are now seeing administrators, both big and small, quickly move up the value chain.
Timely and accurate NAVs, transparency in the valuation process, reporting, SAS 70 Level II certifications, liquidity, independent fund accounting—all of these things are now critical, as the increased participation (particularly from institutional investors) in hedge funds has raised the pressure on administrators to execute on these tasks reliably, accurately, and against the time demands set by the market and fund managers. “Being able to claim you provide full service is no longer just about doing books and records, it is about providing operational support,” says Viteos’ White. “Investors aren’t just ticking the box anymore. They are asking tough questions.”
With more scrutiny from investors— and fewer funds to compete for—not every administrator can win. With the move away from the self-administration of the pre-Madoff era, independent fund administrators are now in high demand but, in addition to wanting independence, investors and managers also are attracted to global brand names and well-capitalized administrators. Lee Partridge, outsourced CIO of the San Diego County Employees Retirement Association (SDCERA), questions the shelf life of smaller administrators, “Just as we (the end investor) often gravitate toward larger funds, managers also gravitate toward larger administrators. The sleep-at-night factor is much better.”
This is the challenge that smaller administrators have to overcome—and it appears that many are succeeding. “Some funds feel the need to put a big name in their docs, but for those who are truly focused on getting the right service, we definitely get a fair shot,” says Joan Kehoe, CEO of Quintillion. Moreover, small does not equate with limited service. As White argues, “We might be small but we are not boutique. We have complete coverage of all asset classes as well as global coverage.”
Going with the big names may have been the right decision pre-crisis but, with investors now more concerned with the back-office operation of hedge funds, funds are looking to administrators for solutions to their reporting and operational needs. White observes, “The conversation is no longer just about fees and services. Clients want to know how you are going to address their other business challenges.”
One Piece of the Puzzle
Still, hedge fund administration is only one piece of the puzzle. If Madoff taught investors anything, it is this: Buyer Beware. If anything, administrators are simply one line on a long list of due diligence requirements for asset owners when choosing a hedge fund vehicle. Partridge, who joined SDCERA shortly after the fund suffered large losses with hedge fund implosion Amaranth, reflects: “I don’t know that Amaranth could have been completely avoided. You really have to know your manager. I don’t think even today’s administrators could have prevented Amaranth.” With any potential misrepresentation of material facts, it is always good to get as much independent verification as possible—but administrators are not the complete solution, Partridge notes. “I think the larger issue is understanding the sources of risk and how they overlap with each other,” he adds.
While Amaranth may not have been avoided even with the best administrators, the industry seems to be maturing. This is the new era of fund administration—the ‘Yes We Do’ era, not just for administrators, but for managers, as well as end investors.