After a nervous period of retrenchment, service providers to the hedge fund industry are recruiting again and enjoying new enquiries, in particular from start-up funds launched by former bank executives that have left to go it alone. But the landscape has changed irrevocably, and in the post-crisis environment, administrators are playing a much greater role in the oversight of hedge funds.
“A lot has changed since Madoff, which has been good for the industry,” says Peter Hughes, group managing director of Apex Fund Services. “Investors realise that third-party administrators act as an additional check to protect their interests, and there is a move from those who used to administer internally to look out of house. A third-party administrator will add 10-12 basis points to costs, which is easily justifiable if it means eliminating fraud.”
US funds are also following the trend to adopt third-party administrators, at the insistence of European investors.
Both fund managers and their investors want to be closer to their data, demanding greater frequency, greater detail and often specific reports and risk analytics. Plenty of investors also prefer a separation of the admin and prime broker functions to reduce risk. Custodians continue to see an influx of unencumbered cash assets from hedge funds seeking to diversify away from their prime brokers.
“Independence is a growing issue,” says Hans Hufschmid, chief executive officer at GlobeOp Financial Services. “Institutional investors can see the advantage of having another set of eyes looking over things and that there is no gain in taking additional risk. So while an investment bank will often do the prime broking, execution and cash management pieces, the administration may go to an independent administrator.”
Its also been a big year for due diligence, as investors focus on operational risk, the one risk they can control.
“We have investors doing due diligence on the back office on a weekly basis, while 5-10 years ago that was never a feature,” says Joan Kehoe, chief executive officer of Quintillion.
Sophisticated investors are also making sure fund administrators are pricing securities independently and substantiating custody assets. Administrators report a groundswell in clients asking for full checks into the existence of assets, such as verifying title deeds to property.
Meanwhile the corporate landscape is one of continuing consolidation, particularly the purchase of alternatives specialists by bigger players as clients indicate they intend to expand in this asset class. In December, State Street acquired Channel Islands-based Mourant, making it the number one for alternative assets with $600bn (€440bn) under administration. In February BNY Mellon acquired PNC Global Investment Servicing, while Credit Suisse is in talks with Fortis Bank Nederland to acquire its hedge fund administration business.
Ongoing consolidation should lead to greater levels of scale-based standardisation and automation at the top end, but mid-sized administrators and smaller boutiques have to carve themselves a niche by offering specialist value-added services and client-centric service models.
Consolidated, in-depth reporting functionality across all asset classes can still be a differentiator. Regular valuation of illiquid asset types and collateral management have also been two areas of focus.
“Smaller asset servicing providers are in the position to react faster and with an individual touch,” says Moritz Ostwald, vice-president and head of sales management at Global BHF Asset Servicing, “especially when it comes to local services – for example, sub-custody or Depotbanking services in Germany. National companies have a better network.”
Mr Hughes also believes firms such as Apex can compete with big administrators because of their presence on the ground in 13 countries, whereas some big administrators operate out of huge and remote centres. “Our clients don’t want to be number 328,” he says. “They want to be fourth out of 20.”
Another service where smaller players claim to add value is in capital introductions, as virtually every fund is now open and actively competing for capital.
“Although a large number of small administrators have come into the market, there is space for them all,” says Dermot Butler, chairman of Custom House Global Fund Services. “Managers trying to set up hedge funds can’t afford the bigger administration providers.” Demand can also stem from the launch of a fund in an asset class the manager hasn’t previously invested in, and which the current administrator has no experience supporting.
“Well over half the business we’ve won is from conversion from big players, and we have not seen a lot of fee compression,” says Quintillion’s Ms Kehoe, though she admits that some clients are swayed by having a big name on the rostrum. “I would not say the fund admin industry is commoditised. Our experience is that fair fees are paid for quality services.”
She adds that the big banks have opaque balance sheets, but an independent firm has the accounts of a simple operating company, which appeals to some clients.
As the industry bifurcates, a group in the middle could lose their way. “It will be especially hard for mid-size companies without a clear focus, as they cannot offer the breadth of services the globals can offer and are not as specialised and flexible as smaller providers,” says Mr Ostwald. “The question is whether the globals will continue buying the business of the mid-size providers or whether there will be other alternatives such as mergers of equals.”
Bank-owned administrators like to say they have an advantage over their independent rivals in their ability to offer a one-stop-shop but, conversely, the large administrators can be competing with the funds themselves in some functions, risking conflict of interest. Bank-owned players can also earn revenues from custody and cash management services, and some even force their custody clients to use their administrative services, so they start with basic fees of $6,000-$7,000 (€4,400-€5,200) a month, while a second tier
