This article was originally published in HFMWeek’s special report Future of Hedge Fund Administration 2018.
HFMWeek (HFM): With continued M&A activity, will administrator services be enhanced or diminished?
Jason Cholewa (JC): The effect of M&A activity on service is going to depend upon two things: 1) how the acquisitions are handled from an operational standpoint, and 2) if the firms being combined are complementary to one another. If the acquiring firm’s strategy is to simply increase assets under administration with little thought given to the likes of technology, policies and procedures, and culture, clients will likely see a diminished level of service.
Conversely, if the consolidation is well thought out and each firm brings varying skills and expertise to the table, clients will likely see an enhanced service offering. As firms merge, there is always the opportunity to learn from one another and take a “best ideas” approach to future operations. Through collaborative efforts and a successful integration, the administrator will be positioned to achieve operational efficiencies and provide its clients with new and enhanced services. Additionally, and where the combining firms share a similar culture and vision, the clients will be the ultimate benefactors through the receipt of improved customer service. As this cultural synergy is not always attainable, the divergence of firms with and without a focus on consistent, quality customer service will become starker.
HFM: How will changes in technology affect fund administrators?
JC: Increased operational efficiency has, and continues to be, the primary focus for most fund administrators. Ten years ago, core administrative functions like booking trades, maintaining security master files, reconciliation, and pricing securities consumed tremendous amounts of time. Improvements in technology and system upgrades have allowed administrators to streamline and automate certain functions – factors which help reduce the hours required for an engagement and the number of accounting errors that could result. From a workflow perspective, this has created a commoditisation of the service. This has also resulted in drastic fee compression.
The new technology focus has turned outward. With operations becoming extremely automated and streamlined, the next stage of technology development is all about the client experience. The types of reporting available, the delivery methods of information, and the scope of the data available are paramount to future technology initiatives. Administrators are increasingly being asked to provide reporting outside of traditional accounting and investor records, with a focus now on portfolio analytics and risk metrics. Administrators have much of the desired information and it is simply a matter of providing an interface with which clients can access this information in a meaningful manner and with ease. The industry is responding and we are seeing administrators developing and deploying enhanced user interfaces and secure communication portals for fund managers and investors.
HFM: How is the growth in closed-end structures (PE) changing the admin servicing model?
JC: We have seen a convergence between the typical hedge fund (open-ended) and private equity fund (closed-end) structures. Many hedge fund managers have launched or are considering launching closed-end funds, where the investment strategy is a less liquid version of an existing fund’s strategy. Conversely, a growing number of closed-end managers, particularly those investing in real estate, are launching open-ended funds that have a more liquid strategy. In addition, new funds are launching that are true hybrids, with characteristics of each structure incorporated into a single model.
Historically, fund administrators have either serviced hedge funds or private equity vehicles but usually not both. As existing clients diversify their fund structures, it has become essential for administrators to understand the mechanics and operational nuances of both types of fund product. Some administrators have addressed this issue through the acquisition of another firm that has complementary expertise and service lines. Others have taken a more homegrown approach by building out the relevant expertise. In either case, it is imperative for a firm to take a holistic approach to servicing both structures, especially when considering hybrid funds. In all cases, and regardless of the structure, a servicing team needs to understand the particular mechanics of the fund type in order to provide adequate administration services.
HFM: As the investment landscape adapts, what are the new challenges for fund admins?
JC: The investment landscape is continuously changing, and with this change new opportunities arise. Based on various macro environments, we have seen trend shifts that demonstrate an increased demand for distressed debt funds, global macro funds, and less liquid portfolios, such as those that deploy direct lending. Each type of portfolio has its own distinct set of accounting and workflow challenges for administrators. With prolonged exposure to new asset classes, and many times through a trial-and-error approach, characteristics specific to a particular strategy become more well-defined and the related challenges get solved.
Cryptocurrency funds are a great example of a somewhat new phenomenon that the entire industry is trying to wrap its collective head around. From an administrator’s perspective, there needs to be an investment of resources so as to determine the best way to gather sourced information, verify the existence of assets and process transactions. Another consideration that funds and administrators will need to tackle is whether investor subscriptions can be processed in coin versus a fiat currency and what each might mean for purposes of anti-money laundering compliance.
From an opportunity standpoint, there has been a sharp rise in the launch of cryptocurrency funds. A handful of fund administrators have embraced the servicing of these products, though most remain on the sidelines. There will likely be a shift in the willingness to “figure it out” once there is clarification on how the custody rule will impact cryptocurrency funds and whether or not these funds can actually reach a critical size.
HFM: What new structures are managers developing to accommodate new investor bases, and how are those structures complicating the work of fund administrators?
JC: In addition to the open-ended/closed-end hybrid fund structures, there has been an increasing shift in how capital is raised. A large number of managers have, or are in the planning phase, of launching new closed-end funds, structured as 3(c)(7) private placements and targeting capital through traditional RIA channels. The funds are being sold through the RIAs to high net worth investors, who are charged front-load fees. The capital raising period is similar to that of a private equity fund but with monthly closings and all capital called at each closing. Likewise, public REITs embody a similar distribution methodology and accounting treatment approach.
Most fund administrators are currently not servicing public REITs, and the biggest obstacle to such a client base is not on the portfolio side but related to the processing and maintenance of thousands of investor capital accounts. Fund structures and terms are allowing managers to reach new pools of investors, and as the industry continues to grow in new ways, it is critically important for fund administrators to keep up with the logistical demands of their clients.