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Fund Servicing in Flux
Panel of experts cite processing, staffing and valuation concerns
October 1, 2007
Stability is not a hallmark of today's hedge fund administration business. Competitors have been piling into the crowded fund-servicing field even as consolidation thins the ranks, and funds' growing hunger for exotic instruments has given rise to new challenges.
In the last few years, start-ups, prime brokerage-affiliated administrators, management consultants and outsourcing firms have entered the fray. Meanwhile, large custodian banks, which once serviced only traditional institutional investors, have been building their presence in the hedge fund servicing arena through acquisitions: State Street Corp. acquired Investors Financial Services Corp., Citigroup purchased Bisys Group's fund servicing arm, JP Morgan Chase & Co. absorbed Paloma Partners' middle- and back-office operations and Bank of New York merged with Mellon Financial Corp.
While the handful of bank-owned administrators tout deep pockets and the capability to service a greater number of clients, the dozens of remaining independent providers say they are better able to assist funds with more complex strategies. Both are scrambling to keep pace with a hedge fund industry whose rapid growth and high profile lead some to question whether it can still be considered alternative investment.
There are 10,000 hedge funds worldwide, according to Aite Group. Single-manager funds have $1.4 trillion in assets under management and funds of funds $953 billion, estimates the Boston-based research firm. Even traditional asset managers are moving into hedge fund territory, most notably through vehicles such as 130-30 funds, which incorporate short-selling. In their quest for returns, funds are adopting increasingly esoteric strategies--and relying on their administrators to help process and report these trades.
The industry's expansion has left fewer experienced professionals to go around, which has led to increased outsourcing of operational work to third parties. This has placed pressure on service providers who are trying to stay on top of the growing demand for valuation of esoteric contracts and quicker reporting--tasks fraught with technological difficulties and legal ramifications.
To gain a better understanding of the changing face of hedge fund administration, Securities Industry News senior international editor Chris Kentouris posed a set of questions to several industry experts. Fund managers were represented on the panel by David Friedland, president of Aventura, Fla.-based Magnum US Investments and president of the Hedge Fund Association. The participants included two executives from bank-owned administrators: Drew Douglas, managing director and head of alternative fund services for HSBC in North America; and Allison Smaluk, SVP and head of U.S. global fund services for LaSalle Bank in Chicago, a recent entrant in the sector. Also on the panel was Christine Egan, business development manager for Miami's Kaufman Rossin Fund Services, an independent hedge fund servicer.
The executives were interviewed separately, and their answers were edited to fit the panel discussion format.
Can hedge funds still be considered alternative?
Douglas: Certainly hedge funds have become more mainstream and there is much greater transparency. That said, I still consider many of the strategies today alternative. While long-short equity funds and the newer 130-30 funds are bringing more traditional investors to the table, there are still many more complex funds that I see as alternative and continuing to become more complex.
There is an increase in private investments in many of the hedge funds we service. Valuation of these instruments can be very complex and the liquidity of these types of investments could put any modeled price in question. Many of these investments require a more robust accounting process, whether that is through side pockets or by establishing appropriate pricing practices with boards or auditors of the funds.
