The makings of a new administration model
HFM Week "Comment & Analysis" by Jay Peller
Large managers are increasingly outsourcing a tailored set of fund administration functions to improve efficiency and control costs. As new regulations and increasingly complex collateral pools have forced hedge fund managers to step up collateral and treasury management activities, so they have turned to fund administrators for assistance. While once they might have chosen to do this themselves, no they are increasingly outsourcing.
In the past few years, hedge fund managers with a range of strategies, varying in size from $1bn to $15bn, have asked us to take on collateral and treasury management.
This is the most common example of how alternative asset managers – including private equity – are breaking the mould in administration by turning to us for selective outsourcing. Although previously the largest managers might have relied on internal, gold-plated systems or internally developed applications, for most areas of the middle and back office, this is changing.
The catalyst is the combination of fee compression and soaring technology costs. Such are the current technology demands on businesses that it makes greater sense than ever to turn to service providers with the scale to build the best technology systems.
Since the beginning of alternative investments 50 years ago, fund administration has had two basic models: either the manager has opted for full outsourcing or for the standard model, which involves manager and administrator running dual books and records. In the latter case, the fund manager benefits from keeping control of books and records but they are also verified externally.
But over the past five years, managers have started to dilute the standard model by outsourcing some areas but keeping control of others. With profitability under pressure, the number of managers choosing this form of bespoke outsourcing is growing and looks set to increase still further. There is good reason for this. Under the standard model there are dual books and records – run by two separate teams with two different accounting systems. Selective outsourcing not only cuts costs by eliminating duplication but also provides access to best-in-class systems and expert people.
LARGE MANAGERS USED STANDARD MODEL
Typically, it is large hedge fund managers specialising in complex investment strategies, such as credit and multi-strategy, that have used the standard model. They have opted for the dual books and records approach in order to keep control of critical tasks, including middle- and back-office processing. By contrast, newer hedge fund managers, initially those specialising in long/short equity and other less complex strategies, have tended to opt for full outsourcing. Now we are supporting some of the most complex of hedge and private equity funds.
Fee compression is encouraging large managers to look into bespoke outsourcing, also known as the ‘administrator co-sourced model’. They are openly discussing it as they seek to make their businesses more efficient.
Recently, several of Citco’s large clients – which between them pursue a wide range of strategies, including global macro, multi-strategy, fixed income, private equity and real estate – have opted for a bespoke model. Most commonly, the areas they choose to outsource include investor transparency reporting, regulatory reporting, risk reporting, tax services and treasury/collateral management.
For example, one large global macro fund has outsourced maintenance of its books and records to us, which would have seemed unlikely even 10 years ago. In the private equity sector, one of the world’s leading private equity firms chose to outsource a wide range of its administration functions to Citco in 2014. This involved transferring a team in excess of 30 people to Citco.
MOVING TO A BESPOKE SOLUTION
How do fund managers decide what to outsource? Typically, they work with Citco’s client solutions team to identify their ‘pain points’. Generally, they will select one or two areas to outsource. Every manager has a different infrastructure and staffing, so the solution will always be different. However, the outcome is typically more efficient and scalable.
By selectively outsourcing in this way, managers are cutting back on duplication and cost while keeping control of key areas. They appreciate leading service providers are continuing to invest heavily in technology at a time when older inhouse systems may no longer be efficient. We expect more managers to adopt bespoke outsourcing. It is a new model that is breaking the traditional fund administration mould.
Published in HFM Week