Acquisitions of specialist administration firms by BNY Mellon and State Street reflect that the appetite for alternatives will not abate just because of the crisis, says Nick Fitzpatrick…
Client reporting has become more and more onerous for fund administrators over the past two years, particularly since the collapse of Lehman Brothers when administrators began to face frequent calls for evermore information, sometimes very granular and often relating to complex derivatives.
If smaller boutique admin firms, catering for alternative vehicles like hedge funds, do not like what the world of fund administration has become, then they can always sell their businesses. Recent acquisition activity by admin giants State Street and The Bank of New York Mellon, both custody banks, shows there is an appetite for deals.
State Street bought the fund administration unit from Mourant, a specialit services firm, and BNY bought PNC Global Investment Servicing from PNC, a US financial services provider. Both purchases extend the banks’ capabilities to service alternative investors.
Administrative complexity is never greater than in the hedge fund sector and if anyone thought that the financial crisis would see institutions take a ‘back to basics’ approach and return to simpler, quainter investments like blue chips and office blocks, then they need to think again. Cutting-edge investments – and the administrative challenges they bring – look set to define the future just as much as they did two years ago.
2009 hedge fund returns were the best in a decade and a recent survey by Deutsche Bank of over 600 investor entities with over $1 trillion (€0.74 trillion) invested in hedge funds found that just over a quarter of them will increase their allocations to equity long/short this year because they believe it will be one of the best performing strategies.
With inflows into hedge funds predicted to be $222bn – increasing the total amount of hedge fund assets under management to approximately $1.722 trillion by 2011 – challenges for fund administrators with hedge funds on their books are set to persist.
State Street and The Bank of New York Mellon have powered up their ability to offer administration for alternative investors with the acquisitions of Mourant’s and PNC’s fund administration businesses.
State Street’s purchase is still not finalised but when it is it will extend the footprint of State Street’s alternatives capability further into Europe and Asia. A big attraction for the firm is that Mourant will boost State Street’s knowledge base in these markets.
George Sullivan, chief operating officer at State Street’s alternative investments unit, says the intellectual capital that came with Mourant was important.
“The European private equity and real estate market is different to North America. We were present in Europe but we did not have as big a presence there before the acquisition of Mourant.”
Boosting the knowledge base in Europe is important for State Street due to changes in Europe’s Ucits directive that have allowed traditional and alternative fund managers to use derivatives to create hedge-fund-like strategies for a wider audience.
It is, largely, the greater use of derivatives that distinguishes alternative fund administration from traditional administration, as well as trading volumes, says Sullivan.
“The number and type of over-the-counter (OTC) derivatives have been more substantial in hedge funds, and now private equity firms are starting to use them as well,” he says.
Unbundling hedge funds
The financial crisis is forcing administrators to do more for less as service requirements increase at a time when profit margins have been under pressure.
Fred Perard, global head of fund services at BNP Paribas Securities Services, says: “My perspective is that complexity has increased along with reporting requirements and risks, yet there is no risk premium. Fee structures are not adapted [to the new environment].”
But he points out that the crisis has had benefits for certain administrators as investors have sought to unbundle their hedge fund investments.
“The crisis made everyone ‘discover’ collateral and there has been an increase in demand for independent collateral management,” he says.
Sullivan, at State Street, adds that because clients of hedge funds have driven their hedge fund managers to take risk management more seriously, hedge funds in turn have sought stable administration firms to help them.
And one way in which this help is manifesting is in the segregation of a hedge fund client’s assets from a prime broker’s balance sheet. Though ultimately a custody issue, it inevitably impacts administration.
Rick Stanley, head of product development at BNY Mellon Alternative Investment Services, says: “Institutional investors are much more educated now. They know the right risk management questions to ask and so we have to help hedge funds respond to their institutional clients’ concerns.”
The unbundling of custody from prime brokers’ balance sheets is as much a response to prime brokers’ needs as it is to hedge funds’ needs, though. For example, BNY has worked with Deutsche Bank’s prime broker unit to create the DB Integrated Prime Custody Platform. This allows funds to hold ‘unencumbered’ assets, which would normally be held by a prime broker, in a separate custody account held at BNY Mellon or another provider.
More sleepless nights
But surely all this greater work in the field of alternative services must mean more complexity, more reporting and more sleepless nights for those admin officers who have to worry about the timeliness and integrity of their data.
With the amount of technology available to support data management, it might come as a surprise that number crunching and reporting client positions is still such a concern. Why is it that admin officers do not always sleep well at night because they worry about reporting deadlines?
Part of the reason, according to Kirk Botula, chief operating officer of Confluence, a fund administration software provider, is the pace of regulatory and statutory change, such as modifications to accountancy rules imposed by various national and international bodies from time to time. He highlights as an example the SEC’s recent reform of money market funds that, among other requirements, expects fund holdings to be reported using XML language.
Other challenges for automation arise much closer to home, particularly the fast evolution of products and strategies from fund management firms themselves.
“Administration is a very dynamic environment, in some ways more so than trading. People invent new products that require new rules, but if the rules aren’t there yet then the systems will not be there yet either,” says Botula.
A survey by Confluence of 130 European and North American administration managers found that data integrity in fund reports is the issue that worries them the most and nearly 72% of respondents worry that manual processes impede their ability to meet reporting deadlines. About 60% of respondents want to replace their manual processes with automated technology in the next 12-24 months.
A fundamental issue with reporting is the transparency of investment strategies and processes. Investors want to know more about everything, be it pricing sources, counterparty risks, or what other types investors they are commingled with.
On this latter point Stanley, at BNY Mellon, says: “When the meltdown occurred some institutional investors were hurt because they did not want to redeem hedge fund investments owing to their long time horizon – yet many high-net-worth individuals did pull out.
“But institutions are much more educated now and they want to know more about the other types of investors that they are investing with.”
This sudden rise in education has meant fund administration has had huge demands put on it in a short space of time, while fees struggle to catch up. Administrators are still experiencing one of their toughest times, and more work for no extra reward will probably be the rule for many more months.
©2010 funds europe
