Introduction
Choosing the right hedge fund administrator is one of the most important decisions that an investment manager can make and failure to do so could be costly to a fund. The administrator plays an invaluable role and will generally provide investment accounting and valuations, shareholder services, corporate secretarial services, domiciliary compliance, and assistance in the preparation of financial statements. A good administrator can remove all administrative headaches allowing the investment manager to focus on its trading activities. It is important to note that time spent on choosing the right administrator may save time in the long run.
In the past there was a distinct separation between the administrators and the large prime brokers: the latter provided typical brokerage services such as execution of trades, stock lending and (leveraged) finance whereas the administrators were the typical 'back office' of the investment managers. This boundary is getting less distinctive. Traditional administrators-such as Fortis in the past-are evolving into full service administrators, custodians and banker/financiers, simply by using their banking divisions. Lately, typical prime brokerage firms are buying administrators in order to be able to offer the same 'one stop shop' concept to their clients.
Changing environment
An administrator essentially performs the duties of a CEO,
CFO and Company Secretary and reports to the board of directors
of a fund. The administrator will also be the principal point
of contact for investors, other service providers and the
regulatory authority of the fund. Choosing a professional
administrator who has experience in servicing funds of hedge
funds and hedge funds will enable the directors and the investment
manager to focus on their own tasks, rather than having to
get involved in administrative issues.
As hedge funds become more accepted as a recognised asset class, their appeal is extending to a wider range of investors. Traditionally, institutions and sophisticated private investors accounted for the majority of investors in hedge funds. However, increased participation from pension funds, insurance companies, family offices and retail investors, both directly and through funds of hedge funds is more evident now. Institutions and asset allocators who are investing on behalf of their clients apply strict fiduciary responsibilities and investment restrictions whereas retail investors attract higher levels of protection from regulators.
As a result of increased interests of other investors as well as a continuous search for better risk/return rewards, the popularity of funds of hedge funds is growing by the day. Funds of funds account for the largest growth in the entire alternative investment arena. Not surprisingly, this leads to specialist service providers for this particular group. So far, only a small number of banks are able to leverage funds of hedge funds or to provide general financing facilities. However, the number of banks that are developing these techniques is expected to grow.
In recent years there has been a notable growing trend for funds of hedge funds and hedge funds to be domiciled or listed and administered in highly regulated jurisdictions, leading to a burgeoning industry in European offshore locations such as Ireland and Isle of Man or at more "exotic" locations such as the Cayman Islands and BVI.
Traditional Administrative Tasks:
Pre-launch Assistance and Administrative Support
An administrator can provide considerable assistance during
the set-up phase of a hedge fund. An experienced administrator
will be familiar with, and able to explain, all activities
prior to the fund launch as well as the complex structures
utilised for hedge funds and funds of hedge funds. Structures
can range from plain vanilla stand-alone companies with a
single share class to more complex Master/Feeder structures
encompassing multi-currency share classes each with different
methods of calculating management and performance fees. In
addition to understanding complex structures, the administrator
operates the fund strictly in accordance with the prospectus
and can provide advice from a procedural and operational perspective.
The administrator can liaise with the fund's lawyer, review
and comment on the prospectus and agree appropriate wording
relating to the operation of a fund. Some administrators will
employ a new business support team to manage pre-launch operational
issues. This can greatly assist in the resolution of any teething
problems experienced by a fund.
Calculating the NAV
One of the primary tasks of the administrator is to reconcile
the books and records of the fund and ultimately produce the
net asset value within the agreed deadline. The timeframe
for producing an NAV is becoming increasingly tight and typically
ranges from between one to five business days following the
NAV date. This is critical as any delays in the release of
an NAV can cause concern amongst investors. Hedge funds often
require more frequent calculation of estimated net asset valuations
that compel the administrator to process trades and cash on
a daily basis. In order to meet these deadlines, an administrator
must have the ability to interface with the prime broker and
fund manager. Without a high quality software interface, an
administrator will struggle to meet deadlines and may expose
itself to errors through manual intervention. The administrator
may also be responsible for instructing payment of all fees
and expenses of the fund including management fees, performance
fees and other operating expenses.
As the investment manager may enter into complex transactions including short selling of securities and the opening of various short and long positions, it is vital that the administrator can record and report the details accurately. Therefore, it is important that the administrator is in a position to understand the fundamentals behind the hedge fund strategies. In most cases, prices for listed securities are readily available from mainstream pricing sources. However, pricing for some of the more esoteric OTC instruments are more difficult to obtain and can present an onerous and manual task for the administrator. They may require quotes from calculation agents or broker/dealer counter-parties. The administrator must at all times maintain independence in the operation of a fund in respect of the recording, reconciling and pricing of securities.
Communicating with Investors
The administrator is responsible for on-going communication
with the funds' investors and for delivering information pertaining
to their holdings in a timely and efficient manner. Furthermore,
the administrator is required to deal with more complex queries
from investors on issues such as performance fee equalisation.
The administrator also maintains the fund's share register
and investor details, carries out all client identification
checks, processes all dealing transactions such as subscriptions,
redemptions and transfers to the fund, maintains client subscription
accounts of the fund, makes redemption payments, distributes
investor statements and investment manager's reports, if required.
Recent trends and changes in regulation has forced the administrator
to enhance its systems to track and report on anti-money laundering
or 'know your customer' documentation and issues relating
to the eligibility of investors to invest in a particular
fund. Prospective investors are required to confirm whether
they are eligible to invest in the fund, whether they are
Qualifying or Professional investors, ERISA plan holders and
also whether they are eligible to invest in hot issues. The
administrator should ensure that appropriate automated investor
systems and procedures are in place to track and monitor the
aforementioned issues.
Preparing Financial Statements
As well as providing the core services to the fund, the administrator
may prepare the fund's financial statements in accordance
with current accounting and regulatory requirements. The administrator
liaises closely with the fund's auditors to ensure timely
completion and distribution of financial statements to shareholders.
In addition, the administrator may also be responsible for
the filing of the financial statements with the relevant regulatory
bodies and stock exchange, where applicable, on a timely basis.
For some clients, the administrator may be required to provide
tax reporting for funds in various jurisdictions, under the
advice of the fund's tax advisors.
Corporate Secretarial Services
Where requested, the administrator can provide full company
secretarial services and will ensure that all companies law
and regulatory requirements are met. The specific tasks performed
by the administrator in a company secretarial capacity include
maintenance of statutory books and records, ensuring required
filings are made with the fund's local regulator and companies
registration office and the convening and holding of both
board and general meetings. Promoting good corporate governance
at the fund level is also an objective of the company secretary.
Due Diligence
The quantity of due diligence requests being submitted to
the administrator is increasing. Investors want more transparency
and, as a result, the administrator needs to fulfill more
onerous reporting requirements. In addition to the investment
manager, investors are becoming increasingly concerned about
how their funds are being administered. Institutional clients,
in particular, are focusing much more on compliance and due
diligence issues and some may go as far as to ask for biographies
of staff involved in the administration of their funds. It
is also essential that administrators act independently of
the investment manager especially when it comes to the pricing
of a portfolio. A well-known and experienced administrator
with a global presence can often provide comfort to investors.
Adding value: custody and finance
Those administrators that are capable of providing custody services benefit from the fact that they have an ideal position as financier as well: the collateral that is needed to provide bridge finance or leverage finance is already registered in their name (as nominee). There are only a handful of custodians large enough and with the necessary balance sheet to provide this combination. Some of them are also providing stock lending as a service, based upon their own assets under custody.
Calculating leverage
The percentage of leverage which can be offered to a fund,
whether it be a hedge fund or a fund of funds, is determined
by the quality of the investment portfolio. Factors such as
liquidity and rating of the stocks, diversification of the
portfolio and, of course, the investment strategy play an
important role. Just as important, however, are 'soft' factors
such as the track record of the investment manager and the
quality of the underlying administrators. Hedge funds traditionally
have been provided leverage by their prime brokers/custodians
and for the calculation of this percentage, there are a number
of systems on the market. Since funds of hedge funds do not
necessarily need a custodian (their holdings are interests
in investee funds rather than exchange-traded equities) such
systems have not yet been developed widely for the leverage
of this type of investment funds. Again, there are only a
handful of banks such as Fortis that have developed internal
systems in order to be able to provide leverage to funds of
hedge funds.
Finance is mostly provided in the form of a current account
facility, which can be used for:
- leverage of the fund on an ongoing basis;
- bridging of a possible mismatch between incoming subscription
money and redemption amounts to be paid out; and
- margin calls for FOREX and other hedging transactions
Conclusion
In recent years the traditional roles of administrators versus prime brokers and banks have become more diverse. This enables an investment manager to choose the perfect match for his fund, whether he only needs a 'simple' administrator or a high-level investment banker and custodian as well, capable of tailoring complex financial products to his needs. In choosing the right service provider, an investment manager should consider visiting the administrator's office to meet face to face with those responsible for the fund's administration and its meeting its financial requirements. Meeting with the service provider will help the investment manager get a feeling for what he can expect from them on a day-to-day basis. Written or verbal references from existing clients of the service provider are sometimes a useful indicator of the level of service provided.
The investment manager should view the relationship with his service provider as a partnership that can provide flexible solutions as its business grows.
