How important is independent third-party outsourcing of administration for a fund?

While an independent third-party administrator is usual for European-based fund managers and is often a legal requirement, funds in the US are still resisting the move. However, investors are keen to see separate and independent verification and checks on all aspects of a fund’s activities, so many expect the vast majority of funds to outsource administration in future.

Independent administration is absolutely critical for a fund, declares John McCann at Trinity. “Self-administration seems to be the prevailing and recurring theme of many of the greatest hedge fund failures to date,” he adds.

McCann says investors can influence the fund’s choice of administrator or lack of independence. “Two of the biggest investors in hedge funds – Union Bancaire Privée and Mirabaud & Cie – along with the hedge fund Millennium’s decision to outsource all of its administration to an independent party are clear evidence of this growing trend,” concludes McCann.

At State Street, Deborah Yamin says investor-driven demand for greater transparency has “taken hold and continues to become a ‘best practice’ across the industry”. Over the past 12 months, she points to several multi-billion dollar, self-administered funds such as DE Shaw Group and Caxton that “validate the importance of this trend by contracting with third-party administrators”.

“Leading administrators have now not only caught up, but have demonstrated a proven, outsourced operating model that lends credibility to an increasing role for independent fund administrators,” she concludes.

Investors are now expecting managers to have independent administration of their funds, says David Morrissey at SEI. “In this environment it makes even more sense to outsource. Companies want to avoid large capital expenses involved with building or maintaining technology, system upgrades, disaster recovery and so forth,” he says. He also believes fund managers will want all their resources focused on their core competencies, managing assets and servicing clients.

Northern Trust believes independent administration is a critically important part of a fund’s governance structure, according to Ian Headon. “While there are many reputable managers who self-administer, we believe that as managers look to respond to investor demands, the creation of a world-class governance structure is essential, and that a quality independent administrator is a critical part of that environment,” he comments.

“A number of managers are looking to outsource this function to enhance investor comfort,” agrees Joseph Truelove at Kleinwort Benson. “Most managers would prefer to outsource this specialised work to a reputable institution with the relevant systems, experience and qualified staff, rather than become involved in additional non-core activities such as administrative services,” he adds.

Paul Stillabower at HSBC Securities Services agrees with others. “Following the events of 2008, it is pretty clear that fund managers will struggle to attract or retain investors unless they have high-quality, third-party administrators. The urgency to have a third-party administrator varies from region to region and country to country, but we expect that it will standardise globally as a core requirement over the next five years, whether through government proscription or investor demand or both,” concludes Stillabower.

“It is essential,” notes Hans Hufschmid at GlobeOp. “True administrator independence – un-conflicted by trading, custody or lending activities – has increased in value to investors concerned about conflict of interest or counterparty exposure,” he notes.

Stephen Castree at Equinoxe agrees that it is “absolutely imperative that a fund use an independent administrator to provide comfort to investors on the existence and valuation of the fund.” He believes as a manager seeks larger and more institutional investors, this need increases. “In 2010 the ability to self-administer and raise capital is very rare unless is the purely manager money with no intent to market the product,” he says.

The independence of the administrator, offering independent valuation and independent asset verification, provides considerable comfort to investors, agrees Dermot Butler at Custom House. “Complaints by managers – usually exclusively in the US – that they already have the infrastructure and are able to provide administration are not really valid, because any manager worth its salt will be carrying out most of the middle- and back-office accounting functions in order to be able to apply their risk management procedures,” notes Butler. “The independent administrator is there to provide independent comfort to the investor that both the prime broker and the manager have got it right,” he adds.

Citi’s Richard Ernesti thinks regulatory oversight and compliance requirements will grow rapidly in frequency and complexity and this will drive the move to independent third-party administrators. “Outsourcing key support functions to third-party service providers is increasingly becoming the industry norm. The industry will converge towards traditional asset management, resulting in significant revenue opportunity for service providers,” he predicts.

“Investors are concerned with transparency, consistency and avoidance of doubt,” notes David Aldrich at BNY Mellon. “Third-party administration of funds is a key tool to help alleviate investors’ worries but the selection of the administrator partner is as important as the fact that a provider is nominally independent,” he adds.

Peter Hughes at Apex believes “it is just the US market that hasn’t grasped the value that can be added by having independent checks, proper technology and passing the administration cost from their own books to a fund.” He reveals that Apex’s US office receives 20 requests for proposals each month and converts only 10% into clients compared with a conversion of 40%–50% in offices outside the US. This, he says, “shows the US market is finding out more but is not yet prepared to act. The fact that the main Swiss allocators have clearly stated that they won’t invest in self-administered funds seems to have passed them by.”