How will costs change over the medium and long term? How much is it a factor in the choice of an administrator?

Smaller fund launches are proving a challenge to the industry although most are eager to gain new clients. Costs, however, are a key concern for both the administrator and fund management company. With pressure on fund managers to be more efficient, administration costs may come under the microscope, although few believe quality will be sacrificed for keeping costs down.

Jonathan White at Viteos Fund Services admits there is a challenge. “However, we don’t believe this will affect the cost of fund administration in the long term. There is little hesitation among larger funds to pay for quality, product and good service. The hedge fund industry has always believed in high-quality service providers and ‘you get what you pay for’,” he declares.

Deborah Yamin at State Street agrees. “The question about costs can be assessed more fairly when viewed under the lens of overall value delivered by a fund administrator and the ongoing automation and efficiency gains that can be provided to hedge fund managers. Leading fund administrators have the wherewithal to continually invest in and expand the scalability of their technology and operations infrastructure, as well as develop new software applications,” she points out.

“The aggregate costs can then be spread across many users versus being borne by an individual in-house operation, which could become unsustainable over time due to increasingly complex processing requirements,” adds Yamin.

While regulation may increase compliance costs, estimates vary widely. “It remains to be seen how deeply new regulations affect overall compliance and fund administration costs.

SEI’s David Morrissey does not believe fund administration will become a commoditised business. “By nature hedge funds are diverse in structure and process, so there’s always going to be a need for specialist expertise. And being able to provide high-quality services is also a value-add,” he notes.

“The lowest costs are always attractive but managers need to evaluate the risks in their due diligence and make sure they are comfortable with what’s being delivered as part of the solution,” he cautions.

“Fund administrators that leverage technology and offer innovative, highly automated services will continue to differentiate themselves from providers that utilise more manual, human capital-intensive processes,” notes John Buckley at Omnium. “Such premium services will both shape the decision-making process and influence customers’ willingness to pay more for a broader scope of services, particularly as investors increasingly value the control that third-party administration provides.”

In the experience of Northern Trust, most managers will consider a variety of factors – cost, service model, technology, innovation, management attention and focus – together with product range and financial stability, notes Ian Headon. “We have not seen many bids decided purely on price and we do not anticipate this changing over the medium and long term,” he states.

“However, we do anticipate that investment managers will seek greater transparency from their fund administrators from a cost perspective as well as greater demonstration of the value they provide in the servicing of their funds and underlying investors,” concludes Headon.

“The competitive environment is exerting downward pressure on price, with large administrators pitching aggressively for even modest start-ups,” notes Stuart Feffer at LaCrosse Global Fund Services. “But this is a temporary phenomenon that will reverse when assets under administration levels begin to approach pre-crisis levels,” he predicts.

He points out that in 2007 and early 2008, the larger administrators were hiking prices and terminating relationships with managers of up to $200 million in assets that were not performing well or were no longer growing.

“Credible fund managers understand the value to their reputation of embracing high standards of corporate governance and are prepared to pay for it,” declares Joseph Truelove at Kleinwort Benson.

Paul Stillabower at HSBC Securities Services believes costs will “almost certainly rise in the medium to long term and there is a strong possibility that costs will rise substantially.”

He thinks regulations, including the EU’s alternative investment fund managers directive (AIFM), will push costs higher, although who would absorb these costs needs to be determined.

“Currently, cost is very clearly a factor in the choice of an administrator, with many clients choosing the provider that offers the lowest cost. This will likely change over time as the importance of balance sheet and fiduciary liability becomes clearer,” he notes.

Hans Hufschmid at GlobeOp takes another view. “Cost is not the focus following the clear and decisive shift in the balance of power toward investors in 2009,” he declares. “Investors want to be reassured by a credible independent source that fund assets are real and valuations are accurate.”

Stephen Castree at Equinoxe sees a paradox: “Funds are seeking increased service, more depth of experience but wanting to pay less.”

“With management fees at 200 basis points (bp) plus performance fees, an administration fee of between 8bp and 20bp depending on fund style, volume, strategy etc to give comfort of existence and valuation is a fee worth paying. We would expect fees to trend upwards over 2010 and 2011 as the capacity in the industry adjusts and funds recognise the importance of quality and solidity over all service providers,” he predicts.

For Dermot Butler at Custom House costs are a major factor in a start-up, “but not a major factor going forward because, frankly, administration fees are still relatively inexpensive.”

There are two points of view relating to the future of administration fees over the medium and long term, notes Butler. One view is that they will rise because the requirements imposed on administrators by managers, investors and regulators will get stronger and that will increase the operating costs. The other view is that, as the administration function becomes more automated, costs will drop.

“In my opinion the increased reporting costs that are likely to be required by the regulators, as well as the potential requirement to establish a parallel fund in Europe or another feeder to a master feeder structure, if the EU AIFM directive is implemented, could cause an increase in fees, which would only be fair,” he says.

“Most administrators will have to make a significant investment in both technology and human resources to guarantee the viability of their business in these quickly changing times,” points out Akshaya Bhargava at Butterfield Fulcrum. “This is likely to increase the costs of doing business in the short term but will ensure a more scalable operating model which will work to keep costs down in the medium to long term.”

Therefore Bhargava thinks larger administrators, who can invest in an operating model now, will be more successful at keeping costs competitive in the long term.

“However, while many administrators in today’s environment compete on price, administration fees will likely become less of a deciding factor for clients over the medium to long term. The hedge fund manager of tomorrow is going to be more concerned with an administrator’s ability to provide the desired services in a consistent, accurate and timely fashion,” Bhargava concludes.

For David Aldrich at BNY Mellon, quality of service and safety of assets are the prime considerations of both investors and managers. “The cost of fund administration is mostly insignificant relative to the costs of financing and execution, and the critical issue is whether administration costs are delivering the quality and security that investors demand,” he says.

Taking a slightly different position, Liam McNiffe at Bank of Ireland Securities Services notes: “Despite increasing demands on administrators to provide more frequent reporting, administrators will seek to offset this increased cost through higher levels of straight-through processing and a greater degree of automation.” 

“Costs will not increase significantly but administrators will seek to add additional value-added services such as middle-office functionality, like trade matching and daily P&L, and charge accordingly for such services,” he says.

Currently the labour market is soft and, as a result, there is a lot of price competition among administrators, says Peter Hughes at Apex Fund Services. “As the world moves out of recession these models won’t work when staff become more expensive so these models will either increase their fees or go out of business,” he predicts.

“It is an important factor for smaller funds when they need to focus on returns but it is a false economy to choose an administrator without proper systems, independent pricing, web-based reporting and a SAS 70 as it will be a struggle to raise capital without these core requirements,” he concludes.