Fund Administration Special
GPs may dream of a future where fund administration gets cheaper and simpler, but they’re more likely to get hoverboards first. One fund manager says he has employed more people in the back office than he has doing deals over the years, leading him to wonder if he was actually in the business of investing. The realisation made him outsource his fund administration, and he’s not alone.
Fund administration has only become more complicated as more fund managers raise larger pools of capital and invest in more domiciles. Limited partners are putting pressure on costs while demanding better reporting from general partners. So, many firms are happy to outsource the headache, which created a boom among service providers, with a wave of new players and plenty of M&A.
But the headache has been transferred to fund administrators, requiring them to make major investments in technology and talent. Administrators may then find themselves in a hyper-competitive future, as larger, more complex GPs demand more from their service providers.
While it’s not quite Fury Road out there for fund administrators, GPs who don’t outsource should pay attention. They may have to join the arms race, by making investments to keep up with industry standards. This, in turn, can drive outsourcing.
Unlike hedge funds, where nearly 90 percent of firms outsource fund administration, only 30 percent of private equity and real estate firms use a third party. According to a recent study from Preqin, that is likely to jump to 45 percent in 2018.
Regulatory complexity makes fund administration costly, labor intensive and top-of-mind for LPs. Satisfying the requirements of regimes around the world can be hard for an in-house team.
“From AIFMD to FATCA to the new privacy regime in Europe, it can really burden a chief financial officer’s staff,” says David Bailey of Augentius.
At the same time, LPs are demanding more transparency while being sensitive about cost. “CFOs are essentially being asked to deliver better reporting on a smaller budget, which makes outsourcing an attractive option,” Bailey adds. And LPs like the independence of a third party, with one admitting that if an administrator they trust is servicing the fund, they don’t feel the need to double and triple check the numbers.
One task at a time
Even the larger groups which may not outsource their entire operation rely on third-party administrators for smaller projects. “Some of our clients are looking to outsource certain tasks, just to address bandwidth issues,” says Krista McCoy of Leverpoint.
Others are tapping third parties for certain geographies. “They may come seeking Dutch expertise or to look after a Luxembourg feeder fund,” says Bailey. “And what happens over time, as we handle those smaller tasks, is they feel more confident about outsourcing more and more of their work.”
GPs don’t need to use fund administrators to recognize the growth potential of the market. Many have invested in the sector, such as GenStar, which bought Apex Fund Services and Equinoxe Alternative Investment Services to create a single fund administrator. It went on to purchase Deutsche Bank’s Alternative Fund Services business in October.
The Deutsche sale wasn’t an outlier. Experts find more and more big banks like Wells Fargo and Credit Suisse are shedding their fund services units because of the regulatory risks and the high cost of continuing to invest in the technology and expertise required.
“There will be an expanding gap between those administrators that invest in their people and their technology, and those that can’t,” says Jeff Gendel of Gen II Fund Services. “The barrier to enter this industry and to meet client demands is getting higher and higher.”
Some small and mid-sized service providers are looking to scale up their offerings through M&A, especially into new geographies. The Luxembourg-based Alter Domus Group acquired Courtland Capital, which is based in Chicago, in November, while Maitland Group, also in Luxembourg, acquired Phoenix Fund Services to enter the UK market.
Geography is a key element to the administrator’s offering. “GPs are marketing on a global basis,” says Bailey. “A firm that raises $500 million for their debut fund is likely to look at raising close to a billion for their second, and that often requires international investors, with international concerns.”
Best of frenemies
Not every administrator has the means to buy their competitors. Some choose to build a network of strategic partnerships that can be tapped as their client grows. And not all those partnerships are with other administrators.
“A lot of firms are vying to serve this space, on a number of different fronts,” says Cesar Estrada of State Street. “Some are figuring out a way to digitise more of the process, some are expanding their service offering to include data management and analytics, and some are looking to address gaps in the current service model.”
So, Estrada finds himself in situations where his firm will partner with a firm in one situation and compete with that same firm in another. “It’s about finding ways to capitalise on these ‘frenemy’ situations which will be increasingly commonplace in the future.”
However, there are times when the service provider will have no choice but to spend capital to address the problems that fund managers are outsourcing to them. Technology is a major spend – a recent survey of administrators by Longitude Research found that 89 percent of them expect to make investments in new systems and technologies by 2020.
Investor communications will always be a vital part of fund administration, and technology has already done plenty to improve the speed and volume of data being shared. But there is a paradox at the heart of LP reporting. As McCoy points out, while LPs want transparency, too much data can be hard to sift through. “It can be a double-edged sword, but that doesn’t stop it from being our core focus.” The key is being generous with information in ways LPs can digest.
“We’re aiming to set up our systems so that LPs can look at asset-level data as if they were looking at their very own fund,” says Estrada. “We’re not there yet, but it’s our north star.”
Artificial intelligence will help, but it’s not quite clear how yet. “We’re in the early stages of AI in the industry, so it’s hard to say where it will go,” says Rishi Khanna of SS&C Technologies. “But we think it’ll vastly improve data gathering and collection first, and that may be in the next few years.” Khanna expects AI may eventually upgrade data analysis to impact valuations and idea generation.
But providers can’t focus on data management to the exclusion of data security. “There’s an enormous amount of investment in information security, especially in light of new regulations like General Data Protection Regulation and the Securities and Exchange Commission’s continued focus on the matter,” says Gendel. GPs and service providers complain about the costs of the training, testing and software which still doesn’t guarantee a breach-free existence. “The costs of staying on the cutting edge is rising exponentially,” says Gendel.
Even if a service provider spends big on reporting systems and security protocols, there’s a new front in the tech wars. “There are now technologies to track the workflow of fund administrators,” says Bailey. “GPs can see exactly where a provider is on distributions or drawdowns, so it’s complete transparency.”
Even the best technology can’t ensure a service provider keeps its clients happy.
“Fund administration is a people business that is buttressed by technology, not the other way around,” says Gendel. “So, we invest heavily in the training and professional development of our staff, which leads to higher retention rates.” His firm hired an executive devoted to training.
Every fund administrator we spoke to for this story stressed the need to get and retain top talent in the space. “Turnover is a huge concern for the industry,” says Kevin O’Neill of Broadscope Fund Administrators. “We’ve been fortunate to have a very low turnover rate and we’re always focused on keeping it that way.”
That effort requires ensuring compensation is attractive and that young associates see a long-term career path. That takes time and money in an industry where clients are sensitive to cost. Further complicating the question of talent is the fact that some providers are expanding their suite of services.
“In the past, the industry has viewed the administrator role as a matter of offering accounting, reporting, and other investor communication,” says O’Neill. “It has become much more robust. For example, we provide significant assistance with regulatory and compliance matters.” One example is Broadscope’s ability to provide anti-money-laundering/know your customer or Foreign Account Tax Compliance Act assistance.
If outsourcing is indeed the future of fund administration, it prompts the question, how happy are those firms who have done it? In a recent survey from Preqin on GP satisfaction with service providers, administrators did not fare well. More than 36 percent of respondents had switched their administrators within the year, while only 20 percent of them changed placement agents or auditors, and 24 percent changed law firms.
GPs cited cost, portfolio complexity, an inability to cope with regulation and a dissatisfaction with the quality of service as reason for switching. Some experts suggest the dissatisfaction may begin when a smaller GP grows and asks more of the service provider than it is capable of handling. Gendel stresses that fund managers should be more aware of their service provider’s ability to scale as the GP expands in size and complexity.
The vast majority of GPs outsourcing their back office are satisfied, but it is clear it is hard to administer a fund, full stop. And even if a GP decides to handle everything in-house, their back-office operations will face all the same pressures to scale effectively with the firm. The future of fund administration may not be outsourced, but it won’t be getting simpler or cheaper any time soon.