Wed, 26/10/2016 - 13:36
In order for the alternative funds industry to evolve one point that needs to be addressed is that the term 'Hedge Fund Administration' is too narrow. Firstly, one cannot avoid a trend towards convergence within alternatives that has steadily gained traction in recent years as hedge fund managers develop more private equity-like fund strategies, and vice-versa; this has resulted in the term 'hybrid fund' being bandied about.
Secondly, as traditional asset managers and asset allocators move beyond the concept of hedge funds as a distinct asset class and move towards portfolio strategies such as risk factor analysis, engineered beta, and synthetic alternatives, it is giving rise to more sophisticated portfolio construction as they adopt hedging strategies and techniques long practiced by hedge funds. Asset managers are running a gamut of absolute return funds to compliment their long-only products, and across the industry (both traditional and alternative) managers are launching regulated liquid alternatives to cater to a wider audience.
These two trends are essentially part of the same narrative: industry convergence. At a wider level, what this means is that fund administrators need to become solutions-oriented to support their clients, which in turn means going far beyond the confines of what was once considered hedge fund administration; the industry has simply moved on.
"We believe there is going to be significant convergence in the alternatives arena in terms of service providers as well as asset managers all converging to offer overall alternatives strategies rather than specific products: hedge funds, private funds, etc," says Peter Sanchez (pictured), CEO, Northern Trust Hedge Fund Services.
"In the end, with a broader 'alternative' fund administration mandate we believe that to stay competitive in this business – given the consolidation of the industry, the price pressures that managers are feeling, the demands from regulators and investors – there is a significantly higher bar to investing in your business. We think only the committed asset servicers and committed trust banks will be able to make continued capital investment into their people and technology."
Private equity capital structures (closed end funds) are being used more prevalently by hedge fund managers to trade distressed credit and other long-term investments, which changes the way they rely on their appointed fund administrator. Not only do these managers want enhanced transparency and reporting on listed securities, they want expertise in servicing hard-to-value, less liquid assets, as well as the accounting complexity necessary to support closed end [waterfall] structures.
"As hedge fund managers increasingly use PE capital structures to make investments into long-term distressed assets, hedge fund administration becomes too narrow a description for the challenge of operating that convergent and consolidated investment model. In that context, we are looking to leverage our capabilities, not only by looking to solve things from a capabilities perspective but also from a client's needs perspective in terms of reporting and accounting," says Sanchez.
Another distinct trend that Sanchez increasingly sees is a mindset among its fund manager clients to outsource functions in such a way that enables them to partner and run their businesses cheek by jowl with their service providers. This is evidenced by the fact that an increasing number of PE managers are turning to outsourcing.
"We've seen reports stating that 50 percent of the PE industry will be outsourced whereas just a few years back that number was probably in single digits," says Sanchez. He says that rather than call itself a hedge fund administrator, Northern Trust considers itself as a 'strategic operations partner' to support its alternative fund managers with a much broader service model.
What Sanchez is referring to here is the ability to react to the pressures that Northern Trust's clients face at any point throughout the lifecycle of their business. As the convergence trend continues, and managers and investors alike move away from the concept of hedge funds as a distinct asset class and embrace alternative strategies, tomorrow's successful fund administrators will be those who can deliver the right solutions as a valued partner.
As Sanchez points out, managers are feeling the pressures related to regulatory reporting – Annex IV under AIFMD, Form-PF, FATCA (and the associated investor due diligence requirements); investor demands in terms of transparency on exposures and evolving strategies; diversification demands in terms of finding new sources of alpha; pressures related to lack of financing balance sheet as prime brokers pull back their level of support; continuous risk reporting pressures, not to mention ongoing cost pressures in relation to management fees and performance fees.
"Managers have got to run a business whose investments generate performance in the most cost-efficient and scalable fashion and the only way to do this is to find a strategic partner that can give the manager ideas as to how to grow the business efficiently and minimise their operational risk. Someone who will take accountability for their responsibility, as any good partner should, and invest in technology and expertise to support managers as they look to move into new areas of the market and develop new strategies," explains Sanchez.
This illustrates the extent to which fund administration has changed. Any serious fund administrator today is one that does not react to client demand but develops a blueprint such that the administrator proactively creates solutions to support the client in their business evolution. Rather than merely offering a suite of commoditised products, managers want a la carte services in order to benefit from operational efficiency and greater accountability.
This ability to act as a strategic operations partner is part of Northern Trust Hedge Fund Services' DNA and originated with the 2011 acquisition of Omnium, a hedge fund administrator subsidiary of Ken Griffin's Citadel; Northern Trust's first hedge fund client.
"This was a hedge fund administration business built to service middle and back office in any trading strategy; global macro, event-driven, convertible arbitrage, etc. Its core foundation was technology. When we acquired Omnium a significant number of people stayed on from Citadel and we have continued to build out our technology capabilities with significant investment over the last five years," confirms Sanchez. He says that some of the key aspects of being a strategic operations partner as opposed to an administrator include:
When asked what the future of hedge fund administration might look like, Sanchez responds: "One thing you have to remember about trust banks is that their core business is asset servicing. Their whole bottom line – be it profitability or return on equity – is based on that business.
"I think the winners are going to be those administrators who solve client needs, meet client requirements, and move towards a partnership-orientated business model rather than a product-based business model. I think to do that, to be really solutions-focused and an extension of a client's business, you are going to have to invest in the business. In that context, I think going forward the trust banks will be in a much better position to reinvest in the business than the independent fund administrators."
Northern Trust Hedge Fund Services actively encourages managers' feedback to help them develop their solution-based model. By knowing what those insights and frustrations are, Northern Trust is able to tailor its functionality. Some of the larger clients it works with act as test pilots for the solutions that Northern Trust develops and are, says Sanchez, "instrumental in terms of influencing the way we build out functionality."
"For a client who is looking to outsource some of their collateral management functionality, for example, they strategically partner with us to define what their needs are and write the requirements that then form the basis of the technical functionality that we build and the operational teams we put in place."
In conclusion, Sanchez says that Northern Trust intends to remain at the forefront of the fund administration industry and continue to solve the challenges that its clients face:
"We are trying to develop a multi-service type business with our clients. If we leverage the two trends – the convergence within alternatives and the expectation of clients to have a broad capability set from their fund administrator – the future bodes well for Northern Trust."
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