What Is a Fund Administrator?

See Related Feature: Funds of Funds Will Stress Independence and Technology to Avoid the Next Madoff Scandal

After getting caught up in the Madoff scandal and losing millions of dollars, institutional investors are putting pressure on hedge funds to hire third-party fund administrators. But what are fund administrators? What services do they provide? And why is their role becoming increasingly more important?

Essentially, a fund administrator serves as an independent third party that protects the interests of investors. Typically fund administration services are charged to investors as a fund expense.

The main function of a third-party administrator is to independently calculate the net asset value of the fund, according to Thomas Davis, president and CEO of Meridian Fund Services, a fund administrator in Bermuda that caters to all types of hedge funds. "At the end of the month, we have to make sure that all the transactions that are processed actually took place," he says.

Traditionally pricing is among the end-of-month activities. "We reconcile between the broker statement and the investment managers," Davis explains. "The administrator will collect information provided by the investment manager [and] the prime broker and make sure everything is reconciled and calculate net asset value." As part of that process, the administrator will consider activity such as investor assets flowing in and out of the fund because such activity can influence the value of the funds. For instance, a hedge fund may have to sell securities to raise cash to cover investors' redemption requests.

The trades that are prompted by the investment adviser would be reconciled against the trades of the broker, which executes all the buys and sells for the hedge fund and generates statements on the trading activity. In fact a hedge fund could be executing trades through multiple brokers that are then consolidated through a prime broker. In a situation where the investment adviser owns the broker, as was the case with Madoff's operations, Meridian typically relies on a separate clearing broker to settle trades because the administrator needs to verify that the trades took place at prevailing market prices. The fund administrator prefers to verify the trades with a major third-party clearing broker (e.g., Morgan Stanley or Goldman Sachs) because a captive broker could be conspiring with the investment adviser. The clearing broker is usually a member of the DTCC and other clearing and settlement organizations.

The next major responsibility of a fund administrator is to ensure fair pricing of each security that has been traded. If a security is listed on an exchange, the price is easy to obtain. But if it's a complicated holding, the administrator has to use a mathematical model to come up with the price, Davis relates. "You should get three broker quotations and use the average of them, but that's not always possible," he says.

The largest fund administrator is Citco Fund Services, an independent fund administrator based in New York that offers a full range of hedge fund administration services from 16 strategic centers globally. But many other fund administrators are owned by banks (e.g., Citigroup; IFS, a State Street company; HSBC Securities Services; and Northern Trust) or prime brokers (e.g., Goldman Sachs Administrative Services and J.P. Morgan Hedge Fund Services).

According to Hans Hufschmid, CEO of GlobeOp Financial Services, his firm's independence has become a competitive advantage as investors increasingly call for transparency. Noting that the London-based firm is "totally unconflicted," he says, "We don't hold securities. We don't trade securities. We are not in this business to do executions. We are in the business to provide middle- and back-office and fund administration services."

Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio