Hedge fund “admins” are perfectly poised to capitalize on the recent changes to the financial services landscape and the new face of the $2+ trillion hedge fund industry.
The recovery from the financial crisis has led to a changed financial landscape. Investments in hedge funds and more broadly alternative investments are on the rise. More start-ups have opened their doors. The number of institutional investors and the percentage of their funds being allocated to alternative investments have increased as has the demand for more transparency and liquidity. Last but not least, with the purpose of averting another financial crisis, regulators continue to issue new compliance mandates that address risk exposure, among other things.
Without making any alterations to their service offerings, these changes in the financial landscape present more money-making opportunities for hedge fund admins. More funds equal more potential clients and higher assets under administration. However, if hedge fund admins revamped their services with a more comprehensive offering at a lower price point (think Walmart), they could really profit. Hedge fund admins can position themselves ahead of the curve by going beyond offering the traditional services, such as Net asset value (NAV) calculations and determining fair value of each security. This would help admins meet market demand at a fee attractive to hedge funds, who have historically expected their fund admins to provide more services for the same fee — 10 basis points.
Given the fact that the concept of a single prime broker is a thing of the past — with the hedge fund’s investment book now effectively split across its multiple prime brokers — many services traditionally provided to the hedge funds by their prime broker are no longer possible. This has opened the door for the hedge fund admins — who, with few exceptions, do continue to enjoy a view of the fund’s entire investment book — to offer these new services. Some have already started to do so but not yet at an attractive price point. The challenge is that unlike prime brokers, hedge fund admins cannot make up the cost of providing these services via other mechanisms, such as financing, stock lending or trade execution fees. In order to provide this level of additional service, the hedge fund admin’s only recourse is to raise fees. Yet the hedge funds have resisted this.
Change on the Horizon
This is changing. Right now, many hedge funds are looking to other, pricey service providers (auditors and consultants) for services they previously were receiving from their prime broker. To capture some of this business, the hedge fund admins can market themselves as an economical, one-stop shopping solution. They could say to the hedge funds, “if we provide service X to you for a cost of $Y, you can save at least that much when you stop using consulting firm ABC to provide service X.” The hedge funds are listening. They want to lower costs. This would make it easier for them to go after the increased dollars flowing into hedge funds and to tap into the growing amount of institutional dollars entering the market.
Some hedge funds are also making other changes that will make it easier for them take advantage of this lucrative market. Currently, some savvy hedge funds with more than $5 billion in assets under management have been known to maintain their own in-house departments to “shadow” their outside admins. Some are adopting the idea of down-shifting to “partial shadowing.” Instead of 100% duplicating what admins do (maintain the fund’s books and records), these hedge funds are looking to right-size this internal functionality and reduce the associated operational costs. They instead want to focus on their core business — investment management and gaining more clients. As a result, admins who can re-invent themselves and increase their focus on offering comprehensive services to their investors / clients can tap into a possible windfall.
Another consideration — the fact that hedge fund admin fees more often than not get passed to investors and are not paid by fund managers — can help attract more hedge fund business. What is more attractive to the hedge fund owner is that if they buy service X from their fund admin instead of from a consultant, it is easier to pass the cost of that service on to their investors than if the manager buys the same service from a consultant.
The smart, early adopters of this one-stop shopping approach among hedge fund admins stand to gain by differentiating themselves from the competition, but it’s not without its challenges. According to Ernst & Young’s sixth annual survey of the global hedge fund market, Finding Common Ground, investors are skeptical about the effectiveness of all of these regulations and compliance requirements when it comes to protecting their interests and helping to prevent the next financial crisis. In addition, and perhaps more importantly, they do not want the cost for any additional transparency passed on to them.
Here is a list of some fund metrics and compliance services hedge fund admins can provide as part of a more comprehensive offering to better meet client/industry demand: • Daily Reporting: Calculation of the NAV including the calculation of the funds income and expense accruals, and the pricing of securities at current market value; Net Exposure; Purchase and Sales
• U.S. Tax Analysis:
-- Analysis and treatment of Wash Sales, Constructive Sales, Straddles, Qualified Dividends and Dividends Received Deductions (DRD). (i.e. create the fund’s tax book)
-- Go beyond end-of-year tax compliance, by offering on-demand tax management analysis and reporting for the more tax-sensitive fund trading strategies (e.g. daily tax alerts)
• Foreign Tax Analysis: -- For hedge funds trading instruments globally, help them navigate the income tax differences that exist between Generally Accepted Accounting Practices (GAAP) and International Financial Reporting Standards (IFRS) countries, with a focus on countries such as Germany, Spain and Italy for issues including capital gains taxes and equity percentage thresholds
-- Address Fund Income Reporting compliance requirements for individual countries, such as Germany (Income, Interim Profit, Equity Gain, Allocation Ratios)
• Risk Management: VaR, Beta
• Performance Analysis: Time weighted return (TWR) and Internal rate of return (IRR)
• Foreign Account Tax and Compliance Act (FATCA) Support: for offshore funds
• Regulatory Compliance Reporting: Forms 13F, 13D, and PF; UCITS Funds