Picking a Hedge Fund Administrator

June 8, 2011

If you’re starting a hedge fund, you need a hedge fund administrator. You’re likely to fail at marketing your hedge fund to institutional investors without one. You might not even be able to secure a banker for routine transactions if you’re leaving it to yourself to calculate your own net asset value. Having a fund administrator is table stakes. If you don’t have one, you’re not marketing a hedge fund; you’re running an investment club.

“Today’s investor base, particularly institutional investors, won’t look at a hedge fund manager who doesn’t have that function and organization in place, says Thomas Pearson, president of Cortland Fund Services in Chicago. “They want to see it’s not a one-man band.”

Fortunately, cash flow shouldn’t be too big a barrier to entry. By all accounts, one item that is not a driver for selecting a hedge fund is cost. It’s inexpensive enough for entry-level service — about $10,000/year — and, after that, you get what you pay for: size, scalability, ancillary services. The question really, is who should be running your fund administration and how the relationship should be structured: an internal hire, a service provider or — essentially a hybrid of these two approaches — an outsourcing agreement.

“True, it’s a commoditized business, but there’s a lot of room for differentiation,” says Adam Horowitz, partner and chief operating officer of the Hylas Capital Management L.P. hedge fund in New York, who states that ancillary services determine whom managers might select as a service provider and how much they’d be willing to pay for these services. “One [ancillary service] that comes to mind is risk and performance analytics — the ability to show managers a breakdown of their portfolio, where they made money, where they lost, where they’ve taken risk, what are their exposures.”

He also suggest that an ability to do a full-service daily NAV calculation, as opposed to just the month-end, is an important value-add. Even so, there are any number of things a good fund administrator with a clear mandate can do for you, and it’s not all accounting.

In addition to NAV calculation, a fund administrator can provide such investor services as anti-money laundering diligence and subscription processing; also, your fund administrator can perform such back-office operations as clearing transactions and initiating wire transfers.

Overall, there are really four ways that fund administrators can make their mark:
  1. Expertise: Although audit experience is hardly a disqualification, it’s more important that a fund administrator understand hedge fund operations at least as well as compliance. Even so, don’t discount the importance of having a fund administrator who can authoritatively prepare you for a SAS 70 Type II audit, according to Pearson.
  2. Scalabilty: “Do they just do long-short equity? What if, down the road, you want to add another strategy?” asks Angie Kim Harrison, CEO of San Francisco-based Core Fund Solutions. Do your prospective fund administrators understand options, futures, forex, bonds or whatever else you’re likely to throw their way?
  3. Chemistry: Of course, every business is a people business, even the back office of a hedge fund. “They need to share your philosophy and communication style,” Harrison cautions, then offers this advice: “The best practice is to make sure you have someone internal to shadow. We see too many times that admin firms finalize books and records and send them to the hedge fund managers, who have no idea if these numbers are correct and need some way to compare and reconcile.”
  4. Infrastructure:  As important as old-fashioned customer service is, these days fund administration is a technology game. Platforms need to not only do what they’re supposed to do without crashing or (even worse) making a calculation error, they need to be simple enough so that non-techies can handle it. And no, Microsoft Excel doesn’t cut it.

A hedge fund is “too high-risk a business to run it on a spreadsheet,” Horowitz says. A more sophisticated application may be necessary, “but it’s got to be user-friendly or nobody’s going to want to use it.” Additionally, the platform provided by the fund administrator has to support whatever strategy the hedge fund manager is managing — event-driven, in Hylas’s case. It’s also important that, if you need different platforms for different functions, all the applications are capable of swapping data.

“We also provide shareholder and partner accounting, and some administrator systems aren’t capable of handling that in a sophisticated way,” says Pearson. “Sometimes platforms don’t talk to each other.”

So hedge fund technology is important. So is compliance and operational competence. But a lot of fund administrators have a handle on all this. As you go about starting up a hedge fund, it’s up to you to find one that will facilitate your growth strategy. Sketching out your growth strategy for your prospective service providers is really the best place to start.

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