EVAN COOPER: Welcome. I’m Evan Cooper for Asset.tv and in this session of Masterclass we’ll be discussing the trends and challenges of hedge fund administration in 2014. With me to discuss this timely topic are four leading experts in the area: Ian Asvakovith, Co-Founder and CEO of Piedmont Fund Services; Michael Rucci, Managing Director and Head of Alternative Fund Services in the Americas for UBS Global Asset Management; Peter Sanchez, Chief Executive Officer of Northern Trust Hedge Fund Services; and Christine Waldron, Executive Vice President and Global Head of Alternative Investment Products at US Bancorp Fund Services.
The hedge fund industry now sits atop more than $2trn on assets and while the performance of those $2trn is of great interest to investors, the day-to-day work of administering the assets as well as the other operational aspects of running a hedge fund are equally important to the hedge fund managers themselves. If we consider just regulatory and tax changes alone, which seem to grow more numerous and incomprehensible each year, it’s easy to understand why guidance into operating a hedge fund efficiently and compliantly is so essential. So who better to update us on important trends and hedge fund administration than our four experts? Christine, let’s start with you, give us an idea what’s going on.
CHRISTINE WALDRON: Well certainly one of the trends is providing the investors with the transparency to a variety of things. First off all of the onslaught of regulatory changes that are being experienced in the alternative space, also providing them greater transparency and a better means for communicating back and forth with the investment manager themselves in accumulating information etc. to comply with those regulations, and also just providing them greater transparency into the overall process, reconciliations, valuation and just the overall quality of the service that’s been provided.
EVAN COOPER: Terrific. Peter, what do you see?
PETER SANCHEZ: As a result of consolidation in the hedge fund market where institutional investors are really looking for institutional asset managers that they can invest in – institution being defined as those asset managers who have significant technology in infrastructure – that consolidation on an asset management side has to some degree driven consolidation on the administration side.
So we are seeing quite a bit of consolidation over the last several years of administrators, and generally the theme is administrators going to financial service firms or banks or custodians. Why? Because one of the themes in the market is a consolidation of fees, pressure on fees, and so while fees have gone down for administration, as well as to managers, what you’re really seeing is more services for those fees.
EVAN COOPER: Definitely a good combination. Michael?
MICHAEL RUCCI: I would echo that at the technology and building the scale around that is key for a fund administrator to be able to survive. So say having the services, the operations, I mean a fund administrator just doing fund administration today is, you can’t survive; you need to be able to provide those added services whether it’s in middle office and even front office type technology. So be able to service your clients, to be able to do that in a way that it adds value to them, provides scale and keeps their fees down, you obviously need to be able to keep your fees down, and having a scalable technology that’s front to back straight-through processing is key.
EVAN COOPER: And Ian, give us your view.
IAN ASVAKOVITH: Well, Evan, you have served one thing that’s really interesting, the industry has now grown over $2trn. I think hedge fund dated back as early as 1950s and even though we’ve come a long way the industry as a whole there’s still a lot of mysterious, we’re commonly misunderstood by the general public or certain investors. If I was to ask some of my friends who are not in our industry to describe one word about hedge fund, or a hedge manager what would you say, they typically would say fraud, greed, Madoff, high fees or excessive risk.
EVAN COOPER: Great image, right?
IAN ASVAKOVITH: Yes, in other words I think positive image and trust are really hard to come by in our industry. So by working with an independent fund administrator I think it helps to mitigate some of the risk of fraud for the investor. As Christine has mentioned about doing the fund accounting, valuation, those sort of things help take the edge off investor fear a little bit about investing in a hedge fund and help to certainly make them a little bit more confident investing in a pool vehicle such as hedge fund.
EVAN COOPER: So I want to go back to two points that some of you mentioned, one was a transparency issue and the other was the value added services. Transparency, Christine, let’s go into that more, what’s transparent? What is it first of all and then how do you deliver it?
CHRISTINE WALDRON: Yes, I think that’s a very good point. I think that’s something that the industry is grappling with, and it really is being driven from the investor side, and each investor has a different definition of what transparency is to them. And so I think it’s very hard for investment managers in the hedge fund space to really grapple with what type of information to provide, and they look to their administrators to help them with the trends that they’re seeing in the types of data that are being provided so that they’re not at a competitive disadvantage.
But certainly transparency around compliance with regulations, making sure that the fund is compliant with those regulations, making sure that the fund is compliant with the strategy that they said that they were going to be deploying, and just an overall process and procedure understanding in compliance and transparency to it, gives the investor, especially institutional investors, a much higher degree of comfort.
PETER SANCHEZ: So I think Christine touched upon some of the transparency artefacts that an investor would expect from their managers. And the vehicle to get that data to the managers is the administrators, all of us. So compliance a big one, Christine touched upon that, risk, valuation, cash management would be some of the primary themes, and then you would say probably performance as well. So those are the artefacts that they’re looking for transparency on, I would say Evan.
MICHAEL RUCCI: I would say again just what’s interesting if you look at the private equity market today, the private equity market is probably where the hedge funds were over a decade ago; 70% of the private equity firms are self-administered. And investors are going to be looking for the transparency, it hasn’t happened yet, but that is a trend that I see coming around private equity and there are administrators out there who can help them. But to me it’s still a little bit strange that that number is so high.
IAN ASVAKOVITH: Yes, one thing I’d like to add about the transparency, if I was to go back 15 years ago when it just starts getting in the industry, you know, the capital statement the investor typically gets from a hedge fund manager is just four simple lines. Beginning balance, contribution, the P&L, redemption and then ending balance, and that’s all they’re seeing when you’re investing in a blind pool, regardless of how much money you put in. Now I think investors are demanding more maybe like at the portfolio composition, breakdown by sector, geography, just to better understand where investment is being invested. And in the past managers say look you guys go and invest with us and this is our business you don’t need to know anything, but now the pendulum swings the other way I think investors have a lot more opportunity to ask for additional information. I think it’s just going to be a balancing act between how much managers are willing to give up versus how much investors are willing to be able to get from them.
EVAN COOPER: And Ian, you mentioned before the image issue, which brings about the issue of trust and are the assets real, are they custodied someplace that are real? How do you deal with all that and what do you do to assure investors that yeah the stuff is actually there? Yes.
MICHAEL RUCCI: I think it’s working with prime brokers right who are well respected and having a robust reconciliation process.
PETER SANCHEZ: Yes, what I would say is and Christine opened up with this, but I think it’s worth pausing and clarifying, the services we provide ultimately are to the manager; however where the markets evolve to is those same services the investor expects to get transparency on them. So when we talk about those services in the context of technology, in the context of transparency, in the context of a lot of the artefacts I talked about, it is the same services that have evolved for the manager, the investor is now looking for those to be available to them.
EVAN COOPER: So let’s talk about those services and what each of you offer, how does that respond to what clients are looking for? How do you keep a step ahead of them so that you get even more assets? So tell us what you do and how you do it, Ian.
IAN ASVAKOVITH: Sure. I think in addition to gaining trust and confidence in investors I think by outsourcing the fund administration it also helps to lower the operating expenses. If you can imagine if a fund manager was to go out and hire a full team of fund accountants and license a portfolio accounting system and keep up to date with all the regulations and accounting pronouncement on a yearly basis, it’s going to be very expensive for them to do that. And also if a few were to leave their company, there’s a lot of concentration that walk way out the door. So by outsourcing to a fund administrator we can help maintain those fund accounting, you know, as Christine mentioned, calculating the NAV, calculating the management fee so that investors feel confident investing in a fund. And I think the industry has evolved, I think people are expecting more from fund administrators. Before it was just calculating NAV and now we’re becoming more of an advisor in different areas such as compliance, tax regulations and AML compliance and so on.
PETER SANCHEZ: So Evan I would say that leveraging the point that he just made is we can answer the last two questions you asked. One is how do you get investors comfortable that there are control checks in terms of substance on the underlying investments and products, and two what are the services that are evolving in the marketplace. So what’s really happened is it’s moved from a monthly service function to a daily service function, daily reconciliations against your custodians, against your prime brokers, daily reconciliation of the assets, verification of the valuation of those assets and verification in management of all the cash flows those assets are generating as well. That daily services are the additional services that come out of the box with fund administration today and also give investors comfort that there is substance behind any investment that they make.
EVAN COOPER: Michael?
MICHAEL RUCCI: Yes, I think it varies by the type of manager. So the large multiple billion hedge fund manager has a full suite of technology. The emerging managers or the mid-tier ones, where we can help we just launched a product called UBS Frontier, where if fund administration is what it is, it’s NAV calculation, it’s the shareholder services, it’s the reporting. Where we see the challenge that we’re trying to help managers with, especially the emerging managers, is around offering a full suite of technology, not just a back office and not even just a middle office, but an actual front office.
So we have just partnered with SunGard and a firm called HazelTree to be able to provide not just the middle office operations, but for office portfolio management using Hedge360 from SunGard, which is based around Front Arena, and that is a portfolio management, desk level risk, pre-trade compliance, position keeping, real time P&L, along with market risk, its own fund accounting engine, and then with HazelTree you have cash management securities financing, collateral management, prime broker margining, and then you throw on top of that a managed service around UBS Fund Services. It is literally a hedge fund in a box. So from a new manager perspective if you have an idea, some capital, a lawyer, and an internet connection, UBS can solve the rest for you.
EVAN COOPER: And just pay the rent and you’re ready to go right?
MICHAEL RUCCI: Yes.
EVAN COOPER: Christine, tell us what you do.
CHRISTINE WALDRON: Well I think certainly there is the trend for the emerging manager to provide everything for them. But for the larger institutional managers I think it’s really providing a custom solution for what they’re looking for. Right, they’ve invested a lot in their infrastructure. That is part of their competitive advantages that they talk about when they meet with their investors, and it’s really providing the support to them in a custom way so that they can find the solution with us for the problem they’re trying to solve for. Some of them certainly are trying to look for everything in one fell swoop here.
MICHAEL RUCCI: Most of the smaller ones and that definition of yours.
CHRISTINE WALDRON: Right, like the larger ones are looking for very narrow services. And so you really have to have a very diverse service offering ranging from really the front office support all the way through the back now. It used to be you just provided the back office, and that was fine, and so really providing that full range of services for a manager to select from, but also to everybody’s point moving from a timing perspective to the daily type of environment, real time type of environment. No longer is it okay to just provide the reconciliation by noon, right, you have to provide it before the market opens, and so you really have to move the bar forward to help support the client.
PETER SANCHEZ: Let me leverage those two responses to talk a little bit about another trend that we’re seeing in the market, so when a fund launches they are looking to outsource everything from portfolio management all the way to custodial work. As it evolves, becomes say a half billion to a billion, they take ownership of some of their value-add services; that would be collateral management, that would be risk management and it might have been compliance. Once they reach a certain size multi-billion they have potentially multi-admins, and what they’re really looking for is governance structure tools that they can oversee the data and, lastly, they’re looking for what we call data aggregator, and this is our capability where you aggregate data across administrators, across PBs and are the ultimate voice for regulatory reporting, performance reporting, risk reporting and ultimately a consolidated NAV.
EVAN COOPER: What I’m curious about is in the marketplace it seems, and correct me if I’m wrong, that the managers themselves are getting nichier in trying in terms of getting yield and returns in an environment where it’s not so easy to do, they’re doing different and more exotic things. How does that affect you, if indeed that’s true? Like what does that do for the administration part of things?
MICHAEL RUCCI: It depends on what the products are. It could be quite challenging on some of the more exotic instruments. I think the trend is actually going a little bit more away from that just from the transparency perspective. I see the complexity on some of the OTC, especially with a lot of the OTCs moving to cleared, I was kind of expecting then, we’re just going to make up some new OTC instruments, and from my perspective we haven’t really seen it.
EVAN COOPER: Christine, you want to say something.
CHRISTINE WALDRON: Yes, I do think that certainly as they expand their product offering and stretch, it forces us as administrators to be very proactive looking at the market, understanding the market and making sure that our systems in our compliance, in our risk management processes are really in place to help the client manage through that. So we really have to be very proactive in taking a look and making sure our systems and our infrastructure can support what they’re doing.
EVAN COOPER: Peter?
PETER SANCHEZ: Yes, so here’s the comments on it. You’re right; managers are looking for yield, and seeking different ways of creating that yield. It might be direct lending, it might be student loans, some type of exotic products; however, unlike say ten years earlier niche providers or niche managers have a real difficult time developing the regulatory reporting that’s required today and the technology infrastructure that’s required today unless they get significant capital backing from some prime institutional investors.
So where you’re seeing those yield seeking strategies are with the large multi-strat traditional alternative asset managers that have been around a while. They’ve got the infrastructures, the controls in place to actually release those type of products, and I think again a lot of our clients, who happen to be those institutional managers, are looking for us to satisfy a new strategy or new trading.
EVAN COOPER: And that isn’t that hard to do?
PETER SANCHEZ: Well, so to talk a little bit about our system, it’s agnostic to product and it’s agnostic to strategy. So whether it’s a bank loan, pick payments, mortgages, pay-downs, a private equity with stock splits, we handle every product in an automated way on a cash flow basis, and then we run it through a posting engine to create the journal entry. So it’s a fund accounting system, plus a trade processing system, and to your point, Michael, it is a front-to-back system as well with really significant product and strategy coverage.
CHRISTINE WALDRON: I think you can’t overlook though the actual end user and the quality of the accountant who’s actually pushing the buttons, and making sure that they are trained in understanding how a given investment type is treated from both a financial reporting perspective and a tax reporting perspective. It’s great if you’ve got the system to do it, but you really have to have very knowledgeable, very seasoned staff who can really understand those products and make sure that the system is doing the accounting for them properly.
PETER SANCHEZ: It’s a significant point Christine’s making, which is you can have world class technology, but in the end this is a service business, and the managers and their investors are looking for service, and ultimately you need people who understand the business, especially accountants.
EVAN COOPER: So we have an accountant right here who understands everything, Ian.
IAN ASVAKOVITH: Well I think it’s important to know what you know and do well at what you do. As a boutique provider, we tend to be very focussed in terms of the type of fund that we work, that we work with a wide variety of clients, but there are maybe some certain products that we’re not comfortable dealing with, and we’d never be afraid to say no and refer to other firms who may be better to assist the client. So I think it’s important to try to find somebody who is good at what they do and also able to say no when they’re not good at something.
EVAN COOPER: Are you finding this nicheyness increasing? I mean when somebody comes to you with a product that’s new or different…?
IAN ASVAKOVITH: You know, if I see more I probably would invest up the product and do more of that, but I see the traditional type of fund growing as well. So we haven’t had any slowdown in terms of the traditional type of asset classes that are coming our way. So we continue to plough through that direction.
EVAN COOPER: Let’s look at regulation for a minute. What do you see on the horizon coming this year or soon or implementing stuff that’s already here, what are the challenges for administrators in terms in the regulatory front?
IAN ASVAKOVITH: There are quite a few, right. I mean I’ll just name one, FACA requirement that’s coming due this quarter of 2014, and it’s a requirement where fund managers now have to do the due diligence on investors making sure that they meet the requirement. If you have an offshore fund you have to be registered as a foreign financial institution, and if you have a US taxpayer in that fund you have to withhold their taxes; otherwise if you’re not registered properly then you’re going to have an issue with IRS. So that’s one of the many compliance and regulatory issues that are coming down the pipe.
EVAN COOPER: Michael?
MICHAEL RUCCI: I think it’s good just to see that we’re starting to get some finalisation to some of it. I think there’s so much uncertainty around a lot of them. Our big focus is AIFMD, and every client that I talk to when I ask about AIFMD, and I ask them if they are concerned about it…
EVAN COOPER: For someone who is not as familiar with the jargon tell me what that means.
CHRISTINE WALDRON: Alternative Investment Fund…
MICHAEL RUCCI: Or Directive.
CHRISTINE WALDRON: Directive.
EVAN COOPER: And who is that from?
MICHAEL RUCCI: And that’s within Europe. So if you want to market your fund to European investors you need to be AIFMD compliant with a directive. I think the US managers are going to need to be able to work with a fund administrator who can service their AIFMD needs.
EVAN COOPER: And is it two kind of different things for US investors and for European investors? You do two things simultaneously or?
MICHAEL RUCCI: It all depends on who you’re marketing to. If you’re marketing to a European client, and then to make it even more difficult within the different European jurisdictions the rules are actually different and it could be more strict, but if you’re a US fund with US clients you don’t have to worry about it. And if you have European clients, existing clients and you’re not marketing to new ones, you’re also fine.
EVAN COOPER: Is it okay? And Peter, what do you see regulatorily?
PETER SANCHEZ: So in terms of regulation significant opportunity for fund administrators, and custodial and asset servicing banks. Form PF should be a significant offering of any fund administrator today, and off your risk system, off your portfolio management system you should actually be able to deliver a form PF for your managers to the SEC. FACA should be part of your offering, you’re talking about significant revenue, and I think the crown jewel as Michael pointed out is AIFMD, especially for a business that is used to providing trustee and depositary services.
So administration combined with depositary, combined with trustee-type like services is going to be a significant and additional revenue source for those fund administrators and custodial banks that offer it.
EVAN COOPER: And Christine?
CHRISTINE WALDRON: I think certainly everyone’s spoken to a lot of the regulations that are applying directly to the hedge fund managers today and their existing product, but one of the trends that we’ve seen is the push into this liquid alternative strategy, which is really a registered fund wrapper around a hedge fund strategy, and it’s done in a variety of ways; forming registered closed end funds or business development companies in the private equity space or going so far as to having partnering up traditional managers with hedge fund managers as the sub-advisor. And as the hedge fund industry starts to push into that space it brings with it a whole host of additional compliance and processes and procedures and regulations that the industry has never seen before, and the manager has not seen before, and so really consulting and working with the clients as they start to push into that space is something we’ve certainly seen as a growing trend as well.
EVAN COOPER: So do they come to you, let’s say they’re approached by a conventional fund manager to say sub-manage my new alts fund, what do they do typically, how does that work?
CHRISTINE WALDRON: The first place they turn is to their administrator, and they say how are we going to change our valuation policies, how are we going to change our compliance programme, how does this going into that registered fund space change what we do as a manager today, and are we willing to make that investment, are we going to see the return for that investment? So it’s certainly a growing trend from a product development perspective that’s impacting the industry.
EVAN COOPER: Is it expensive for them to do that?
CHRISTINE WALDRON: It can be depending on where they’re headed in terms of their strategy. Certainly layering more compliance systems, pre-trade compliance, much more robust infrastructure around their trade order processing, certainly is a trend. Getting involved with board of directors, understanding the cost associated with educating your board. It’s certainly a substantial investment when going into the registered fund space.
EVAN COOPER: Does anybody see anything else that’s on the horizon or here, but just in the beginning stages?
IAN ASVAKOVITH: I don’t know if this is in horizon, but what’s been getting a lot of press lately is the insider trading. You hear a lot of news about hedge funds being prosecuted for insider trades, and you can see how far the regulators are willing to go in terms of prosecuting these guys; wiretap and taping conversations. We don’t know to what aspect the fund administrator will play or maybe not any, but I think that’s another area where we’re starting to see that the regulators are coming down hard on these fund managers who are trying to benefit from getting non-public information and trade on them.
EVAN COOPER: I’m just curious how are you all regulated?
CHRISTINE WALDRON: Well as part of a large financial institution we’re regulated by certainly the SEC, the OCC, all of the normal onslaught of regulators that you would expect to see.
PETER SANCHEZ: We’re also a regulated bank as well.
IAN ASVAKOVITH: Yes, there is no regulation on fund administration as a whole, but I think that will be something maybe possibly in the future, because the SEC are probably looking at this and saying well a lot of things are being done at this third parties and even though they’re not managing assets, they’re not managing any money, but there’s a touch point where you move funds and things like that.
MICHAEL RUCCI: But every fund goes through an audit, a year-end audit in which the fund administrator is a key part of it.
EVAN COOPER: Do you have to sign on that?
MICHAEL RUCCI: Absolutely.
PETER SANCHEZ: We may want to touch upon Christine’s point about the DC capital. So defined contribution, your 401k plan’s a significant opportunity for the alternative market, you’re talking trillions and trillions, and therefore if we get it right in terms of maturity of daily servicing, valuation, registered fund regulation, it could be a significant opportunity. The other thing to point out, and this is a neat trend, is those daily services that we said the market moved to, until we had actually moved to that point of daily valuation, daily processing, daily reconciliations, we could not have actually serviced a fund or a registered fund that had those daily requirements, and therefore the maturity on the hedge fund administration market or hedge fund servicing market allowed us now to actually adjust and adapt to this trend.
EVAN COOPER: So imagine the investment to do all that is a heavy technology investment, right?
PETER SANCHEZ: Significant.
EVAN COOPER: So it’s not something that the hedge funds themselves really can afford to do.
MICHAEL RUCCI: At a time right now where there’s fee pressure from them from their investors, you know, the days of free spending are done, and they are very very focussed on their cost, and they look to us as fund administrators, as partners to be able to help them find ways that they can reduce our cost. So as Peter said earlier is the fund administrators often provide a lot of the additional services, most of the time not at additional cost. So that’s a challenge for us. So we need to figure out how we become more scalable, and then we need to invest in more technology, but we all work in the same environment and we’re under our own cost structure.
So it’s finding creative ways to build scale, and we’ve been pretty successful at it, but it is definitely a challenge, and that’s why I think from, Ian’s an accountant, I’m not, I’m more of an operations business analyst aspect and I’m looking at the business to figuring out how to get more scalable, and I definitely echo the point that you need outstanding accountants, and we do and we would be nowhere without them.
IAN ASVAKOVITH: And also I think one of you guys mentioned earlier that the clients were used to getting their T Plus 1 report at noon, but now they want it before the market’s open. And I think for a hedge fund to be able to do that, internally, they probably have to have some people working at night in order to get that done. But with a lot of the global fund administration firms now, ourselves included, we have an office overseas in a different time zone where when it’s midnight when the custodian posts the information, our team overseas can actually do the reconciliation and by 8am the next morning the report will be available for the other fund managers.
So I think unless the hedge fund clients are big enough to be able to expand in a different market area where they have a team overseas in a different time zone it’s going to be very hard. You can’t get somebody to come in at night and do the reconciliation.
MICHAEL RUCCI: It’s a great point and it’s really that follow the sun model. For the longest time our office was based in Cayman, and we have an office in Toronto, and we had offices that do the non-alternative. But over the last two years we’ve leveraged them. We leverage our office in Singapore to do the reconciliation, we leverage our office in Poland to do valuations, because you’re right you would never be able to deliver it on a client’s desktop by 7am, 8am.
PETER SANCHEZ: Yes, we’ve talked about a lot of trends, but the primary trend is outsourcing, and outsourcing because of data and technology are solving the major issues and challenges for hedge fund managers and their institutional investors. So all those regulatory reporting requirements we talked about, all those daily services to the institutional investors, all the data management around compliance, performance, front-to-back services that we talked about all sought through technology and data management. And it’s going to be very very difficult for hedge funds to actually make that type of investment in technology and service their clients and meet the regulatory requirements that are expected.
EVAN COOPER: And Peter, you alluded to something before though and Christine touched upon too that because of the daily reporting and a movement of alternatives into this more conventional space that hedge fund managers may be going into even 401k plans at some point or offering, would they do it directly? Would they do it through the envelope of a conventional mutual fund?
PETER SANCHEZ: I would think that especially initially it would be a platform, a traditional platform that they could leverage. They will not build out the infrastructure to create a registered platform or plan themselves.
EVAN COOPER: And you’d be more involved in that, because the scale is much more large if they were doing that kind of stuff.
MICHAEL RUCCI: And it goes both ways, so you see a lot of hedge funds getting into more traditional products, but from working in or managing the operations in a large global asset manager within UBS we were traditional asset manager, but when you looked at the investments that they made that that line is very very narrow. So a lot of the traditional asset managers are getting into more hedge fund like products, but still keeping them under the umbrella of more of a RIC.
PETER SANCHEZ: Two trends that we’ve talked about that I want to expand on; one is targeting operating model, the other one is private equity. So private equity’s a little bit of a quicker point, and you nailed it Michael, you know, it’s about ten years behind hedge funds, significant opportunity. Outsourcing to private equity means reporting for them and producing a NAV, that’s about it, and that’s really how we defined the evolution of administration, how it started. So I think daily services capturing a little bit more detail around the investment, liquidity, all will be services for private equity.
MICHAEL RUCCI: How about valuation though, I mean I know for the time being it needs to stay with the manager, but do you see maybe five years from now there’ll be other technology that comes out that’ll allow the valuation from the manager to move to the administrator?
PETER SANCHEZ: It’s a much more complex valuation, and what I would say is it’ll either be specialist, vendor specialist or stay with the manager.
EVAN COOPER: But let me just throw in a sort of monkey wrench in a certain sense in that if with alternative investments one of the lures in a sense, one of the things that makes them compelling is that they’re illiquid. That, you know, it’s like your house, I mean there’s a certain value to it, but you’re not selling it every day or three o’clock in the afternoon every day. So even if you have technological tools and the accounting tools, how can you value something daily that’s not liquid? I mean what do you do?
MICHAEL RUCCI: We don’t value it daily.
IAN ASVAKOVITH: Well there’s a difference between price and valuation really. I mean the price is what we typically refer to as valuation for fund administration, whatever the last trade, somebody willing to pay for this particular asset is what we would value. Now to the manager maybe this particular asset is significantly undervalued, that they think that they should be worth a lot more and that’s why they buy it. So in the accounting standpoint we have to value it based on what the market participant would be willing to pay for that asset on that particular day. So if there’s no trade you have to go out and try to see if there’s a quote out there, somebody would bid for that asset; if not you try to find something that’s comparable to it and try to mark to that. So there are ways that you can do it but I think…
EVAN COOPER: I’m just getting into a philosophical point, because it seems as if an asset goes like this and this every day like it’s not a real reflection of what it’s worth, you know, you’re looking for a price, but anyway I’m just…
MICHAEL RUCCI: I mean that’s what keeps the private equity firms in business; they know how to value what that illiquid asset is.
PETER SANCHEZ: You actually touched upon something that might be a real neat offering in the risk management arena, which is liquidity risk management and being able to value illiquid products in a much more timely and accurate way. And I think liquidity risk management is probably the next theme in risk management.
EVAN COOPER: Do you do that now?
PETER SANCHEZ: Starting to build it up, still starting to build it up.
IAN ASVAKOVITH: I should also mention too that I mean the hedge fund industry is pretty large. I mean I think the last hedge fund research that we got a copy on I think we had over 10,000 funds out there and about, I forget the number, maybe 75% have less than 100 million; if you drill down like maybe more than 50% has less than 10 million. So there are a lot of funds out there that are what we call emerging or entrepreneurial managers. They are just getting by, and to them they may not need all these bells and whistles at the moment, but as their business grows they’re going to need it. So for them the challenge in the beginning is to find a solution that’ll be cost effective, to help them grow the business, and eventually if they’re able to grow then something that can scale.
EVAN COOPER: All right, let’s make believe I started a hedge fund – I should be so lucky – and I come to you and go shopping for a fund administrator, on the provider’s side what would a smart hedge fund look for? Like what’s a good way to be a good shopper or a good buyer of hedge fund administration services. What should they be asking that’s smart?
CHRISTINE WALDRON: Certainly experience with your given strategy. Depth of experience around servicing strategies similar to yours, clients similar to who you are, both from a strategy perspective, but also from what services you’re looking for right. So if they don’t have a deep bench of clients subscribing to their risk service, but that’s really what you want, you probably need to evaluate that. So certainly it’s looking from both the service offering perspective as well as the strategy perspective and their depth there.
I think certainly if you look at the technology, how that technology, how you interface with that technology, what your requirements are around the technology. Too often I think people come in and we all have it, right, this really fancy system that will show you, but is it really going to solve your problems? Are you going to use every aspect of it? I think that’s one of the things that we struggle with is that the requirements are not clearly defined that the manager is looking for on the frontend of the process. So I think those are two big areas to really focus in on.
PETER SANCHEZ: Yes, I mean a couple of things that Christine touched upon, one ultimately it’s a service business, so you need what we call domain, people who understand the business, be it accountants, operations people, not only do they understand the business, the products, their cash flows and the strategies, how they work, what they trade on, how they manage cash etc. Two, you want administrators that have made a consistent and continued investment in technology. That’s critical for all the things we’ve talked about today, right, regulatory requirements, investor needs, transparency, data management is through technology. And three, I would say you need a robust and strong counterparty that you want to do business, with very little risk on the balance sheet, very conservative and very service oriented.
MICHAEL RUCCI: Echo all those points. I would add in really when it comes to the staff the partnership between that single point of contact, right, being able to go to your relationship manager or your accountant and knowing that no matter what question you have you have someone who is going to answer that and qualified. And that they’re here, right. So we see a lot of, you know, wouldn’t say hedge fund administrators, but other service providers have gone east and gone offshore - which is great for certain aspects of the business, but when it comes to hedge fund administration you want your clients talking to someone that they know.
So for our perspective is we are that trusted advisor, that trusted client with a good set of technology, with a good balance sheet, that knows their clients in and out. So when a client picks up the phone or emails us they know that the person that’s going to be answering that knows everything about them inside and out.
IAN ASVAKOVITH: Yes, so I think often at times when new fund managers shopping for service providers the common mistake that they make is they believe that all the fund administration it’s a service commodity. Everyone pretty much does the same thing; you cut the NAV and calculate the fees, what could be different right? Like just go with the lowest cost. But actually that can’t be further from the truth. I think you have to find the right partner that understands your business, like as Christine mentioned. You have to understand who is going to be working on your account, because you could be talking to a salesperson, but then when the fund started you don’t really know who is that you’re working with. Well it’s a service model, who is going to be assigned to your account, do you have to call four or five different teams to get an answer or is there like an account manager that works with you directly? As well as is that a fit in the culture?
Piedmont is more of a boutique high class service provider that catered more to emerging managers, and it’s always been our culture and DNA from day one. We like to help smaller funds to help get started and grow the business with them, and we know that when they start the fund, they walk away from their comfortable career, comfortable high paying job to start the hedge fund, because they believe not only in the business or monetary reasons, but also they have a value they’re trying to capture for the investor. And in many ways that resonates with us and I think that’s also important to find the right partner. Because when you have somebody that’s going to interface with your investor, you want to make sure that they understand like how important it is for that investor relation team to, you know, because that’s your whole reputation.
MICHAEL RUCCI: And it’s a great point as far as the partnership because we had the same approach with the emerging managers, and we see it and/or they see it as much of we’re making an investment in them, and building those solid sort of relationships is key. We do as much due diligence on them as they do on us, because we want to partner with clients who we think are going to be around and will give them a significant break for the first couple of years to be able to help them manage that cost, because it is very difficult. So we look at it very much as a relationship around investing in each other in partnering.
PETER SANCHEZ: The ultimate parameter in terms of judging an administrator is speak to the clients; what type of services are they getting, what type of performance from the people on their account, what type of investment are they making in the technology, and do they have talent in a broad way across all the clients? So speaking to the actual clients of the administrators is the ultimate test.
EVAN COOPER: How long does it take? This is kind of a very basic question, they say okay we love you, we want you, how long does it take to start working with them?
PETER SANCHEZ: So if it’s a launch it should take no more than 45 days, you should be up and running, launch should be up on your platform. If it’s a conversion from another administrator or a significant conversion from self-administration it can take anywhere from three to 18 months.
MICHAEL RUCCI: Depending on the size and complexity.
EVAN COOPER: And then obviously you must have teams that work with them and they go there and…
PETER SANCHEZ: Exactly right.
EVAN COOPER: So it isn’t like, you know, get a computer and say Microsoft is so easy nobody can figure it out.
IAN ASVAKOVITH: Yes, I like to joke, you know, switching a prime broker is like breaking up with their girlfriend, switching is a little bit harder, it’s like breaking up with the wife, you have to explain to your investor now switching fund administrator or going from self-administration to a fund administration outsource it’s like splitting a Siamese twin, it’s very hard. And all the data that has to bring over, but it’s an important long-term decision, so if it’s something you have to do then you must do it.
EVAN COOPER: Okay, so what are the takeaways? If somebody had a question about fund administration both looking for one or the trends that they’ll be facing this year and they’re looking to you for answers give us in a capsule what they should know, so Ian I’ll put you on the spot first.
IAN ASVAKOVITH: Sure. The trend that what they should know, well just to recap I think find the right fund administration partner is key. It’s not like a one size fits all, it’s not a cookie cutter solution, so you have to take time to understand the source provider that you’re going to be working with and making sure that they’re a good fit for you. And also because of the increased regulation, increased scrutiny on the different tax area you want to make sure that you find somebody who is going to have this capability to provide that to you. And even though the fund administration firm that you’re looking at now may be a fit today either because they’re low cost or whatnot you want to make sure that their business model can also scale as your business grows, because like I said before splitting a Siamese twin is not easy, you want to find a solution that’s going to be long term.
MICHAEL RUCCI: I would echo that, it is finding that right partner that has the technology so from an emerging manager to mid-term manager to be able to provide a platform is one and then on the more larger funds, larger clients it’s having the flexibility to be able to find that more narrow service that they’re looking for is key. So I would say it’s scalability, it’s partnership and then it’s flexibility.
EVAN COOPER: Peter, what’s your advice?
PETER SANCHEZ: I would say that listen we talked about a lot of trends in the end we said they’ve all ended up with more outsourcing, so the bar for managers should be incredibly high and they should look for an administrator who’s investing insignificantly in technology, has significant talent, but a real high bar in terms of the type of services be it middle office, be it traditional fund administration, be it all the regulatory reporting, be it performance risk, compliance, all should be part of or capabilities of that administrator. So basically more services for the same price should be the expectations. Lastly I would recommend the manager speak to investors, what’s their expectation in terms of deliveries from the administrator and from the manager and again the administrator should be in a position to provide those services.
EVAN COOPER: Christine?
CHRISTINE WALDRON: I think hitting on the point of expectations is a really important one. As a client understanding what your expectations are as an investment manager, what your requirements are and likewise what your investors are is very important. Certainly looking at the firm that you’re potentially going to be working with is an extension of yourself in making sure there’s the right cultural fit is also very very important.
EVAN COOPER: Well looks and sounds like 2014 will be another challenging year for hedge fund managers and for the administrators, so I mean your help will be more important than ever. I want to thank you all Ian, Michael, Peter and Christine for your insights and thanks to all of you who have attended this Masterclass for asset.tv. This is Evan Cooper.
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