By: Mark Melin for ValueWalk Premium
As degrees of administrative complexity have been mounting for hedge fund managers, increasingly they are outsourcing the complexity to third-party administrators. A recent Citco report noted that the alternative investment industry is at a “tipping point” as shifting regulatory challenges, rising costs, increased technology needs, and strategy complexity is encouraging fund managers to focus on investments and increasingly outsource the complexity.
As the landscape for fund managers change, so, are administrators, as evidenced by the recent acquisition of Deutsche Bank Alternative Fund Services by Apex Fund Services. The move highlights how fund services are finding competitive advantages by increasing their size and reach – and in doing so, they create economies of scale.
As the “phenomenal” growth that comes from quant funds increasingly relies on technology to track and account for hedge fund activity multiplies regulatory concerns, Apex Fund Services CEO Peter Hughes says fund administrators must keep track of the shifting regulatory sands as well as offer clients sophisticated middle-office services. When compared to a hedge fund engaging in such activities in-house, it is a costly overhead expense that can be more efficiently handled through global specialization in a shared services offering.
“As alternatives become more mainstream, combining active and passive strategies and smart beta, it produces complexity,” David Rhydderch, Global Head of Alternative Fund Services at Deutsche Bank, noted. “Creating cost-effective methods to manage that complexity is critical for a fund manager.”
There is a general trend of fee compression combined with generating risk-adjusted returns in an uncertain market that plays into the global service offerings. With the addition of the Deutsche Bank Alternative Fund Services business, the Apex Group now has 38 offices around the world. With the recent Brexit concerns, managers have been looking at Apex for advice on creating stable domicile structures in locations such as Luxemburg and Ireland, for instance.
“Fund administration is capital intensive, increasingly requiring a high headcount,” Hughes said. “There is currently a flight to size,” as fund administrators who offer advanced technology and untangle regulatory complexity are the winners. “The bigger your network, the more effective an administrator becomes.”
Citco anticipates the hedge fund industry will see even greater diversification across asset classes, a move into hybrid strategies and launch a wide range of investment vehicles, ranging from Cayman-domiciled funds and regulated on-shore funds. “This trend will lead to a greater number of fund administrators offering bespoke solutions to fund managers, rather than a traditional standard model,” the report noted.
In the area of private debt, Citco is now offering dedicated bank debt teams with monitoring capabilities and portfolio management software that allows managers to automate asset monitoring and accounting from a centralized system. Apex, meanwhile, offers a hybrid direct lending solution that speaks to the disintermediation of capital-intensive banking services while using artificial intelligence applications to lower costs.
“Private debt strategies are growing based on bank disintermediation,” Rhydderch said, pointing to a “specific area where we see active growth and interest.”
Citco notes the growing importance of real estate fund, now with over $3 trillion under management, a sector that has experienced significant growth. “As a result of this trend, real estate fund managers are choosing to outsource operations to build scale, enhance efficiency and gain access to best-in-class technology,” the report noted, predicting “over the next three to five years, real estate fund servicing will mature.”
Real estate funds, as well as individual private equity, are particularly impacted by tax reform around the globe, which could have far-ranging and complex effects as a result of interest deductions, lower tax rates, territorial taxation, tax on business income, and capital expense.
The world is becoming more complex. For fund managers, this means focusing on their core skills – generating alpha – and leaving back office administration to those who can do it more efficiently.
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