BILL McINTOSH, The Hedge fund Journal, April 2011
In the 1980s and 1990s hedge fund administration was a customized, accountable, high value added service to an industry that was on the cusp of massive growth.
Fast forward two decades and the hedge fund universe encompasses over 10,000 funds and $2 trillion in assets. It is thus no surprise that the scale of what administrators do has expanded similarly. But amid this growth two things were lost: client service and accountability.
Putting that at the forefront of the service to hedge fund clients was the impetus for the 2009 launch of Centaur Fund Services. Each of the co-founders – Ronan Daly, Karen Malone and Eric Bertrand – already had over fifteen years of fund servicing experience, and along with Gavan McGuire, who joined the firm in 2010, all four had previously worked together building and running BISYS, which grew to oversee $250 billion in assets and hundreds of funds, before it was acquired by Citi Fund Services.
“We saw a really clear gap in the market,” says Daly, who is Centaur’s executive chairman with core responsibility for strategy and business development. “In fact, we were approached by several funds who said that what they really wanted was the service that had been delivered many years ago but done in a more institutional manner. That is the background why we put the business together.”
What’s fallen by the wayside in Centaur’s view is the administrator’s accountability to funds and the provision of a high quality, customised service.
“Accountability means having key people working on an account and being totally accountable to the fund,” says Daly. “What most fund managers, board directors and investors want is an administrator with a team of people who will commit to deal with issues and make sure the fund is getting a good service. What they want, in short, is a very clear, answerable and accountable group of people servicing the fund.”
“We speak constantly to fund managers, investors and fund boards,” he says.“It’s very clear that the main concerns of all parties revolve around administrators who are not standing over their work; are delivering shoddy, inaccurate and late reporting; and – even worse – have attempted to limit or exclude their liability for their core services. In the current climate it’s imperative that all stakeholders can rely on their administrator to independently verify that assets exist; independently calculate the NAV; and act in an open and transparent manner with investors and fund boards.”
Instead, as hedge funds went through two decades of transformative growth, hedge fund servicing has become commoditised. Originally, hedge funds had worked with specialists who understood their strategies, structures and the instrument types they used. Administrators, in sum, were real specialists. But as hedge fund growth exploded in the mid-2000s most of the high quality specialist administrators were acquired, typically by large banks. Hedge fund administration is often not a core service to many of these organisations and the process and service delivered has been reduced to a very basic commoditised securities processing business. The result for clients has been a disjointed and low quality service.
Infrastructure and experience
Centaur’s team are well-known in the market and, indeed, have been highly involved in many industry developments and innovations both by working with several hundred fund groups and by being actively involved in industry bodies such as AIMA. This experience has led Centaur to invest heavily in their infrastructure and technology. “We see many groups trying to adapt existing systems sets for the particular requirements of hedge fund servicing” says Malone, Managing Director of Centaur. As a new firm, Centaur was in a unique position to select the best of breed technology and build defined workflows and processes around the market and client needs. Centaur uses SunGard’s accounting technology and on the investor services side uses HWM Mantra. In addition, the underlying platform is SAS 70 compliant.
“What is an administrator hired for?” Daly asks. “Well first and foremost to verify that the assets exist and to value the assets. But now most administration agreements have a big carve out saying the administrator is not responsible for the valuation of the securities. You have to ask: what is anyone paying for? For investors there is a false comfort factor: you think the administrator is doing something, but instead there are huge caveats and limits on liability.”
From a legal perspective, Centaur’s position is straight forward: its job is to be responsible for servicing the fund. This includes producing the NAV, dealing with investors, providing the corporate secretarial services, while delivering better contractual terms than what has crept into practice in recent years.
Embracing service and responsibility has helped Centaur sign up 16 funds with another half-dozen in the pipeline with more to follow. Some of its clients include Polar Capital, Pendragon Capital and Zebedee Capital. Once the platform has 50 funds, Centaur expects it will begin to look at overseas expansion, with a focus on North America likely. Daly envisages the business eventually growing to a couple of hundred employees as more funds sign up for its services.
Centaur is working with a combination of boutique type and larger multi-product asset management groups. Among the former some are running $100 million across one or two funds, while among the latter are firms like Polar where hedge fund and long only assets exceed $3.5 billion. It is a slow burn strategy with a bottom up, service-oriented approach.
Using client facing teams
iNAV is the fund service model Centaur uses. It combines technology and the organisation of their staff into client facing teams which feature dedicated staff for specific client accounts. A fund will know who handles the different functions for their account. This eliminates gaps between functions and makes it easy to drill into the detail of a fund and account for a problem with, say, reconciliation or valuation when that occurs.
Centaur’s institutional quality technology and accountable contractual terms are designed to be the most rigorous in the fund administration sector. Highly customised reports round up the service proposition and help a fund client know exactly where performance is being generated. Since the fund is the client Centaur looks to engage regularly with its directors.Centaur will attend all board meetings and aim to be open and transparent with both directors and investors.
“We think it is massively important that investors are able to come into the administrator and double check when we say we are reconciling the positions that we really are doing it,” says Daly. “We encourage investors to come in and ask searching questions.”
Dysfunctional business models
Consolidation of many fund administrators has meant business models have sometimes become dysfunctional. Often the big banks just see administration as an add-on to custody or some other service and seek to recruit big name funds with little care extended to service levels. Such a commoditised offering may end up giving hedge funds a mutual fund level of service that is less specialised than they need. “Historically we have run a decent margin business,” says Daly. “That is exactly the model we follow today. It is extraordinary how a lot of firms in this business lose money and continue to do so every year. One can only assume they carry on because they feel the business is important for other reasons, namely, because it helps attract custom in other business lines, like lending or custody.”
The industry standard fee for hedge fund administration is around 10-15 basis points calculated on AUM. For mutual funds, the fee is in the region of 2-5 bps. Centaur’s argument is that a lot of administrators now are still charging hedge fund fees but delivering a mutual fund service that finds it difficult to handle complex trading strategies, multiple currency share classes, master feeder relationships, complex fee structures and increasingly elaborate anti-money laundering rules.
"There is a real mismatch there,” says Daly. “Clients have been happy to pay hedge fund fees to us because they feel they are getting a real hedge fund service. We charge competitive industry rates. We feel we can justify this because we do more, we take more responsibility and our contractual terms are much more favourable than our competitors. Our cost base is lighter than larger institutions. You might think there are greater economies of scale in what they are doing. In reality, there is a huge amount of bureaucracy and redundancy going on in these places. So their cost bases are high.”
A professional services business
London-based business development director McGuire argues that the big financial services institutions think administration is a processing business when it is really a professional services business. “The reconciliation and valuation processing work should be an absolute given and funds shouldn’t have to worry about it,” he says.“But a lot of our larger competitors have mutual fund-like servicing and they think that is fund administration full stop. Our point is that we think it is a lot more than that. The processing is at the heart of what we do but the added value is having really competent experienced people talking to the client every day and making sure that everything fits together and really works well.”
Regulatory change and the growth of UCITS funds are changing how hedge funds operate with a knock on impact for administrators. There is, for example, much more of a mix in the structure of funds today than there was a few years ago. This means that the automatic preference of most managers for a hedge fund to be set up in Cayman has given way to a more mixed approach. UCITS funds will be handled by Centaur much like any other product, though the level of reporting will be much more prescribed, especially concerning the minimum requirement of twice monthly NAV reports and VaR reports.
“A lot of firms will still use Cayman and it will be the most prevalent domicile,” says Daly. “But there is a lot more business that is going to be domiciled in Europe. Ireland, Luxemburg and Malta are all places where people will consider setting up. The likely impact of the Alternative Investment Fund Managers Directive for a fund administrator is likely to be a change in domicile for some of the funds.”
In fact, it is possible that the Directive might offer good business opportunities for a specialist, hands on fund servicer like Centaur. This comes from the way the Directive is aiming to enhance accountability among both mangers and service providers, notably depositaries and administrators. It is these demands that are making banks chafe at the level of accountability the Directive is seeking to enforce on valuations.
“Clearly given our model that doesn’t worry us at all,” says Daly. “In fact we think we have a serious competitive edge in being happy to step up to the plate and be more accountable.”