Summer 2013

HEDGE FUND ADMINISTRATION: Size matters

Measuring tapeLarge, bank-backed hedge fund administrators have significantly increased their market share in Asia. However, Stefanie Eschenbacher finds making comparisons based on assets under administration tells only half the story. Asia’s largest hedge fund administrators have increased their market share over the past five years as the industry is consolidating and smaller players are leaving. Today, the ten largest hedge fund administrators by assets under administration have a combined market share of 80.5%, research by data provider Eurekahedge shows. Five years ago, the combined market share of the top ten – the list has been reshuffled over the years – was 66.6%. Smaller administrators have gone out of business as the smaller hedge funds they service have closed; larger administrators have increased their market share as the larger hedge funds they service continue to attract institutional investors. In a research report, 2012 Key trends in Asian hedge funds, Eurekahedge notes that in the post-Bernard Madoff world “no investor will consider allocating capital to a hedge fund that does not have proper third-party administration”. The report also examines the changing role of prime brokers in Asia. Goldman Sachs and Morgan Stanley remain the region’s largest prime brokers by assets under management when it comes to hedge fund administration there. Their market share, however, is now smaller than five years ago when they serviced more than half the market. After the collapse of Lehman Brothers, many hedge fund managers chose to spread their counterparty risk by employing multiple prime brokers rather than depending on one. Javed Rahman, managing director and head of Asia at Alter Domus in Hong Kong, says there are other reasons for the decline of prime brokers. “Prime brokerage relationships are typically too expensive for smaller managers.” Hedge funds typically use prime brokers when they seek leverage – managers employing equity long/short strategies represent the largest customer segment for most prime brokers. With the Asian market maturing, however, equity long/short has gone somewhat out of fashion. In fact, the share of equity long/short has declined from more than half of the strategic mandates to just over a third. BOOM
Event-driven, multi-strategy and distressed debt have become more popular. Amod Dixit, director of transaction banking and regional head of investors and intermediaries at Standard Chartered Bank in Southeast Asia, says the boom in the capital markets has led to growth in the funds industry, with a number of new funds launched both in Hong Kong and Singapore. “As competition increases, the funds are trying to come out with more innovative products as well as expand into various new asset classes,” he says. Rahman says bank-backed administrators have an advantage because they can provide comprehensive solutions for what sizable hedge funds – those with more than $100 million of assets under management – would need. This includes, for example, custody, prime brokerage and cash bank accounts. Large independent administrators, such as Alter Domus, are able to provide a more customised, client-focused service because their principal focus is  in fund administration, he says. Within the “open platform” approach that independent firms adopt, clients have a broad array of service providers to choose from. Rahman says that hedge fund administrators will need scale, technology and people who understand the region if they want to compete, and adds that smaller, independent hedge fund administrators are being “squeezed out of the market”. Glenn Kennedy, sales and business development regional head for alternatives in Asia Pacific at HSBC Securities Services in Hong Kong, shares this line. He says there has been a “continued institutionalisation” in the hedge fund administration space. “Larger hedge funds have gained market share and larger hedge fund administrators have gained market share – these two are not unrelated.” Though who the largest players are when it comes to hedge fund administration is open to debate. DISPUTED RANKINGS
Peter Hughes, group managing director at Apex Fund Services, questions the validity of rankings that list hedge fund administrators by assets under administration. “A list of hedge fund administrators by assets under administration is not truly representative of what is going on in the market,” he says. Hughes, who says Apex Fund Services is one of the largest hedge fund administrators by number of funds, says it would be more meaningful to rank hedge fund administrators according to the number of funds they service. He argues some players have been propelled into the top ten because of a few – even one – large hedge fund that pushes up their assets under administration. Today, 44% of hedge funds in Asia have less than $20 million of assets under management, up from 27% five years ago. HFA tables“The non-big bank administrators are doing well in Asia,” Hughes says, adding that the market has changed significantly in the past six years. “Larger names have diluted massively and smaller names have become competitive.” Hughes says the services of independent providers can be more tailored to suit the needs of a broader base of hedge funds. While his bank-backed competitors typically charge between $5,000 and $7,000 per month as minimums in hedge fund administration fees, Hughes says fees by independent service providers are more likely to range between $2,000 and $4,000, plus ten basis points. “The fee structure grows as the fund grows,” Hughes says, highlighting that this model is a lot more suitable for the large number of smaller hedge funds in Asia. Kennedy does not elaborate on prices, but says that “there is not an off-the-shelf fee” he charges his clients. “People who throw out numbers are trying to differentiate on a cost basis.” Rahman says he has seen fees in Asia as low as $1,500 and as high as $10,000 per month for administrating a hedge fund. Fund administration costs for a hedge fund depend on a variety of factors – such as what the hedge fund trades, what reporting requirements it has and the number of investors it has. HAND-HOLDING
Hedge funds or not, smaller funds usually have a disadvantage because fixed costs are proportionally higher. Regulation, the need to comply with it, and the costs associated with such investments, has become a game-changer. Hedge fund administrators will have to decide how – and how much of it – they will pass on to their clients. Kennedy says his clients acknowledge that costs for the service of administrators will increase, but they expect service providers to help comply with new regulation. “Bigger players are able to invest in governance and infrastructure,” he says, adding that they will not only be able to come up with the initial investments but also be able to keep up with investments on an ongoing basis. While some may be willing to cut prices to compete, Rahman says this may work in the short-term but it is not sustainable in the longer term – “smaller players are not going to be around much longer”. Only larger, bank-backed hedge fund administrators and large, independent ones will be make the transition, he adds. “The market is consolidating, now that administrators have to invest in infrastructure and train people.” Singapore and Hong Kong, where most hedge fund administrators have established their hub to service Asia, are already expensive. Not only do businesses face some of the highest office costs in the world, but competition for talent is also fierce. Gaining market share is difficult at a time where hedge fund administrators need to invest in infrastructure. Hughes, however, sees his competitive advantage in other services. These days, he says, he provides a lot more “hand-holding” and advisory services, such as help setting up the fund, legal structures and suggesting a prime broker. Kennedy says his product offering is also driven by what his clients want. But, ultimately, it is about what their investors want or who his clients “think their investors want to see as counterparties”. It is no longer about issuing clients a net asset value statement that consolidates the value of an entity’s assets and that of its liabilities, but how it is priced. REPORTING
Investors increasingly also ask where the assets are held, by whom, how they are priced – and what proportion is priced independently, and what is not. “The big trend is around reporting,” Kennedy says. Although risk management has not been in demand to the same extent as transparency, he predicts this will evolve. Dixit says a reputable custodian and fund administrator serves as an independent third-party that protects the interest of investors. This helps funds to get more investors as they
are looking at transparency before they invest. When institutional investors invest in hedge funds, he says, they will choose a reputable custodian and administrator because of their clients. “Clients are also becoming more demanding when it comes to things such as reporting,” Dixit says. In the end, what will determine the service offering of hedge fund administrators is not regulation but customer demands. ©2013 funds global asia

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