The 2014 Alpha Awards: Top Administrators

As chairman of HedgeServ, a New York– and London-based fund administration firm, James Kelly takes a very big-picture view of his business. According to Kelly, an administrator should, for example, be able to follow the day-to-day settlement of trades in real time and get a rundown of the tax consequences by the next day. Kelly has gone head-to-head with clients about their monthly calculations of a fund’s net asset value, telling them he can’t be a passive party who just signs off on what the fund manager declares.

“It’s our responsibility to make sure the net asset value reporting is correct,” says Kelly, who co-founded HedgeServ in 2007, five years after selling his previous firm, International Fund Services, to State Street Corp. “We apply the highest standards to ensure that all components of reporting are considered and accurately reflected, especially valuations.”

Kelly’s clients would agree. HedgeServ leads the Alpha Awards ranking of the world’s top hedge fund administrators for the second year in a row, based on a survey we conducted last fall in which we asked managers to rate their administrators in nine areas critical to their businesses.

With $185 billion in hedge fund assets under administration, HedgeServ is dwarfed by State Street Alternative Investment Solutions and Citco Fund Services, which have $818 billion and $740 billion in assets, respectively. And HedgeServ isn’t the only smaller firm to receive high marks from clients: No. 2–ranked Morgan Stanley Fund Services, led by longtime CEO Seth Weinstein, administers a modest $195 billion in assets and also edges out Citco and State Street, which come in at No. 3 and No. 4. SS&C GlobeOp, which has $560 billion under administration, rounds out the top five.

Hedge funds aren’t legally required to use administrators. Since the financial crisis and the Bernard Madoff scandal, however, investors have demanded that managers hire third parties to review their books and verify what the funds are worth. For their part, managers of larger hedge funds generally view administrators as a necessity, though not as the final arbiter on such basic services as account statements, NAV calculations or tax reviews. But when it comes to compliance with the new U.S. Securities and Exchange Commission regulations and the European Union’s Alternative Investment Fund Managers Directive (Aifmd), which went into effect in July 2013, managers pay especially close attention to the quality of the work that their fund administrators perform.

“Administrators have become an integral part of hedge funds’ operations and are necessary for maintaining official books and records, but the final responsibility is on the investment manager, and proper control procedures should be in place to verify the accuracy of the administrator’s data,” says Nadya Frukter, chief financial officer at Hudson Bay Capital Management, a $2.9 billion multistrategy hedge fund firm based in New York. Like most managers since the financial crisis, Hudson Bay shadows its administrator’s calculations, checking to make sure that they’re done correctly. Administrators say they welcome shadowing: The objective, after all, is to get everything right.

Kelly and HedgeServ’s three co-founders — Robert Aaron, Eugene Mannella and Justin Nadler — are all veterans of both the hedge fund and administration industries. In addition to running IFS, Kelly is a former president of Louis Bacon’s Moore Capital Management. Vice chairman Aaron was CEO of hedge fund administrator DPM Mellon. HedgeServ CEO Mannella served as CFO at Lehman Brothers Capital Management, and president Nadler worked for Daniel Loeb as COO of Third Point.

When they launched HedgeServ, their idea was to offer technology that would go further than anything they’d seen before by monitoring trades in real time and showing how their firm made its calculations. In addition to its real-time technology, HedgeServ makes a point of letting clients know that it’s possible to customize data. One customer, a hedge fund manager, wanted to receive tax data at 9:00 each morning and use it to trade. HedgeServ hired a few additional tax experts to provide this information.

HedgeServ is banking on winning clients with value-added services in what is generally a low-margin business. Administrators typically charge clients 5 to 10 basis points of assets under management. According to users of administrative services, it is not uncommon for administrators to keep head count fairly low and put the day-to-day work in the hands of technology specialists who don’t necessarily understand the details of securities trading. For the hedge fund managers, the goal is to choose a well-established administrator from day one — and choose wisely. A divorce from an administrator can be an unwieldy proposition, especially for a fund manager with multiple portfolios and complex trades, because the administrator is likely to have all of the fund’s records housed within a proprietary software system.

Furthermore, investors might suspect that something is amiss if a fund changes administrators, just as investors and the general public might suspect there’s been some kind of disagreement if a company changes its auditor. Investors might understand, however, if a fund manager changes administrators to go with one that has more-advanced technology. Chicago-based Northern Trust Hedge Fund Services staged that sort of coup when it acquired Bridgewater Associates as a client. “What’s going on in this industry is all about the data — and that’s important as asset managers continue to consolidate, compete for clients and seek every possible edge,” says Peter Cherecwich, head of global fund services at Northern Trust. The firm will start working with Bridgewater this year, a move that is expected to give a significant boost to its assets, which stood at $179 billion as of the end of 2013.

Administrators can grow in three ways: wooing clients away from competitors, taking on start-up funds that become multibillion-dollar managers or merging with other administrators. Kelly says that about two thirds of HedgeServ’s clients are established fund managers that moved their business. The third growth strategy, says Kelly, is something HedgeServ’s management will consider, but the firm wants to remain independent rather than become a division of a bank.

State Street became the largest administrator through its acquisition of Goldman Sachs Group’s $200 billion administration business in 2012. George Sullivan, who heads State Street’s alternative-investment group, says part of the attraction of buying Goldman Sachs Administration Services was that the unit brought in new specialties and therefore the ability to service a wider range of hedge fund strategies. “The GSAS book was skewed 70 percent toward long-short equity strategies,” Sullivan says. “Our book had more credit and distressed strategies, so by combining we’ve really broadened our expertise.”

Like HedgeServ, second-ranked Morgan Stanley Fund Services is an aggressive acquirer of technology. CEO Weinstein says that over the past year the firm has been building a powerful portfolio analytics software system capable of identifying risks and dissecting the source of a fund manager’s performance. Morgan Stanley has brought in new business from the strong crop of funds launching in 2013, many of which have the potential to become very large clients.

“We took on a higher percentage of start-ups in 2013 versus converting existing hedge funds from other administrators,” says Weinstein. He’s been impressed with the caliber of recent launches, noting that “if you’re not partnering with managers from the start, you might not have another chance with them as they mature.”

William Stone, CEO of Windsor, Connecticut–based SS&C Technologies, also hopes to establish a technology advantage. Though SS&C’s aim in acquiring GlobeOp was to become one of the megaplayers, the firm also made a lower-profile acquisition at about the same time, buying Thomson Reuters’ Portia software platform. One of Stone’s main objectives is to build strength around the area of derivatives now that over-the-counter trading is becoming more standardized as most instruments move to exchanges under provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Increased regulation has been a boon for hedge fund administrators. A year ago they were helping clients fill out new mandatory forms from the SEC, notably the 43-page form PF (for “private fund”). Now administrators are gearing up to assist clients in complying with the European Union’s Aifmd, a regulation aimed at creating a harmonized framework to monitor the risks that alternative funds pose. All hedge funds that market their portfolios in the EU will have to file reports annually (funds with more than €1.5 billion [$2 billion] in assets must file quarterly), and administrators have been setting up the technology to meet tight deadlines.

The new regulations open some doors for administrators to provide additional services that are extensions of what they already do — though not necessarily for additional fees. The Aifmd requires any alternative fund marketing or operating in the EU to set up a single depositary — an institution entrusted with the role of safekeeping — for each fund it manages. Fund managers had to name their depositaries by the end of this January, and EU approval of the partnerships is required by July 2014. For large administrators operating in the EU, the requirement presents an opportunity to function as depositaries, monitoring each day’s transactions much the same way they already are doing.

In addition, hedge fund managers say the Foreign Account Tax Compliance Act, which will go into effect in July in the U.S., is a measure that is a natural for administrators. The law is designed to prevent U.S. companies and individuals from using foreign accounts to evade federal taxes. Administrators can help their clients comply by obtaining documentation from the funds’ investors about their tax domiciles and closing all loopholes.

Fund managers are coming to expect such additional regulatory filing services, but they don’t come cheap — at least, not for the administrators providing them. William Keunen, London-based global director of Citco Fund Services, says the biggest cost in providing support services is people, not technology: “Our key investments are in expertise and technology, with about 50 percent of our revenues spent on staff and 15 percent on technology.”

As the regulatory climate places more demands for expertise on administrators, HedgeServ’s Kelly foresees a time when there will be stricter standards for administrators themselves: “Every administrator should be held to consistent standards of quality and transparency when it comes to their controls framework and ability to independently calculate NAVs and manager fees.”

HOW WE COMPILED THE RANKINGS
Institutional Investor’s Alpha compiled the 2014 Alpha Awards ranking of top prime brokers, hedge fund administrators, law firms and accounting firms based on voting from last fall and early winter by some 500 hedge fund firms, including many in the 2013 Hedge Fund 100, our ranking of the world’s 100 largest hedge fund firms. Hedge funds were asked to rate the quality of service they received for the 12 months ended August 31, 2013, across a variety of attributes. The scores were weighted according to a voting firm’s assets under management and then averaged for each service provider within each attribute. In the accompanying tables we rank only those firms for which we received a minimum number of responses. To be considered for the overall ranking, prime brokers needed to rank in at least seven of the ten prime brokerage attributes; administrators needed to rank in at least five of the nine hedge fund administration attributes; law firms needed to rank in at least four of the six law firm attributes; and accounting firms needed to rank in at least four of the five attributes. The Alpha Awards survey was conducted by Senior Research Editor Jane B. Kenney.