Hedge fund administration:

The new paradigm –

step up or step out

William Keunen, director, Citco Fund Services

These are halcyon times for the alternative invest- lishing fund administration arms to maximise
ment industry. While the attention rightly spotlights cross-selling opportunities.
talented fund managers and the institutional This all adds up to an impressive menu of
investors who are sponsoring them, administrators choices for funds making the unenviable decision
have seized the opportunity to assume a more inte- as to who to select as their fund administration
gral role in the investment process and have partner (more of partnerships later). Clearly, one
participated enthusiastically in the ride. size does not fit all and the dialogue between fund
The primary reason for this development is the manager and administrator during the selection
increased focus on the integrity of the operational process is of critical importance.
infrastructure of a fund, resulting in the search for How can funds avail themselves of the specialists
an added-value fund administration service that who work hard to provide dedicated, well-tailored
meets their needs. Fund administrators see this as service solutions? And what should the fund admin-
the opportunity to create a service offering that is istration community do to cement a more deserving
integral to a hedge fund’s investment process. reputation with somewhat suspicious fund man-
Unfortunately, however, for a variety of rea- agers and a needy investor community?
sons, the quality delivered by such a world-class
opportunity tends to be a mixed bag, with many The six core pillars of the fund
administration mandates overselling rather than administration process
providing what a fund really needs. The result The fundamental value proposition of the fund
could be a match made in hell and the recipe for a administrator is their ability to process the fund’s
painful separation. activities efficiently and seamlessly, to report
And, as fund administrators scramble to breaks and P&L, and to provide investors with
enhance their offering to meet the expectations of independently prepared, accurate and timely
an increasingly complex and demanding market- information. The related core processes comprise:
place, the industry is fed a daily diet of fund • investment transaction processing;
administration-related PR announcements that • reconciliations;
include acquisitions, mergers, new mandates • portfolio pricing;
(never lost ones), new and enhanced services, links • fee computations;
to software platforms and increased capacity. • investor-related activities processing; and
Entrants into this space include niche players, • reporting.
hedge funds establishing their own outfits, and Everything else is an add-on. Given the complex
prime brokers and banks either buying or estab- nature of hedge funds, the administrator needs to

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 be able to demonstrate significant investment in which case the administrator typically supplies a
INDUSTRY CONCERNS/HEDGE FUND ADMINISTRATION

people, process and technology to pull off these more traditional suite of services.
seemingly basic requirements. Fund administrators • Partner with the administrator to provide a pre-
who lose sight of these core functions do so at their defined suite of services that could include
peril, and risk doing their funds a grave disservice. systems and middle-office services.
Realistically, for the majority of funds, the man- • A mix of the above to suit the specific needs of
agers must remain in control of their own destiny; the fund.
with anything pre-trade, it’s their own responsibili-
ty while all post-trade activities are mapped out Rattling the cage or rattling the sabre
between manager and administrator in the form of: While the rationale for switching an administra-
• Formal, documented procedures and hand-offs tor is usually perfectly valid, based for example
• Provision for checks and balances by the admin- on the desire to ramp up services, I am surprised
istrator of the fund manager AND vice versa at how often conversion mandates are embraced
• Service level agreements (presumably because of the prospect of mouth-
• Remedial provisions watering revenues) without first fully assessing
• Full and proper disclosure covering all the nature of the operational hazards.
responsibilities Whenever we have been invited to participate
Where new funds are being established, it should in a tender for an existing fund, we have been
be relatively easy to establish an effective partner- inclined to decline the opportunity unless we felt
ship (between manager and administrator) and we could provide an added-value solution that was
form a proper operational infrastructure. meaningful in the context of the fund.
But, for existing funds, it can be difficult to make It may be an over-simplification but, following
a clean break from the status quo, where legacy prac- the demise of one of the “big 5” accounting firms,
tices are often out-of-step with the modern hedge the bar on their approach to managing their risk
fund environment, where the bar has been raised by profile seemed to be raised significantly. The limits
a more educated, demanding investor community. placed on the activities of the remaining accounting
firms have, of course, been compounded by both
Taking fund administration to the next level regulatory and governmental agencies with initia-
In addition to the core functions, administrators are tives such as Sarbanes Oxley in the US. Unless the
adding a suite of new services including front-end fund administration sector is prepared to set and
systems, middle-office services, expanded valua- manage expectations more effectively and adhere
tions capabilities, treasury, collateral management, to its responsibilities to provide checks and balances
risk reporting and compliance services – to name a more robustly (rather than chase assets), the same
few. Whatever the offering, fund administration 101 could happen to one of our own. After all, we can
dictates that the market will determine what a fund all congratulate ourselves on our growth record, but
administrator does well, what they need to improve one bad fund can bring the entire empire down.
and finally what the gaps are in their offering. In any event, regulators, investors, agencies and
The key is to demonstrate that the administra- associations (eg AIMA, IOSCO and MFA) are
tion function adds value to both the investment exerting an influence on how funds should operate,
process and investor communications, at the level with the result that the meaningful money is only
that suits a particular fund’s needs. being invested where there is a proper infrastructure.
And, as developments in the industry proceed
Selection of the fund administrator – three at a lightning pace, with managers and/or the
key criteria funds themselves now staging initial public offer-
Even with such intense competition, the choice of ings, the scrutiny on the role of each of a fund’s
an administrator remains tricky but, if the selection counterparties will naturally intensify and expose
process is handled properly, it should be rewarding. those who are not up to the task.
The fund manager should determine which That is ultimately how self-regulation works
one of three approaches to adopt, always remem- best – either step up or step out.
bering that you get what you pay for:
• Build the infrastructure in-house (using propri- Industry trends that impact fund
etary or third-party systems) supported by administration
in-house operations and back-office teams – in • While there were less mega-start-ups in 2006

112 © HedgeFund Intelligence Spring 2007

 INDUSTRY CONCERNS/HEDGE FUND ADMINISTRATION
I am surprised at how often conversion
mandates are embraced (presumably
because of the prospect of mouth-
watering revenues) without first fully
assessing the nature of the operational
hazards

and this trend seems to continue into 2007, cap- tion requirement and what will ultimately come
ital inflows continue at record levels with down in the formal versus self-regulation debate.
existing, well-established funds seemingly able • Fund blow-ups, such as Amaranth, and the
to attract as much capital as they wish while also knee-jerk reaction of the media to any negative
expanding their roster of funds. This asset growth news about the industry.
is fuelling the entire industry and administrators • The proliferation of surveys, many of which add
who invest the increased revenues in technology little value because they really don’t offer like-
to improve automation will be better positioned for-like service quality of capability
to manage their capacity successfully. comparatives in an industry where the opera-
• Fund complexity – primarily the composition tional support of a complex multi-strategy fund
of the portfolio by way of exotic derivatives and with perhaps 3,000 open positions (of which
illiquid investments, but also convoluted legal 2,000 are probably unlisted) is on a completely
structures to facilitate and ring-fence invest- different level than that of a long/short equity
ments, and to accommodate investors. The fund with 100 positions.
most novel developments inevitably represent a • The challenge of how to satisfy investors’
learning curve for the service providers. appetite for information and transparency with-
• The increased use of complex derivatives and out compromising the integrity of the fund.
the need for staff who understand them and • Conflicts of interest and how they will eventu-
specialists who can price them. ally be addressed. An example of this was the
• The sheer volume of derivatives being traded, comment by one of the largest banks/prime
giving rise to an urgent need for systems and brokers in the wake of Amaranth: “Through
tools to process them – plus the ability to per- hedge fund relationships, such as trade clear-
suade counterparty participants to be part of the ing, we have insight into what’s going on in
solution and supply affirmation and confirma- these funds and can respond quickly to oppor-
tion information on a timely basis. tunities when they come up. Amaranth was an
• The convergence of strategies – many hedge obvious example of that – where our ability to
funds are no longer hedge funds; they have be on the inside, but not compromised, is
added long-only strategies, private equity and extremely powerful to generate profits”!
real estate. This has created opportunities for Finally, I never cease to be amazed at the high
true asset servicing agents that have the capabil- level of commitment shown by fund administra-
ity to offer administration services across tion staff in their efforts to meet client
multiple asset classes. expectations. Their integrity and capacity is a great
• Public listings and ratings, a nascent trend that asset to the industry and is generally under-appre-
everyone is watching. ciated. Perhaps, that is why so many of our staff
• Regulation – the on-off saga of the SEC’s registra- end up working at hedge funds!

William Keunen is the director of Citco Fund Services, responsible for the fund services of Citco. He has
worked in the financial services industry for more than 19 years. Keunen has spent 16 years working for Citco in
the fund administration business, including spells in Curacao, New York, the Cayman Islands and Dublin. He has
also held positions in London as a director of global asset management and as the chief operating officer of
Boar’s Head Management. Keunen qualified as a chartered accountant in the UK in 1982 and holds an Honours
degree in Economics from Manchester University, England.

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