Administration has historically been a lower priority for hedge funds compared to their trading strategies and investment returns. Yet, greater coordination with fund administrators offers a wide range of benefits.
Collaborating with administrators means hedge funds gain enhanced operations, risk reduction, client reporting and access to administrator expertise. With that in mind, this guide presents four compelling reasons for hedge funds to keep a closer eye on administrators and integrate them as key partners in hedge fund administration.
What’s the role of a fund administrator?
One of the most important responsibilities of the hedge fund administrator involves calculating the fund net asset valuation (NAV). Before calculating the official NAV, the fund administrator must certify the accuracy of the data by way of reconciling the investment manager’s data against that of the prime broker or custodian.
Fund administrators are well-versed in the different ways that a NAV should be calculated and the need to agree with investment managers on the methodology to be used before posting an official NAV.
The question centres around why does the investment manager need to reconcile the makeup and accuracy of their NAV if a service provider or fund administrator is already performing reconciliation? After speaking with several operations professionals across the hedge fund administration space, here are the main reasons why an investment manager should shadow their service provider or fund administrator.
1) Pricing issues
One major area of coordination that hedge funds often overlook is ensuring consistency in pricing of assets across their own books, prime brokers and administrators. Many alternative investments like structured products, derivatives and private equity stakes have little or no public price discovery.
Their market values rely heavily on financial models. Without a shared source of pricing inputs and valuation methodology between the fund manager, prime broker and administrator, discrepancies in reported prices are commonplace. These pricing differences routinely trigger reconciliation headaches, potential investor queries about performance accuracy and administrative burdens in resolving data conflicts.
By reviewing pricing methodologies in greater depth with administrators and participating in periodic sampling of modelled prices versus actual broker quotes or returns, hedge funds can materially improve pricing precision. Tighter coordination ultimately reduces operational risks and instils greater investor trust around proper asset valuation.
2) Staffing concerns
Another common source of reconciliation issues and NAV errors is difficulties with staff skill level and retention at administrator firms. Administrators often struggle with high employee turnover relative to hedge funds themselves.
When new or junior staff are unfamiliar with the complexity of alternative investments, mistakes can multiply across corporate action processing, income and expense recognition and trade booking. Lacking industry veterans who share the investment manager’s deep enthusiasm and persistence around solving reconciliation puzzles also allows mismatched data and unresolved breaks to linger across fund and prime broker data sets.
Hedge funds that develop closer relationships between their own operations teams and key lead administrators can shortcut the learning curve through knowledge sharing. Seconding internal staff to periodically work onsite alongside administrators or sponsoring external training on niche products also boosts administrator expertise to the benefit of accurate record keeping.
By focusing greater attention on administrator staffing quality and expertise retention, hedge funds alleviate friction costs around reconciliation and error remediation. The core emphasis is on staff expertise.
3) Investor protection
While administrators handle critical operations like NAV calculations and portfolio reconciliation, the hedge fund itself remains ultimately accountable to investors for the integrity of these processes.
Any misstatements or errors in performance reporting or fee calculations resulting from administrative oversights must still be explained and often compensated by the fund. More stringent investor expectations around transparency and data quality also continue to raise the bar for oversight.
This makes it imperative for hedge funds to shadow administrator activities with high diligence rather than fully outsourcing fiduciary duties. Tight collaboration with administrators allows funds to rapidly identify and resolve issues that could undermine investor interests. Highlighting progress on accuracy metrics and controls during investor meetings further signals the priority hedge funds place on investor protection.
Though delegating back office functions is necessary and advisable, hedge funds should continually treat investor interests as sacrosanct by working hand-in-hand with outsourced providers on meeting standards.
4) Regulatory requirements
Staying abreast of changing regulatory demands is yet another area where close coordination between hedge funds and administrators pays dividends. The rise of major reporting mandates like Form PF in the United States compels funds to maintain firmwide visibility into counterparty exposures, derivative positions, investor concentrations and other statistics across all their portfolios.
However, with administrators record keeping and accounting for most fund assets and liabilities, investment managers struggle to aggregate clean data. By shadowing administrators more closely as Form PF deadlines loom, hedge funds can catch omissions or errors in time to remedy reporting gaps. Jointly reviewing how administrators are capturing key data fields allows managers to validate reporting methodology.
Hedge funds also collaborate with administrators on system upgrades to ensure new regulatory requirements can be addressed accurately and efficiently. Tight collaboration ultimately results in compliant, consistent reporting and avoids risks associated with submitting inaccurate Form PF filings.
Summing up: Why hedge funds should shadow their fund administrator
Hedge funds strengthen operations, risk management, investor trust and regulatory compliance by closely aligning with administrators. While delegating core responsibilities, managers must continue safeguarding investor interests and fund integrity through joint focus on pricing precision, expertise retention, transparency and reporting accuracy. Hedge fund administration is complex but tight collaboration is key to unlocking its full value.