Private banks seek comfort and communication

As private banks and their clients become established as significant buyers of not only funds of hedge funds but also single strategy hedge funds, how can their needs best be met by fund service providers? Clearly, the needs of private banks go way beyond simple fund valuations, as they need to ensure investors’ comfort levels are maintained and that information flows to them are timely and accurate.

Indeed, as private banks shift their clients’ assets into hedge fund products, they are increasingly regarded as substantial market traders. One trend for private banks to access the market is by creating bespoke hedge funds of funds for ultra high-net-worth investors or wealthy families. But private banks are also buyers of hedge funds to their own, non-bespoke, funds of funds that are routinely offered to clients.

Private banks obviously present opportunities for fund service providers. The traditional work carried out by service providers is the calculation of net asset value and assisting the manager in informing investors. It is this communication with investors that remains key to maintaining an administrator’s reputation as being capable and efficient.

Additionally, most large administrators also insist on having an independent valuation calculation. Given the complex nature of hedge funds and the difficulty in providing accurate figures for underlying instruments that are often not trading, independence holds true value for both fund managers and private banks.

Alan Dundon, head of product development, fund administration and middle office outsourcing at BNP Paribas Securities Services comments: “In the US, most valuations are done by the hedge fund managers but in Europe the trend is for independent administrators to do this and other value-added reporting functions, including performance measurement and value at risk. This acts as a front line source of comfort for clients.”

Ian Headon, product specialist, alternative fund administration at Northern Trust adds: “Administrators want an independent source of data especially when it comes to complex derivatives, private equity or distressed debt. And the onus is now on the administrator to ensure that the controls are in place to get the figures right.”

And mirroring the trend in the long-only fund world, some hedge fund managers are also looking to outsource activities that veer more towards the middle office – performance attribution and measurement, producing factsheets detailing investment strategy or top 10 holdings and comparing a fund to its peers, its benchmark and other benchmarks, for example.

BNP’s Mr Dundon comments that once the systems are in place to provide for a given function for long-only funds, then development to provide the same functionality for alternative investments is marginal. He adds that the trend to take on added value tasks is promoted by demand rather than being something heavily sold to fund promoters. “We wouldn’t do it just for the fun of it, the demand is very much there,” he says.

One recent example of this is with value at risk reporting which aims to give the measure of risk of a portfolio losing x per cent of its value within y time. The calculation looks at factors such as volatility and aims to be 95 per cent accurate. Again, this is a valuable tool in its own right but also useful for comparisons between similar funds to be made; all useful reassurance tools for private banks looking to offer their clients an inherently risky investment in a controlled way.

Another function to have recently been expanded is the processing service for funds of funds in particular. The Bank of New York, for example, has been innovative in this area, last month buying a data warehousing facility to be based in both Dublin and New York which will provide transaction processing and custody for private banks. Specifically, the platform provides consolidated reporting and distribution capabilities, transparent trade workflow management, position maintenance at a tax-lot level, data enrichment and document management, all with the aim of providing operational efficiency.

David Aldrich, managing director and head of securities industry banking at the Bank of New York explains: “The software is proprietary and provides an end-to-end solution for clients.” He singles out the ability to align the cash processing with the trade processing, saying that automating the system removes the potential for expensive manual mismatches that can only be resolved on a monthly basis.

But Mr Aldrich thinks the future trend will be more for fund service providers to use their reach in the market place to find the best experts for managers to choose from, rather than providing an increasing array of specialist services themselves.

“We trawl the market for the best specialists in each strategy and then present a matrix to our clients detailing who our source is for each strategy. As far as risk reporting is concerned then we would let our client decide whether to use one of our sources, as we just don’t think it’s feasible for a fund service provider to be the most credible risk measurer in the market,” he says.

Northern Trust’s Mr Headon echoes this and warns that not all administrators will have the capabilities to take on additional functions. “The classic function of an administrator is all the accountancy type functions and getting the expertise in to perform these value added tasks takes time. As a consequence some administrators outsource these additional functions to specialists,” he says.

Indeed the extent to which administrators can or should take on these additional functions is a hot topic of conversation with many predicting that administrators will have to move to London to acquire the right people capable of carrying out these additional tasks.

“London is such a significant hedge fund centre so it follows that it also has a broader range of people with the right skills,” says Mr Headon. “In this context, would it make more sense for administrators looking to expand their services to include more middle office skills to base there as well?”

Dundon: independent data acts as a frontline source of comfort