Why Are Fund Administrators Getting Fired at Alarming Rates?

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administrator-8-25-17.pngPrivate fund managers are showing an increasing penchant for firing their fund administrators. A new report by the alternative investments data and research firm Preqin shows that 21 percent of fund managers changed a service provider in 2016, and of those, 36 percent changed fund administrators.

While that figure is alarming in and of itself, the trend for fund administrators is unfortunately heading in the wrong direction, as this is a 29 percent increase from 2015. All indications are that this will continue in 2017, as the report shows that 72 percent of private fund managers review their fund administrators at least annually, with 30 percent doing so every single time they bring a new fund to market.

Have fund administrators lost their way, or are they being scapegoated by their own private fund manager clients? The study lists the primary drivers given by fund managers for this level of firing as:

  • Dissatisfaction with quality of service provided (27 percent)
  • Cost (23 percent)
  • Increased portfolio complexity (23 percent)
  • To cope with regulation (23 percent)

The inability to help clients deal with more complex portfolios and cope with regulation would both contribute to a dissatisfaction with the quality of service being provided. These factors are interconnected.

As such, I would argue that the overwhelming reason that fund administrators were fired in 2016 is because of the lack of service they are providing to their private fund manager clients.

Going one level deeper, I also feel that a lot of this discontent is driven by a lack of modernization. The alternative investment industry is overwhelmingly document-based and manual in nature. The wave of technology-driven automation and efficiency that has swept through other areas of financial services has only recently started to impact alternative investments.

A peek under the hood of how a private fund is managed and administered would reveal an industry seemingly stuck in the 1990s, with manpower typically being the biggest determinant of the speed and quality with which the industry operates.

Private fund managers are tiring of the difficulty they are experiencing with their fund administrators over critical and repetitive actions. Things like getting monthly financial packages completed, formalizing agreements and sharing validated information with stakeholders is too difficult in an age that values simplicity and convenience.

The other factor that is at play here is that fund managers themselves are under increasing pressure from their investors. Many fund administrators and private fund managers alike forget that the same person that is invested in a private equity fund has banking and brokerage accounts at a bank or credit union.

These people are used to being able to see and interact with their information digitally on a laptop or a mobile device, be able to take certain actions in a self-service manner, and access their information at any time. Customers are frustrated about dealing with a fund manager who only delivers performance metrics in a document via email. To make matters worse, the volume of documents increases the more investments that investor has.

So why does it seem like fund administrators are bearing the brunt of the industry’s lack of modernization? The fund administrator is the backbone of it all. They have not only become the conduit for interactions between the investor and the fund manager, but also that for interactions between the fund manager and the fund administrator themselves.

Private fund managers are increasingly looking for their fund administrators to provide them the tools to better manage their funds and service their investors. As evidenced by the Preqin study, private fund managers are showing an easy willingness to change to a fund administrator that they feel gives them what they need.

Fund administrators that are absorbing this message are starting to take the right steps to address the quality of service that they provide to their clients. They are taking actions like creating investor relations teams that can better handle communications with clients and investors.  They are adopting technology that will automate manual processes between themselves and their clients, as well as make the needed transition to be able to present investment metrics in dynamic and interactive digital dashboards rather than in static documents.

These are the types of actions that fund administrators will need to take to ensure they are on the right side of the firing line.

How to Get Private Equity Out of the Dark Ages

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Alternative investments are on a tear, and no asset class has seen more growth than private equity. According to a recent study by eVestment, assets under administration grew 44 percent from 2015 to 2016. This influx of capital has caused major ripple effects across the entire private equity landscape, with fund managers competing intensely to attract investor capital.

This competition has reinforced the importance of the overall experience that private equity managers provide to their investors, and as a result managers have increasingly been looking to their fund administrators for solutions.

Technology is widely seen as the solution to many of the challenges facing both private equity managers and fund administrators. Yet despite this consensus, “private equity is in the dark ages when it comes to technology” as Allison Piet, director of alternative investments accounting and reporting with insurer MetLife, puts it.

Private equity fund managers and fund administrators alike are finding themselves at a crossroads on two key issues:

  1. Delivering on investor demands for greater transparency and a more modern digital experience.
  2. Handling the operational burden of labor-intensive and margin-constraining processes that are insufficient to meet growing regulatory requirements.

A study by technology provider FIS, titled “The Promise of Tomorrow: Private Equity and Technology,” brings context to these two important issues:

Delivering on investor demands for a more transparent and modern digital experience.

One of the greatest obstacles to solving this challenge is the proliferation of systems that fund administrators and fund managers use across areas like accounting, reporting and document storage.

This multi-system approach adds a great level of difficulty to the process of collecting and preparing data required to provide investors with transparency. Further, maintaining multiple systems often proves to be arduous and time-consuming.

This demand for a more modern experience has placed tremendous pressure on fund administrators in particular, as their fund manager clients increasingly look to them to meet this need. Fund managers are sending a loud message by walking away from administrators that can’t help. In fact, according to a Preqin study, 28 percent of fund managers fired their fund administrator in the past 12 months.

This helps to explain why, according to the FIS study, 26 percent of respondents felt “threatened” by technology. That said, those that are leveraging the power of technology to improve their offerings are realizing that it can become a competitive advantage, as evidenced by the 74 percent of respondents that affirmed this in the study.

A quote from the FIS study makes this key point: “The private equity industry’s effortsto reinvent its relationship with technology also reflect recognition of the critical importance of technology to winning and retaining customers and to penetrating new markets.”

Handling the operational burden of labor-intensive and margin-constraining processes that are insufficient to meet growing regulatory requirements.

The private equity and the alternative investment industries have also been going through a metamorphosis over the past few years in the area of operations, driven in large part by the imposition of ever-increasing regulatory requirements. Compliance is the great equalizer, affecting all stakeholders in the industry from the fund administrator down to the investor.

These requirements become a business-breaking burden when operational efficiency is dictated primarily by the number of people that a company has available to help tackle them. The alternative investment industry is notorious for how heavily it relies on people to handle manual and repetitive tasks that should be automated. These are things like document preparation and distribution, tracking and receiving needed approvals, sending emails for notifications and more.

These manual tasks are exponentially more troublesome when legal and regulatory requirements come into play as most fund administrators have to add one full-time employee for every three or four new clients that they win.

This results in a vicious cycle for fund administrators as they far too often expand their budgets by adding additional staff instead of investing in technology that could solve their root problems.

Technology provides the clearest path to help private equity get out of the dark ages. This is the one solution that will help all key stakeholders improve the overall offering to investors without compromising their ability to build profitable businesses.

This quote from the FIS study encapsulates it best: “Firms that embrace this world of innovative technologies are likely to be the ones that win out in the marketplace.”

What Does 2017 Hold for the Alternative Investment Industry?

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Last year was an exciting one in the alternative investment industry, and all indications point to another great year in 2017. Here are five predictions that will dominate the industry in 2017.

1. Capital invested in private equity funds will continue to increase amidst a further decline in hedge funds
Growth in alternative investments will continue to be explosive in 2017. According to a report from Cerulli & Associates, the mean allocation of alternative investments is still less than 5 percent of overall assets. Depending on the industry source, the general guidance is that the ideal allocation should be in the 15 percent to 25 percent range, signaling that there is a lot more room to grow.

Nowhere has that growth been more evident than in private equity funds, which have increased dramatically over the past few years. Assets have risen from $30 billion in 1995 to around $4 trillion in 2015. This growth will continue, as 64 percent of limited partners plan to increase their allocation to private equity funds, which is up from 26 percent just five years ago.

Hedge funds, on the other hand, have struggled as poor performance compounded by high fees resulted in large outflows in 2016.

2. Regulatory and compliance pressures will continue to increase even under a Trump administration
Regulatory and compliance pressures have been a dominant factor in the alternative Investment industry (and especially among hedge funds) for several years now. While some industry leaders are optimistic that a loosening of regulations will occur under the new Trump administration, the trend toward more transparency will continue to grow.

Study after study shows the impact of mounting regulatory and compliance pressures. Here are two reports that paint a clear picture:

  • In a Longitude Research study last year more than 50 percent of fund administrators predicted that the need to keep up with regulation would have the greatest impact on their activities over the following three years.
  • A report from Linedata showed regulatory and compliance being the chief concern facing fund administrators and fund managers alike.

3. Technological capabilities will become as important for fund administrators as accounting capabilities
Fund administrators are traditionally thought of as providers of accounting services. Technology was mostly thought of as internal plumbing, and the decisions made about the use of technology were often left in the hands of an IT department, with little senior-level involvement.

It’s safe to say that those days are over. This year we will see the further emergence of technology as an integral capability for any fund administrator—on par with the importance of their accounting capabilities.

Fund administrators rely on technology to give them the data, reporting and understanding needed to satisfy the evolving needs of their clients and investors. In fact, nine out of 10 fund administrators plan to invest in technology in the next three years.

4. Consolidation will continue to increase in the fund administration business
Competition in the fund administration industry is intense. This is being driven by the explosion in capital being invested, the increasing demands for regulatory transparency, and the economies of scale needed to effectively compete in a low-margin business. No metric shows this better than the one reported by Preqin that 28 percent of fund administrators have been fired by their clients in the past 12 months.

The trend toward consolidation has escalated significantly in the past two years. While this can be good news for the largest of funds that can afford the services of the largest of fund administrators, this consolidation is likely bad news for both mid-market fund managers and mid-market fund administrators.

5. Fund administrators will become a bigger force in private equity and real estate funds, as well as with family offices
The use of fund administrators is pretty much a requirement for hedge funds, as evidenced by the outsourcing to fund administrators increasing from 50 percent in 2006 to 81 percent in 2013. This dynamic really started taking shape in the wake of the Bernie Madoff scandal, which showed the perils of a lack of validation and supervision within the industry.

In comparison, fund administrators are under-penetrated in private equity and real estate funds, with estimates showing fund administrator penetration at around 30 percent of assets under management today. However, this is expected to increase 45 percent by 2018.

The same conditions that drove the shift to fund administrators in the hedge fund space affect private equity and real estate funds as well. Just as happened with investors in hedge funds, investors in private equity and real estate funds are demanding third-party validation of assets and performance. Regulatory pressures are already having an impact on general partners of private equity and real estate funds.

Although occurring more slowly, the need to turn to fund administrators is also happening in the single and multi-family office space thanks to an increasing rate of wealth and investments in ever more complicated asset types.