Plenty of our recent posts have focused on the declining degree of oversight and responsibility accepted by many of today's hedge fund administrators.
In light of this trend, we were very interested to see a recent paper published by a smaller admin, Crederian. We are unfamiliar with this firm, but certainly like their philosophy, as expressed in a list of eight administrator "best practices":
Administrator’s Best Practices:
1. Maintains accounting records on a comprehensive General Ledger system.
2. Receives an independent trade blotter directly from the hedge fund.
3. Reconciles cash balances, portfolio trades and security positions against the Custodian and/or Prime Broker accounts on a daily basis.
4. Market values of securities are independently priced by a third party, with complete documentation on any security that is fair valued.
5. Subscription receipts are deposited into an “escrow” account.
6. Contributions and withdrawals are independently confirmed to the investor by the Administrator.
7. The Administrator cosigns any transfer of money from the fund’s trading account.
8. A complete monthend accounting report package that includes each general ledger account reconciled with complete documentation, be prepared, reviewed and signedoff by the Administrator.
Crederian also emphasize the need for administration work to completed by qualified chartered accountants / CPAs, which is another area where many current admins fall down.
This paper, and Crederian's positioning, suggests two potential trends going forward. The first is whether investors will be prepared to have the same degree of confidence in hedge funds which have appointed a smaller, less well-known administrator. Certainly, for highly complex funds, there remains an argument for a "brand name" admin, if only because of weight of resources: some funds have a dedicated 25 person plus team working solely on their behalf at one of the major administrators. Generally, however, we're often of the view that a fund may be better being a "larger fish in a smaller sea". To be blunt, the standard of servicing from many larger administrators is so varied, and can be so poor, that we are always open to examining the service quality provided by a smaller firm. If key metrics are met - daily accounting, sourced from the manager, daily recs, independent valuation - then investors can take strong confidence from the procedures performed, even if the admin is smaller and less well known. Indeed, one of the biggest dangers in the industry remains investors' "check the box" mentality, irrespective of actual service quality: as one example, hiring a "top tier" admin, if all that admin does is take data from the PB, import it into their accounting system, and reconcile back to the PB, is hardly worth the basis points the investor has to pay. This is, however, the accounting model adopted by several of the largest fund administrators for many clients.
The second trend is whether the administration industry will start to differentiate itself based on service model and service quality. It would certainly be encouraging if we saw more firms look to position themselves based on their ability to provide meaningful, independent, "best practice" servicing. To this point, Crederian's efforts to emphasize the need for traditional "quality" is certainly a welcome trend. We hope more administrators follow.
Hedge Fund Operational Due Diligence
"Risk Without Reward" is a trademark of Entreprise Castle Hall Alternatives. Inc.