A sofa-bed is both a bad sofa and a bad bed. Some fund administrators say the same applies to single administration systems that try to support multi-asset portfolios. Nicholas Pratt
A greater allocation to alternative assets as risk appetite returns is helping investment managers fulfil investor demands for greater diversification – and this is being reflected in the kind of funds that investment managers are creating.
David Dibben is head of global fund products at RBC Dexia. “There has been an increase in the launch of sub-funds containing alternative assets within an umbrella fund – for example, derivatives within a Ucits fund,” he says. “It is a more complex structure, but not so complex that it cannot be understood by the risk management teams.”
And therein lies the rub. Ensuring the risk management team is able to keep track of the activities of the front office has been one of the fundamental lessons learned from the financial crisis, along with the need for more diversification. But as the hunger for greater returns whets the appetite for more complex instruments and multi-asset portfolios, there is the possibility that a tension will emerge between two apparently conflicting trends: the use of more diverse and exotic asset classes; and the need to maintain simplicity and transparency.
While the responsibility for managing this tension will always belong to the managers themselves, third-party service providers such as administrators are playing a role in ensuring that investment managers are made aware of viable fund structures. They are also playing a bigger role in carrying out the various tasks that the greater due diligence of investors dictates.
“The asset managers are now much more risk-aware and we welcome that. Clearly investors want to remain confident of the investments they make and managers are looking to us as administrators to be able to help them meet these risk management demands, especially in alternative asset classes. So we face a substantial and ongoing investment in technology in order to meet the demand for the provision of administrative support for investments in more diverse asset classes, in a more controlled way,” says Dibben.
While all administrators agree that more capable IT systems are needed, there is less consensus on what form the technology should take, and whether it is possible to manage a multi-asset portfolio containing alternative asset classes with a single system or whether a range of specialist systems should be used.
Bernard Tancré is head of product management, asset and fund services at BNP Paribas Securities Services. “In the alternative world, there are various techniques and features – performance equalisation, complex over-the-counter derivatives and so on that normal administration systems are not able to handle,” he says. “Trying to put everything through a single system will not save you money because there will be so many exceptions.”
Tancré compares the use of a single system to the purchase of a sofa-bed. While combining a sofa and a bed in one system will save you space, you generally end up with a bad sofa and a bad bed. And it is a similar attitude at investment services firm SEI. “Many administrators have tried to jam different product types into one accounting or transfer agency system but we have found that does not work,” says Barry O’Rourke, who heads up SEI’s Dublin office. “Instead we have a suite of best-of-breed systems for different product types and asset classes – private equity, fund of funds and so on – and we use a blend of these systems to service multi-asset strategies.”
However, despite this “best-of-breed” approach, O’Rourke stresses that it is important to be able to put an umbrella over the top of these systems so that managers are presented with a single view of their fund range regardless of product type, jurisdiction or regulatory status.
“That’s a very significant development and a big issue for a lot of clients because they want to see P&L, expenses, currency exposures and accounting records for all of their investment types at any one time.” But as the creation of more new products continues, will administrators find the cost of maintaining new systems for each new instrument and then consolidating their respective output into a single reporting system becomes too onerous and too expensive?
According to Sylvain Privat, product manager at risk and portfolio management systems developer Sophis, firms no longer want separate systems but are looking to combine everything on one platform with multi-asset risk management capability already built in. “Those firms that adopt a best-of-breed approach end up with dozens of systems and complicated interfaces. It is not a sustainable approach because each new project involves so much checking, there will not be too much impact on other systems. Having an integrated system allows firms to take a much leaner approach and provides transparency and control on the risk of the portfolios."
One thing that has helped Sophis achieve this aim is the fact that its “value” platform is based on technology that was originally developed for investment banks. This has helped to attract more buy-side interest at a time when the structured products created by investment banks are back on the radar of investors. “The sell-side functionality that has always been there means that we have very strong asset coverage and risk-management capability, particularly for derivatives and structured products,” says Privat. “What we have been doing over the past ten years is to bring in more buy-side capacities to the front office, such as decision support, benchmarking, performance attribution and compliance.”
As Dibben points out, servicing more exotic and complex assets was no problem when they were small enough in number to be dealt with by a combination of systems and manual intervention. But manual processes have risk and capacity issues and with the rise in volume and the demand for more risk analytics, more robust technology was needed. “The new systems are much more in line with what is being done in the capital markets firms that are devising the derivatives, which in turn makes it much easier to produce the pricing and reporting for these instruments. We have made a conscious decision to install and develop systems that establish a logical link, rather than simply add a derivatives function on top of a traditional fund accounting system.”
Someone, of course, has to pay for the increased investment in technology, and while the administration market remains competitive, this burden will fall on the service providers rather than the asset managers, but for how long? Will asset managers ultimately have to pay a premium for adopting a more sophisticated approach and a more diversified portfolio?
“The market for administration is currently competitively priced, like many other services but as it becomes increasingly automated, the cost ratio changes and this might help to keep prices stable,” says Dibben. “Inevitably though whenever new services are required there may well be a premium involved because some investment is needed and all administrators need to make a profit. The challenge is to do that within a competitive environment.”
John McCann of Dublin-based Trinity Fund Administration agrees that managers may well have to pay a higher price eventually for greater portfolio complexity and the demand for more transparency and various other facets designed to give more comfort from the new breed of hedge-fund investors. The eventuality may be some way off, but if the many market predictions about an increase in institutional allocations to alternative products turn out to be true, the timeline may be shorter than expected, according to McCann.
“Currently only two to six per cent of institutional investment funds are being allocated to alternative strategies, but reports suggest this figure is likely to double in the next three years,” he says. “Therefore the influx of funds may ease the competitive fee pressure experienced by some administrators allowing them to offset the increase in responsibilities and service requirements demanded by investors with increased revenues as the industry asset levels drive upwards.”
The debate around the competitive pressures facing administrators and the need for heavy investment in new systems leads inevitably to further questions about the sustainability of not just those managers that choose to do their own in-house administration but also the smaller boutique providers.
“For more than a decade, we have had predictions that there will be more consolidation among administrators and that the smaller players won’t survive but we have seen several of them thrive,” says McCann.
“There is no doubt that a higher investment in technology is needed now. The days of administrators being nothing more than a glorified accountant are long gone. But I firmly believe there will always be a bipolar requirement for the big and the boutique. I think it is those administrators that are neither of these and fall in between the two that will struggle to survive.”
©2011 funds europe