Convergence between traditional and alternative investment management strategies means transfer agents have to consider how to combine the two onto a single platform. Nicholas Pratt looks at the challenges...
The funds market is rife with talk of convergence once again. Back in the pre-crisis years, convergence was about traditional asset managers wanting to instil some hedge-like features into their long-only funds. Now, in these post-crisis years it is the alternative funds that are looking to adopt more mainstream characteristics.
New regulation is helping to drive this trend, particularly Ucits IV, which is likely to increase the popularity of the Ucits brand among offshore alternative managers eager to migrate to more regulated domiciles such as the Ucits-friendly fund centres of Luxembourg and Dublin. Even the European Commission’s controversial Alternative Investment Fund Manager’s (AIFM) directive is more likely to see a greater take-up of Ucits funds than an exodus of European hedge funds.
While most of the talk around convergence has centred on the front office, there are implications for the supporting services – such as transfer agency. For years the most pressing issue for transfer agents and their software providers has been encouraging greater take-up of automation and straight-through processing from fund managers, promoters and distributors. Now there is another issue to address.
“We are looking at how the growth of the hedge fund market has impacted on software systems,” says Aubrey Nestor, product architect at Bravura Solutions, a software supplier to the transfer agency (TA) industry.
“Transfer agents have traditionally had separate divisions for their hedge funds and long-only funds and would use specific and siloed systems for each division. But now that they are starting to see more alignment between the two divisions, they are asking why they can’t have a single system.”
The benefits to this approach are plentiful, says Nestor, even if there will be an initial investment involved. “There is a long-term cost to running many systems that do the same thing. And the relationship with a single supplier saves time and money, enabling the TAs to focus on their business.”
There are challenges involved in providing this single system; however, many of them are historical. In the past, hedge funds had fewer investors with very specific needs so the systems that were used were lightweight and flexible, but the number of investors in hedge funds has grown enormously and many have been acquired by traditional asset managers. The emergence of so-called ‘newcits’ funds that combine both traditional long-only and alternative traits will only see the hedge fund industry grow further, thus putting more strain on already overworked systems.
Waiting for a system
Ucits IV and its emphasis on master-feeder structures, as well as the ability to set up a single Ucits management company to serve all of Europe, has also concentrated transfer agents’ thoughts on consolidating their systems, although most of them are still waiting for the right systems to become available.
“For the moment we have segregated the two platforms – Ucits funds and alternative funds,” says Julien Cuminet, head of transfer agency at BNP Paribas Securities Services. “There are very specific functions needed for the alternative funds and not many systems out there that can provide this functionality, but we have seen a greater effort from the software vendors to upgrade their Ucits platforms to include greater hedge fund capability.”
Should this effort increase and should the right system become available, Cuminet says that BNP Paribas would consider consolidating the two platforms. “We all need to rationalise the number of different systems that we use but we would have to be convinced that the new system was competitive in terms of fees and maintenance, efficient in its service and able to give us the same level of performance.”
Should this criteria be satisfied, the benefits will be clear, says Cuminet. “The first advantage we would get from a single TA platform is a reduction in training costs. It is easier to teach people to use the system if there is a single architecture and a single database. Connecting to all other systems, like custody, would be easier with a single platform and there would be less middleware to implement.”
System consolidation would also help TAs address what Cuminet sees as the most important operational issue for the next three to four years – the ability to work in a truly cross-border context. “Clients are already becoming more international and Ucits funds are distributed all over the world so we have to be able to deliver a cross-border TA service. With the master-feeder rule in Ucits IV, cross-border distribution in Europe will be made even easier and for French TAs it is a challenge to make French funds available outside of France.”
BNY Mellon Asset Servicing is another asset servicer that has a segregated TA service. “The rest of the market seems to be talking about convergence, but we are running our business model based on two separate streams for long-only and for alternatives,” says Richard Willis, TA global product manager at BNY Mellon Asset Servicing.
The segregation was done in 2007, when the alternatives side of the business underwent rapid growth. It is set to grow further over the course of 2010 due to recent acquisitions, thus justifying the decision to separate the two sides, says Willis. “The growth of the hedge funds market made it increasingly complex to run the two sides of the business as one operation. Once you get above a certain size I don’t think you can provide the specialised service that is required for alternative funds.”
When one is not enough
Although there are two separate platforms for long-only and alternative funds, they are able to talk to each other and, when called for, alternative funds can avail of the industrial strength available on the long-only platform, Rufus GTA. “Obviously convergence is a big issue and I can see why a single service makes sense for smaller operators but the sheer size of our operation means we are likely to continue with the current business model,” says Willis.
While the transfer agency operation will be run as two services, Willis does see the attraction of a single system. The basic functions of a TA system – pricing, trade settlement and accounting – are much the same for both long-only and alternative funds. But there are a number of extra features required for the areas in which hedge funds differ, such as registration, performance fees and the numerous side-pocket agreements needed in the alternatives world.
For a transfer agent with a growing alternatives business, there are currently two options: either strengthen the hedge fund system and make it more scalable; or else add some hedge-fund features to the long-only system.
“The latter option is the easiest because the hedge fund systems were never designed for the kind of scale that is needed now, whereas upgrading the performance fees element is much easier on a long-only system that is already used to dealing with multiple share classes, currencies and valuation points,” says Willis.
The various mergers and acquisitions that BNY Mellon has gone through have left it with a number of TA systems.
“What we’ve found is that all of the different platforms have their benefits. Some are well suited to individual markets, such as the UK retail market, we have alternative platforms and we have industrial-strength platforms like Rufus GTA for global distribution.
This is why we haven’t gone down the route of demanding a single platform to fit all and have adopted different strategies for each platform.”
BNY Mellon is, however, developing a single front-end application to work across all of these systems and present its users – the various fund promoters, managers and distributors – with a fully integrated, single front end, a project it expects to continue its rollout into 2011. “Because of the acquisitions and mergers that we’ve been through, there may be the same fund promoter on multiple different systems because they would have worked with more than one transfer agent in the past. Additionally a promoter may be working in different jurisdictions. This project is designed to ease any concerns they may have about what different systems they may be on and to present them with the same overview,” says Willis.
The benefits for the bank’s customers are obvious but will there be any benefit for the bank itself or will it still be working feverishly behind this new front end, performing its integration work behind the scenes? “The client servicing side will have an easier experience because they only have a single point of access so there will be some internal as well as external benefits,” says Willis.
©2010 funds europe