Hedge fund administration is evolving and growing in pace with the asset class

After a long stint on the sell side, Ronald Suber took a job in prime brokerage at Bear Stearns. It was 1992, and despite George Soros and his bet against the Bank of England, the term “hedge fund” was esoterica. There was no “industry,” no Internet, and all a back office needed to administer a hedge fund was a decent accountant.

“Everything focused on traditional fund administration for exchange-traded product,” recalled Suber, crediting his stint in prime brokerage for giving him a working knowledge of hedge fund administration.

Now, little more than a decade on, hedge-fund administration is a multifaceted undertaking with a global scale.

“Today, we see complex fee structure, complex strategy, illiquid product,” he said. For Suber, who left Bear Stearns last year to become president of Spectrum Global Fund Administration, it might as well be a different business altogether. And it is.

In sum, hedge fund administration is the back-office work done for a hedge fund. At its core, this would comprise account reconciliation, partnership and portfolio accounting, client reporting, NAV (net-asset-value) calculation, risk management and post-trade clearance and settlement. On the surface, it would seem to be a straightforward-enough, if not labor-intensive, enterprise. But, as hedge-fund investing has evolved and the asset class has swelled into a multi-trillion-dollar behemoth, administration has been forced to integrate the latest technology and adopt a broader business model.

“It has not only been an evolution, but also a revolution,” Suber said, and the sheer amount of capital flowing into the asset class is responsible.

The Q3 2007 HedgeFund.net Administrator Survey recorded $2.562 trillion under administration, up from $2.26 trillion at the end of Q1 2007. According to the survey, Citco Group is the largest administrator per asset-size, at $436 billion. Rounding out the top 10 largest is, in order, HSBC, Citi, IFS, Goldman Sachs, The Bank of New York, Fortis, CACEIS, SS&C and UBS.

To understand how much the influx of capital has impacted hedge-fund administration, first hearken back to that passé buzzword from the new millennium, “outsourcing.”

“The era of self-administration is diminishing,” Suber said.

Prior to the boom, a hedge fund could handle its back office “in-house,” with its own personnel and through a combination of automated (technology-based) and manual processes. That is no longer an option. The cost of paying for, training and retaining the skilled manpower and technology needed for a back office is not practical; outsourcing is.

For a fee, a hedge fund can outsource its back office to a third-party hedge fund administrator like Spectrum Global and focus on its core competence: money management.

Even if a hedge fund wanted to maintain its back office in-house, the changing clientele might take exception. Institutional money is used to institutional standardization and, according to Suber, independent, third-party administration is an expectation for the institutional market.

“I would say the first rumbling of this started in the summer given market performance and continued existence of fraud among a small segment of the industry,” Suber said.

Among institutional clientele, there is a growing push for internal control as well as independent, third-party administration. SAS 70, the Statement on Auditing Service 70, is also becoming a requirement. SAS 70 is a standardized method of reporting back-office transaction processing, and Type II SAS 70, the more-stringent SAS 70, is preferred.

“This is going to be a requirement going forward,” Suber acknowledged.

The other bellwether in the progression of hedge fund administration is technology. Suber called finding and effectively using technology to automate processing a major challenge in hedge fund administration.

In the past, an administrator could use semi-automated processes and manpower to handle a back office. Now, end-to-end automation is essential. Further, Suber noted an administrator is better off with its own proprietary technology rather than vendor-market software. Those without proprietary technology “struggle with the need to upgrade,” he said.

Meanwhile, in the midst of its revolution, hedge fund administration has become a business unto itself. Massive custody provider and outsourcing provider State Street Corp. seized its share of the market with its deal for IFS. Wall Street powerhouse Citi bought BISYS Group in May and gained a $325 billion alternative asset administration business. The Bank of New York merger with Mellon Financial created a massive administrator.

“It has become a hot business,” Suber conceded. “It used to be just a back-office function, but given institutionalization, I think it has moved to the foreground.”