Why Funds Should Shadow their Administrators

For hedge funds and private funds, Fund Administrators play a critical role in managing back-office operations, maintaining accurate books and records, and ensuring compliance. Fund administrators typically have sophisticated systems that can capture and analyze vast amounts of data to meet expectations of fund managers. Despite their pivotal function, there are several problems that fund managers face while interacting with their admins. Common challenges include occasional discrepancies in data reporting, timely availability of reporting, and communication barriers. In addition, there is a growing demand for customized investment solutions and personalized experiences requiring faster and accurate results. Shadow Accounting is here to bridge the gap, enabling fund managers to gain more clarity in a more efficient way.

In this blog post, we discuss the challenges fund managers typically face when working with fund administrators and how shadow accounting helps address these issues and enhance fund performance.

Challenges of working with fund administrators

1. Communication gaps

Effective communication is important to investors, fund managers, and other stakeholders. Fund administrators need to ensure all parties are aware of fund performance data and provide updates about any changes. This can be a challenge when stakeholders reside in different countries or regions. Lack of timely communication between fund managers and fund administrators can cause errors and delays in critical processes, such as reporting, trade settlement, and compliance.

2. Handling complexity

When funds operate in different countries, it is very difficult for the administrators to navigate diverse regulatory frameworks. Each jurisdiction imposes unique rules and compliance requirements on financial institutions, including hedge funds and fund administrators. Managing varied regulations requires a comprehensive understanding of reporting standards, local laws, and tax obligations. Furthermore, constant regulatory changes add a layer of complexity because fund administrators must adapt their systems and processes accordingly.

Moreover, hedge funds often incorporate complex asset classes, such as illiquid strategies, derivatives, and structured products, that each have unique regulatory requirements and valuation methodologies. Fund administrators must be able to understand intricate pricing models and data sources to determine fair value of assets and ensure compliance with accounting standards and investor reporting obligations.

Overall, managing funds is a complex task that requires fund administrators to handle various asset classes and maintain high standards for valuation and regulatory compliance. But it is fund managers who must ensure fund administrators are aware of and follow all of the requirements set by investors and regulators.

3. Accuracy and timeliness

Most investment management firms rely on fund administrators to prepare final books and records. Fund admins provide fund financials such as Positions/holdings summary, P&L, and Net Asset Value (NAV) reporting. However, a significant challenge arises when these data sets are not available until several days after the month’s end. When this happens, intra-month reporting must rely on substandard data. Any delays in obtaining accurate and comprehensive financial insights can hinder decision-making processes, leaving fund managers with incomplete information and potentially impacting investment strategies and risk management. This is a notable challenge for any fund seeking real-time insights into performance.

4. Dependency risk

Investment funds face a significant risk because they are dependent on fund administrators. When fund administrators leave the organization suddenly, for example, it could endanger the funds they service. The departure of a fund administrator could disrupt crucial back-office functions such as reconciliation, trade processing, and financial reporting. Funds may struggle to find an immediate replacement or any alternative solution, which could lead to compliance issues and operational inefficiencies.

Switching administrators is not an easy task, one that entails a substantial amount of time, resources, and effort, and would likely disrupt normal fund operations. Fund managers must conduct thorough due diligence on potential new fund administrators to ensure they meet the fund’s specific needs and regulatory requirements.

 

5. Customization

Fund administrators may lag behind in fulfilling customization needs for the fund. Fund administrators often use standardized processes and systems that are designed to accommodate a broad range of clients. This approach ensures efficiency, but it may limit the fund administrator’s ability to customize the service for any individual fund. Customized reports, however, have become increasingly important as investors seek to evaluate the fund’s performance more accurately and gain a deeper understanding of the fund’s investment activities.

How Shadow Accounting bridges the gap

Shadow accounting has emerged as a new way for fund managers to address all of these challenges while achieving greater control, transparency, and confidence in their financial operations. Specifically, shadow accounting provides four important benefits:

1. Operational flexibility and independence

The flexibility and independence offered by shadow accounting ensures that funds are not as dependent on third-party administrators, which provides valuable mobility and risk mitigation.

Firms that rely on third-party fund administrators have no way of verifying the accuracy of the information they receive. Shadow accounting provides an accurate record of performance that gives funds more independence. Funds can verify the data they receive, and if any errors are detected they can be resolved earlier. Because funds gain more control over their data, they can switch providers if the TPA costs become too high or if service levels drop. Most important, the availability of real-time data through shadow accounting enables more timely decision-making, which optimizes portfolio management and trading strategies.

Additionally, mergers and acquisitions are common in the fund administration industry. Using shadow accounting enables funds to maintain a complete set of books and records and always have a clean copy of mission-critical data, regardless of any M&A activity.

2. Improved performance

Direct access to accurate, real-time data from an accounting book of record (ABOR) is extremely valuable for a fund. In this scenario, when any internal decision-making tools require up-to-date data, they can pull it from a consolidated data store. This has an obvious effect on the quality of decisions made with these tools.

Access to structured and enriched holdings data and exposure reports, along with the ability to filter and analyze by strategy, enhances the effectiveness of management information dashboards, front-office tools, and risk management functions. As a result, the fund’s decision-making will likely improve as will its ability to articulate a competitive edge to potential investors.

3. Better client service

The ability to provide allocators with high-quality, responsive service more efficiently is a crucial consideration for shadow accounting.

More and more institutional investors seek hedge funds with robust risk management capabilities. Shadow accounting improves visibility, control, and oversight, enabling funds to reduce reliance on third-party fund administrators and manage market and operational risks more effectively.

Reporting expectations of allocators are also changing. They expect faster, more customized information and are no longer willing to wait until the end of the month for a NAV pack.

Shadow accounting helps funds meet these changing expectations with the ability to create and send reports without waiting for official books and records from a fund administrator.

4. Investor due diligence

In today’s fundraising environment, hedge funds must satisfy strict due diligence demands to attract investors. The allocation process takes years and competition is intense. Firms must find ways to stand out among a multitude of strategies and a larger number of funds than ever.

Investors need assurance that their investments are safe and accounted for correctly before the chief investment officer or portfolio manager can explain the fund’s unique selling point (USP) or why their strategy is better than their competitors. It is essential to have the fundamentals in place from the beginning. Even a single missed checkbox on the due diligence report can veto a fund. In contrast, firms with a robust operational infrastructure are more appealing to institutional investors.

Shadow accounting allows investors to assess the operational resilience and contingency planning of the fund. With a clear understanding of how the fund manages its accounting and reporting processes independently of a fund administrator, investors can more easily gauge the fund’s ability to mitigate operational risks and adapt to changing market conditions or disruptions.

Keep in mind, not all shadow accounting providers are the same. IVP Shadow Accounting Services provides a cost-effective solution for managing complex financial portfolios. By partnering with IVP, hedge funds and others can benefit from our “digital first” services that automate processes using industry best practices. In fact, customized services are available that allow hedge funds to choose partial or full shadow NAV services tailored to a specific strategic approach.

Learn more about IVP Shadow Accounting or contact sales@ivp.in to schedule a live or online demo.