Beyond the Numbers Blog

5 Things to Consider When Starting a Fund Administration Business

Posted on September 26th, 2019

Launching a fund administration business is not much different than starting any other entrepreneurial venture. It’s important to understand why the particular business is of interest to you, determine the upside potential, and be realistic about the barriers to entry and resources needed to get it off the ground and ensure long-term viability.

Industry veteran Eric Warshal should know. As president of Fund Associates, a fund administrator based in Georgia, he has had firsthand experience launching a fund administration business. To best position the business for success, Warshal recommends five key considerations: weighing strategic factors, selecting technology, identifying the target market, establishing service offerings, and determining how to differentiate your business from competitors.

Strategic Considerations – Opportunities and Challenges
Fund administration has several core attributes that make for a viable business. For one, it is known for “sticky” relationships. Since fund administration provides the processing infrastructure to run a fund, it is difficult to change service providers once a relationship is established. As a result, clients tend to stay for the long haul. These long-term relationships make for a dependable, recurring revenue stream. The fund administration business is also a very niche market. While there is certainly competition, it is more predictable and all the players are widely known.

On the flip side, there are challenges to consider. Fund administration services are somewhat commoditized, so it is easy to get caught in a downward spiral of pricing to remain competitive. This is where focus, positioning and service excellence become crucial.

Resources present another challenge that can be a barrier to entry. Fund accounting requires a very different skill set than traditional accounting due to the complexity of structures, fees and shareholder reporting. If you do not already have expertise in fund accounting, you’ll need to fill in gaps with outside resources. If fund accounting is already a strength, then technology and running the back-end of the business may be the only stumbling blocks.

Technology infrastructure
Unless you plan on supporting your entire operation with Excel (which will only take you so far since it is not scalable), selecting a technology platform is the single most critical decision for future success. It becomes the “plumbing” upon which your business is built.

“The platform you standardize on can have a long-lasting, material impact on the business you create,” said Warshal. “It must be robust enough to accommodate all types of clients, markets and services. Changing platforms once installed is difficult, so choose wisely from the start.”

Assiduously research vendors, perform due diligence on all viable options and ensure the selected accounting platform can support your current needs and more importantly, future growth. While cost is always a factor in launching a new business, think long term and don’t be penny wise and pound foolish with technology.

Target market
A new fund administrator must decide whether to target established or emerging managers as well as determine which type of funds they are able and willing to administer. Liquid traded funds (e.g., options and foreign exchange) require a different skill set and administrative effort than supporting illiquid funds such as alternative investments, private equity and real estate. The market(s) you enter and the funds you decide to support will directly impact your choice of technology platform.

Fund managers typically remain with their selected fund administrator for years unless a specific trigger prompts them to look elsewhere. Triggers might include poor customer service, inability to support new products, or dissatisfaction with the cost of services the administrator provides.

While it is possible to grab business from a hedge fund manager exiting an existing relationship, a new fund administrator will find that focusing on emerging managers offers greater potential. Yet, working with emerging managers presents its own set of issues. While managers launching a fund might be seasoned investors, they typically have not run their own fund and are not familiar with all aspects of back-end operations. Walking a new manager through each step of fund formation can be quite time consuming.

Service offerings
As a new fund administrator, your business will not be able to provide the broad range of services that larger, more established firms offer. There is, however, a base level of services and corresponding skills that need to be available from the start to get your business off the ground.

Basic fund administration services include managing subscriptions and redemption requests, handling the portfolio reconciliation and calculations and providing reports for fund managers, capital investors and other stakeholders.

Warshal points out that there are two ways to handle reconciliations. He calls these “net asset value (NAV) light” and full administration. NAV light describes fund administrators that can pull statements from banks, brokerage and custodial accounts and look at the transactions, but they can’t reconcile transactions directly in their system.

A full-service fund administrator has established relationships with the banks and brokers of each hedge fund so they can directly download the transactional history for each fund and reconcile it in their system, perform necessary calculations and generate reports. They subsequently work with the auditor to issue K1’s, financial statements and footnotes.

Established fund administrators also offer other services to clients such as tear sheets and pitch books. Some firms provide treasury and cash management services, including acting as a secondary approval for the release of wires if the client’s bank requires it. Other firms go a step further and do full compliance. Some large administrators will provide full back-end support that might include collecting rents for a real estate fund, for example. In essence, once the basics are established, there are numerous opportunities to grow the business with additional services.

Differentiation
Differentiation is important at all stages of business growth, but particularly when starting out. Once all the underpinnings are in place – technology, market, services – determining how the firm should be positioned and marketed is next. New fund administration businesses will have a difficult time competing with established firms on price and fund services, so focusing on client experience and client service can be the strongest differentiators for a new business.

For example, larger fund administrators often have different groups for portfolio accounting, partnership accounting and account management, and a different account contact for each. Smaller fund administrators are able to provide a single point of contact across all departments – a strong differentiator in competing against larger, established fund administrators.

Mitigate Risk
Although there is no regulatory requirement for hedge funds to use the services of a fund administrator, many firms choose to do so anyway. Fund managers may not have the time, the desire or the skill set to manage the complexities inherent in fund accounting and reporting. Or, they may see using a fund administrator as a way to safeguard against financial or reputational risk. In all respects, it’s clear that using a fund administrator makes wise business sense.

Contact us to learn why over 40 fund administrators around the globe depend on FundCount to solve all of their fund administration needs.