Udit Gambhir is associate director, Fund Services for Amicorp Singapore Pte Ltd. He has worked as a supervisor with Citco Fund Services, as well as Dynamic Mutual Funds, both in Toronto, Canada. Prior to this, Udit worked as a marketing manager in promotional merchandising in the USA. Udit also successfully started and ran his own diamond-trading venture in India, which is now part of his family business. Udit is proficient in English and Hindi, and is originally from New Delhi, India. He is now based in Singapore and joined Amicorp Singapore Pte Ltd in November 2007 as an associate director for Amicorp Fund Services. He handles business development and marketing, fund structuring and administration services for the Asia-Pacific region. He has a Master of Business Administration degree in finance from Babson College in the USA and a Bachelor of Science degree in marketing from Bentley College in the USA.

Abstract

Globalisation and reducing investment restrictions have encouraged capital flows across the world. Product development in financial markets has hastened the channelling of this capital into ‘bets' that hedge against the negative impact of exposure, or simply for speculation. Enter the world of alternative investments - of which hedge funds form a primary part, in addition to private equity, fund of funds and other non-traditional asset classes. As of 2007, the global hedge fund industry had assets of about US$2.48tn. Alternative investment managers are distinguished by an objective to deliver absolute returns. These funds accept investments from high-net-worth individuals (HNWIs) and/or accredited investors and institutions.

With increased assets under management, managers are outsourcing key components of their day-to-day activity. Today, accountants, administrators, attorneys, bankers, brokers, custodians, consultants and marketers are a few key service providers to this industry. This paper will try to provide an overview of one of the key service providers: administrators. It will provide a general overview of the key service providers and delve deeper into administration, and aims to provide the reader with an understanding of the administration process, as well as certain key things that must form part of a checklist when selecting an administrator. It will also list some best practices in administration that could help administrators to improve their processes and streamline operations.

Industry Overview

In general, a fund is a collective investment vehicle in which managers pool incoming monies and invest the same into different securities or ‘growth platforms', to be able to return those monies with higher-than-normal capital appreciations. In essence, investors pay these managers a fee so that their investments yield higher returns than those that they themselves can generate.

A manager depends on many different service providers so that his or her main focus remains on identifying under- or overvalued investments and channelling the resources towards these. This division of labour has become more intense, with increased asset allocation to alternative investments. Larger funds outsource these key components, freeing up valuable in-house resources and providing the manager with additional ‘hands' for fund or investment management.

A few of the different players in the alternative investments industry are as follows:

• Analysts assist the manager in ‘number crunching' and provide some credible forecast to movements in valuations for underlying investments. They also assist the manager with return calculations, fee calculations, net asset value (NAV) review, etc.
• Brokers/banks are intermediaries that the fund uses to channel the monies collected into various investments. Brokers serve to connect the investor with a counterparty willing to serve on the other spectrum of the transaction. For example, an investor wanting to buy a stock will go through a broker, who will find a counterparty willing to sell the same. Brokers earn a fee on each transaction as well as earn interest on any credit facilities provided to the fund (prime facilities). Banks pool all incoming monies and pay out invoices or fees, etc. They also provide interest on any cash balances remaining in the brokerage accounts.
• Custodians are intermediaries who hold physical or paper custody of the assets into which the fund invests. Many times, the (prime) broker and custodian are the same, but this is not always the case. The custodian earns a set annual custody fee for providing this service. A fund vehicle is encouraged to outsource custody and hence an independent third party provides this service.
• Auditors ensure that the book of accounts of the fund is accurate and reflects the correct position of its net assets. They ensure that the fund is not defrauding any investor or making false claims in any form. They check the financials, looking for any reporting mismatch, and certify the books as being the true reflection of the fund's value. They also check to see if the fund has followed predetermined (ie stated in the fund offering documents) accounting standards.
• Administrators are intermediaries who maintain the book of accounts for the fund, as well as maintain its share register. Typically, they ensure that fund investments are reflective of stated strategies as per the original offering documents. They also ensure that all trades are captured in the book of accounts, that valuations are current and independent of the fund and that accruals reflect current knowledge of future cash flows, as well as that NAV calculations and attributions of income are accurate and error-free. The NAV is the main driver for the performance fee and also provides a per unit value for the fund. The administrators ensure that investments into the fund comply with ‘know your client' (KYC) and anti-money laundering (AML) regulations. Some also provide structuring and documentation for offshore investment platforms, but do not replace legal counsel. In essence, administrators serve as independent third parties that try to safeguard investor interests.
• Lawyers help in structuring offshore vehicles or funds to channel individual investments into a collective scheme. They provide jurisdictional information, as well as documentation, to govern the relationships amongst different providers, as well as deal with government regulations and filings. They serve as legal counsel and advisers on the board of the offshore vehicle, and handle all legal aspects of the fund's activities.

While the above service providers and their expertise are available for the manager to use, the manager remains in full control and outsourcing does not necessarily absolve him or her of responsibilities towards investors. These services are provided so that a manager does not have to maintain and accrue high costs by retaining such talent in-house. These companies are able to distribute the costs of such ‘expensive' talent over numerous clients, and charge a bit extra for these value-added services and make profits.

It is extremely important for a manager to understand his or her own operation, and to have processes in place that make outsourcing cost-effective and not prohibitive. The manager should share such process flowcharts with service providers. Outsourcing works more efficiently and effectively if it is a collaborative effort between the client and the company taking on the outsourced activity.

Selecting an Administrator

The main basis of this paper is a focus on operations. A few important facets of operations in the hedge funds world are accounting, NAV generation and investor/shareholder service. These are generally referred to as ‘fund administration' and administrators employ accountants to do majority of this work. Before a manager outsources such duties, a certain amount of due diligence must be performed. Below are some considerations that must be part of a well-planned due diligence process to select an administrator that compliments the fund's activity. These are a few key checks and are by no means exhaustive, because different managers have different requirements.

• The size of the administrators' operations Some start-up funds require more hand holding and are more price-sensitive. A large administrator might not be able to provide such a service or might charge more to do so than would a small-to-medium-sized provider. A fund's asset and activity size also dictates the size of administrator that can keep up with it.
• The time zone of the service centre or relationship office that will be assigned to the fund It is always preferred that at least the client relationship manager be in the same time zone (give or take a few hours) as the fund manager. Due to cost considerations, a lot of administrators have their operations staff (such as fund accountants) in low-cost jurisdictions (India, Australia, Canada, Ireland, etc), which could be many time zones away from the traditional financial hubs and expensive cities of New York, San Francisco, London, Tokyo, Hong Kong or Singapore. Having a service provider or relationship office in close proximity of the manager's time zone improves turnaround times and efficiency.
• A dedicated in-house team for the relationship or a team handling accounting for multiple funds Having dedicated people at the administrator level handling one account is not always possible, unless the account is big enough to allocate such resources exclusively. Usually, a team of fund accountants handle a few different funds based on these funds' activities, reporting deadlines and complexity. It is not unusual to see a team of six fund accountants handling about 12–15 funds that they rotate occasionally amongst themselves. Having the same team handling a fund greatly improves efficiency; over time, this team and the manager begin to understand one another and handle expectations. Switching fund accountants or this dedicated staff frequently should be discouraged, because it increases risks associated with errors, relationship management and timing.
• The KYC/AML process It is important for the administrator to have KYC and AML checks, and to provide proper documentation for such procedures. These must be communicated to the manager, who can thus ensure adherence via subscription and redemption documents from investors. Today, such checks are common practice and many managers appreciate that it saves them valuable time to outsource this.
• Process flows and timeliness These are imperative from the manager's perspective in order to understand fully what ‘transpires' behind the scene to get him or her the NAV pack every reporting cycle. These flows and timelines also help in building reasonable expectations and hence greatly enhance operational efficiency. A manager should be able to gauge the efficiency of the administrators' process and how it would fit within the scope of his or her own operations. The manager should demand a written manual of procedures and timelines, which should be customised to the fund once the relationship begins. These also need to be checked by the manager to ensure that enough checks are built in to avoid errors or any kind.
• Redundancy if and when required A manager needs to ensure that the administrator has proper back-up plans in case of emergencies. Such need not only be cataclysmic events, but also simple things, such as staff vacations, turnover, etc. A full process for such contingencies must be provided so that the manager knows how he or she can provide assistance when required.
• Team leader, as well as relationship manager, credentials A manager should check the experience and communication skills of the accounting team leader and the relationship manager. There are high chances of future complications if, for example, the relationship manager does not speak English and the manager only speaks English, or if the relationship manager or team leader does not understand futures and the fund only invests in futures.
• Various inputs required by the administrator These might be custody reports, income/expense statements, broker confirmations, pricing feeds, etc. It is important for the manager to investigate whether the administrator can access such reports directly from the service provider and, if not, must provide the same immediately upon availability. Generally, for daily transactions, electronic feeds can be sent by the broker to, and captured by, the administrator system. Also, being a third party, it is important for the administrator to be able to get these reports independently and the manager must encourage them to do so. This is very important in the case of pricing reports, in relation to which, unless explicitly stated (in the offering documents of the fund or the administration agreement), the administrator should verify pricing of the underlying investments independent of what the investment manager proposes. Valuations are the main drivers of net assets and can be manipulated to over/undervalue a NAV.
• Method of dissemination of the final NAV package and associated reports/reconciliations and financial statements Generally, NAV packs and reports are disseminated to managers via email or websites. There is no single standard, but efficiency is much higher with website reporting. In this, the manager is informed that the NAV and other documents for that cycle have been made available at the administrator's website. The manager then accesses these using his or her account-specific username and password. This avoids unnecessary delays caused by compressing files, or e-mails bouncing back due to sizes larger than allotted limits. Also, it is less risky to use web reporting versus emailing reports, because human errors can result in the recipient not being that intended for that email or some principal being missed when sending out reports.
• Format of NAV package and reports/reconciliations and financial statements A sample must be asked for from the administrator. It is very hard for an administrator to change reporting formats, so the manager must be able to decipher information conveniently from the samples provided, because that is how his or her reports will look. All in-house reports/checks established by the manager must be able to use the data in this reporting format and systems built around such.
• Specialisations such as Islamic accounting or reporting for specific investors (eg US investors, which face mandatory disclosure of foreign income) If the fund is a Shariah-compliant fund, it needs an administrator that can account according to Islamic principles. If there are US investors in a fund, the manager must contract with an administrator familiar with dealing with such reporting requirements. Usually, US investors enter funds via partnership structures. Also, some administrators provide K1 forms for the US Inland Revenue Service (IRS). If such services are required, the manager must contract with an administrator that has the capability to do so.
• Relationship of the administrator with different players in the industry It is not uncommon for a manager to ask for references. With such high fragmentation, sometimes, a smaller service provider might turn out to be a preferred candidate after the due diligence checks. Because many of these do not have the brand recognition, a manager can ask for names of some funds already being administered. Such a check can actually provide a better understanding via the experience of another manager.
• Turnaround times for an NAV as well as any ad hoc requests For new managers, this is essential, because they require a lot of hand holding. It is imperative to understand standards at the administrator for return phone calls, answering queries, etc. Also, managers who deal in many complex investments must find out how long it can take for the administrator to turn around a NAV package, once all reports have been provided. The NAV of a fund of hedge funds is dependent upon NAV(s) of the underlying investments, which have their own valuation agreements with different administrators.
• Audit assistance and year-end consolidated draft financial statements The manager must find out if the administrator will provide audit assistance and the location of the office providing this service, as well as the administrator's experience in preparing year-end draft financials. During audit, it is common practice for auditors physically to visit the administrator's site, and conduct checks and verifications.
• Employee turnover in the last one or two financial years The administration industry is a high-turnover environment. Due to long hour requirements over the first two weeks of a month (ranging from 10 to 14-hour days), many fund accountants quit. A manager must try gauging how the administrator deals with such turnovers, what kind of benefits (such as overtime, food, transportation) it provides its employees and how it strives to retain its staff.
• Work that still will need to be done in-house by manager The manager must understand his or her operations completely. Once he or she has selected an administrator after going through the due diligence process, he or she must understand tasks that will still need to be done in-house. A NAV checklist must exist in-house that specifies certain inputs that the administrator gets from the manager, such as custody or valuation reports of futures, pricing feeds from fixed-income brokers, etc. Complicit in this is the understanding of the analysis required post-NAV to verify the accounts, as well as to ensure that no investment has been missed by different providers.

It is imperative for the manager to select an administrator who understands the process flow of the fund, and is able to administer the same with efficiency and accuracy. The manager must be able to provide a clear indication of the fund's activity to an administrator. He or she must be able to gauge administrator resources at disposal to the fund. This must include prospects of future growth not only of the fund, but also of the administrator's business.

A few things that need clear understanding and full disclosure from fund and administrator are as follows.

Fund:

• the projected growth of the fund;
• the volume of trade and investor activity;
• investment types, complexities (types of security as well as whether exchange-listed, over-the-counter, funds or private placements) and region;
• reporting frequency;
• availability of valuations/pricing;
• region investors coming from and language constraints;
• in-house checklists if applicable to review NAV packages, etc;
• compliance and regulatory requirements;
• institutional investor requirements, if any, along with US investor requirements.

Administrator:

• the growth rate of funds (number and assets) being administered;
• the availability of fund accountants to handle growth;
• training and development available to accountants;
• the availability of resources and pricing platforms such as Bloomberg/Reuters;
• checks and balances to ensure accuracy and oversight;
• process flows and redundancy.

A clear understanding of each other's operations, with full disclosure up front, results in synergised services that compliment one another.

Should a fund manager initially indicate an approximate figure for total subscriptions and redemption for the fund that is subsequently - swiftly - surpassed, serious problems can arise. Capacity constraints at the administrator's team will arise because resource allocation will have been limited to that which had initially been indicated. NAV and investor reports will be delayed because it will take considerably longer to complete KYC and AML checks on each subscription. It may be that further complications will arise, such as the receipt of foreign-language subscription forms and attachments (address proofs, utility bills, signature, etc) without translation.

Such situations can occur as the manager strives to grow assets under management, and being able to handle such and turn around reports in the shortest possible time is the responsibility of the administrator - but the manager must have realistic expectations. This is a deadline-oriented industry and both parties must understand that one cannot function without the support of the other.

The Fund Administration Process and Best Practices

As the number of hedge funds and assets under management grow globally, so does the need for specialisation. More and more managers are being questioned by investors about valuations and calculations; fund investments and strategies are getting more complex; institutional investors have started to demand clear segregation of duties. With increasing number of options available to them, they prefer to invest in a manager with minimal operational risk. Demands for an ‘arm's length' approach or independent third-party performance fee calculations have gathered more urgency. The whole fund administration process is changing to accommodate such demands.

The fund administration process

A typical fund administration process is split into two parts:

• Fund accounting is the actual accounting for all activity within a fund: cash flows, portfolios/investments; income/expense accruals; fee calculations; and return allocations. Such accounting is a daily process, although it is also done weekly depending on the availability of reports from other providers such as brokers. A fund accountant brings the accounts up to date as and when the reports become available. This is especially true for cash accounts and portfolio positions (including corporate actions). If these two are ‘current', almost three-quarters of the work of a fund accountant at NAV time is already done. At NAV time (as referred to at the administrator), all other accounting activity is performed: positions are ‘marked to market';¹ accruals are booked; extraordinary items are investigated and booked; exceptions are highlighted to the manager or concerned service provider for clarifications; and shareholder activity is tied out. A very important aspect here is verification of valuations of all underlying investments, and ensuring that their prices are current and tied out independently to an external source (IDC, Bloomberg, Reuters), unless agreed to another alternative. For some hard-to-price securities, quotes are obtained from the broker-dealers. For fixed-income products, quotes are usually obtained from market makers (the largest traders of that security by volume) of those investments before pricing. For other unlisted investments and private placements, valuations are received as per predefined methods, or these are priced at last available prices. Once these activities are done, the accounts are said to be completely up to date and the NAV can be computed (usually, a system-generated function that categorises/allocates all of the account balances into a balance sheet and income statement). Based on this, fund performance is calculated and performance fee ascertained.
• The registrar and transfer agent (RTA) tracks and reports shareholder interests, KYC/AML checking, profit and loss allocations, and manages the bank account set-up for these investors. Usually, when a NAV is to be finalised, accountants make sure that all of the monies received from the investors is accounted for, all KYC/AML checks are completed and the manager is informed of any ‘red flags'. Once the NAV is finalised, these new investors will need to be issued shares based on that finalised NAV per share and, if any of them have not been processed fully, they will miss out on this allocation.

The fund manager, as the decision maker or investor, and the broker-dealer or custodian, as security intermediaries, are all part of the daily investment process. The administrator is not, however, part of this and a sincere effort must be made to keep the administrator ‘in the loop'. Only then will outsourcing to this service provider result in accurate, timely and up-to-date accounts, with the NAV being a true reflection of the fund's value.

Fund administration best practices

In light of the current landscape of increasing asset base and investor/manager demands, there are certain ‘must do's from a third-party administration perspective, as follows.

• Service New managers require more information and ‘hand holding', especially ones from developing countries of Asia where the alternative investment industry is in its infancy. Hence, administration cannot only be delivery of NAV and reports. To be able to handle all of these questions, the administration team must be well versed in fund accounting and its system as ‘number interpretations/extrapolations' become necessary, especially of system-generated amounts. No matter how immaterial the amount is, it should be explainable should the manager enquire into it.
• Training As investments become more complex, with new products being introduced all the time, a training module designed to keep fund accountants and their seniors up to speed becomes a necessity. Because there is a high level of client contact, proper communication skills must be developed to answer various queries. Also, training by rotation within a fund-accounting team should be encouraged. Different funds have different asset classes and should be used to train fund accountants. This also serves its purpose as contingency planning in case of turnover or employee vacation, in that someone within the team can take over the responsibilities of that person's assigned tasks/funds.
• Process flows and timeliness It is essential for an administrator to have a defined procedures manual that incorporates system-related precedents within it. This manual must clearly state processes for different occurrences such as corporate actions, market values, realised and unrealised tabulations, swap accruals and performance calculations, to name a few. It must clearly define steps that need to be followed in the system to capture a trade, whether for any listed or unlisted security including over-the-counter (OTC) derivatives. There must be well-defined checklists that have to be adhered to and documented signatures. KYC/AML guidelines must form part of this manual. Once such a manual exists, it is easier for a fund accountant to customise the same towards a particular fund. This customisation becomes necessary, owing to the high turnover that plagues this industry. Such procedures, timelines and checklists not only serve their due in training purposes, but also can form the basis of a new accountant taking over a pre-existing relationship. These procedures cannot remain static, but should be updated constantly, taking into consideration system improvements as well as product/investment innovations. Such procedures must be communicated to the managers, who can draw their own timelines based on these manuals and understand their role within them. It is very important to send off a ‘portfolio positions summary' report to the manager within the shortest possible time (perhaps two business days if the account has been current) after receiving all broker/custody reports. The manager can verify all positions and their prices, and ask for any additional backups for the valuations, or provide backups if pricing is deemed incorrect. The NAV and other reports should not take more than two or three business days after the portfolio reports are approved.
• Systems Minimal human interface and seamless systems are very important. Errors and mistakes are possible when more people start to interpret the data and input details in the systems based on their interpretations. More systems are coming to market that combine fund accounting with share registers (RTA). These tend to require almost no human interface if trades or positions can come via electronic feeds directly from brokers or custodians. Such systems reduce turnaround times, as well as provide a higher degree of reliability of the data from the administrator, as well as form the manager's perspective.
• KYC/AML Proper documentation must be a prerequisite at the administrator. This documentation must follow existing regulatory guidelines or best practices in the industry. Increased focus on source of funds and political exposure mandates that administrators do not lapse on this requirement. Managers must also adhere to such prescribed guidelines, because it is in the best interest of both the parties never to be caught in a situation where their respective businesses are used for anything other than investment gains. This is by far the most time-consuming aspect of administration besides NAV preparation. Documentation must be legible, certified/notarised, and translated into English, with a checklist for each investor signed and filed.
• Growth and contingency planning It is imperative for an administrator to plan ahead. Ramping up operations in short time spans is not easy, especially when complex systems are involved. An administrator must plan at least six months ahead and prepare the scale of operations with adequate resources to handle business growth (at an average growth rate of previous year). A responsible administrator knows, that without adequate resources, service quality suffers, hindering growth. Hence, the administrator must only take on new business that it can handle. Contingencies must also be provided for any disaster that might strike the place of work, such as alternative offices where work can be done if primary offices catch fire, are flooded or similar. This is known as ‘business continuity planning' (BCP).
• Documentation Administrators must strive to provide valuations at fair value (unless otherwise specified in fund documents) and have adequate documentation for the same. Valuations must be performed using consistent and transparent methods, and the highest degree of disclosures offered of this mark-to-market methodology. All anticipated income and expense amounts must be accrued for according to accounting standards being used, and payments made based on received invoices. Statistically significant deviations from expected values must be investigated and be explainable by relevant news articles or independently verifiable data. Thresholds for such deviations must be agreed in advance and any breaches to such then investigated. Some special circumstances can occur, but tend to be rare and, in most cases, require approval of the fund board or directors. These impact valuations, fee amounts and NAV hence require close attention to details and documentary or other substantiation. Also, administrators must ensure that prepared reports, calculations and supporting documents are tamper-resistant. Excel sheets, although excellent for substantiation, are easily modified and can be misused. It is consequently safer to present documents in PDF formats than as simple Excel sheets.
• Regulations Generally, these funds are based in offshore tax jurisdictions and are either not regulated or very loosely regulated. They are not obligated to disclose their holdings to any particular regulatory authority except filing annual reports with them. With minimum investment requirements dropping, however, these vehicles are increasingly attracting more investors, and hence regulatory attention. Most investment strategies at these funds are based on certain proprietary knowledge of the manager for asset selection or trading; hence documentation for the same becomes a bit difficult. Usually, there are reporting requirements at the investor level, which is usually tax-based. (The US IRS requires US citizens to pay taxes on ‘global' income.) Due to this ‘unregulated' environment; fund managers outsource bookkeeping and shareholder services to administrators who serve as independent third parties ‘beyond' the influence of stakeholders of a fund. This, in conjunction with annual audits, provides a certain degree of security to investors, who fear accounting and valuation manipulation. Other regulations are usually localised to regions, such as the offshore jurisdiction of Mauritius, which mandates that funds incorporated there be administered by a provider in Mauritius. Administrators must strive to have a process that is unbiased and transparent, with ample checks built in to track deviations from set procedures. They must monitor fund activity to ensure adherence to disclosures to investors.

Procedures, controls and checks certified by an independent accounting and auditing firm provide a more comfortable proposition to fund managers easing a lot of their concerns. For example, Statement of Auditing Standards (SAS) No. 70² for service organisations is a reputed auditing standard developed by the American Institute of Certified Public Accountants (AICPA). The certification of a service organisations' procedures (such as those of a fund administrator) as SAS 70-compliant means that an in-depth audit of the company's control objectives and activities has been conducted in accordance with SAS 70 requirements. This certification provides credibility to the controls and checks of the service provider in hosting or processing sensitive client data. The US Sarbanes-Oxley Act of 2002³, enacted after the Enron debacle in the USA, has made such procedures and controls even more important when it comes to financial reporting. In situations in which there are no regulations, these controls become important from a ‘best practices' perspective.

Operational issues are increasingly gaining attention of investors. The 2007 Global Hedge Fund Survey by Ernst and Young, in cooperation with Ipson MORI,⁴ presents some very interesting results:

• It is now believed that operational issues are responsible for more ‘blow-ups' of hedge funds than investments gone wrong. Managing operational risks is the biggest challenge facing investment managers and investors today.
• The highest level of operational excellence is fast becoming the most important check by institutional investors.
• Greater transparency around valuations is believed to be the foremost regulatory challenge that managers feel they will face going forward.
• Quality and experience and knowledge of staff, timeliness of valuations/NAV and technology are the three most differentiable factors amongst different administrators.

With the industry growing leaps and bounds, managers can not ignore best practices and full disclosure requirements. It is, in fact, in their best interests to select competent third parties that have not only high working standards and ethics, but also reliable and certifiable controls and processes.

Conclusion

In conclusion, fund managers and administrators must have clear and regular communication, and must work as partners that understand each other's business models and scope of operations. Manager questions to administrators about financial statements are expected, but constant doubts about the credibility of the administration staff jeopardises the relationship. On the other hand, administrators need to be professional and have employees that understand not only accounting for hedge funds, but also bottom-line impacts of different types of investment. It can take two or three NAV cycles before proper communication sets in, and the manager and administrator begin to work effectively as a team in their new roles. It is therefore imperative to have predefined responsibilities besides conflict resolution procedures for this partnership to result in streamlined operations. Administration is a daily process and not only limited to periodic NAV statements. For the NAV to be consistently accurate and on time, and the administrator to provide full range of services efficiently, managers must make all information available to the fund accountants in a timely and legible manner.

There are instances when administrators have been ‘bullied' into valuing investments according to what the manager wants. This causes more problems, because it ensures deviations from set precedents and guidelines. Valuation is, by far, the single most contentious issue between the manager and his or her administrator besides delay in NAV reporting. Instead of forcing valuations, the manager should ensure credible or ‘market maker' data/reports are made available to the administrator. This will improve operational efficiency and also avoid the administrator breaching SAS 70-certified processes and controls. The administration process is not conducted in isolation: it goes hand in glove with the investment process in the same way as brokerage or custodian tasks are linked to this process.

If a manager enters into a futures contract, for example, there should be no up-front cash movement. The counterparty broker will, more often than not, produce a separate report for ‘futures mark to market',5 which is not combined with the regular brokerage report. If the manager fails to inform the administrator of this, the chances of such being overlooked become very high because cash accounts are not impacted as yet. This can have significant NAV impacts, because futures contracts can have quite substantial mark to markets. So not only does the administrator produce a portfolio missing a position, but also the NAV generated subsequently could be completely inaccurate. This NAV would never match the manager's anticipated NAV, resulting in time spent on research and investigation, and then redoing the whole NAV. This would delay investor reports to existing investors, and acknowledgements to new investors of their shareholdings. There could be the case in which the manager ‘misses' this omission in his or her review - and this can cause a reporting nightmare, because this NAV (and subsequent NAVs) will have to be revised at a future date when the error is finally discovered.

The above situation could be easily avoided if the administrator were to be set up to receive trade confirmations and periodical reports, or if there were to be a process in which any communication between manager and broker-dealer is copied to the administrator. This highlights the importance of information flow and the dependency that exists between the manager and administrator. The growth in this industry is putting increased pressures on service providers to service new initiatives, with administrators having to cope with more reporting demands from the growing investor base and extremely active manager. To make this process smoother, all concerned players should pursue increased synergies in operations to minimise cost and turnaround times. Such should be exploited not only between the manager and service provider, but also amongst the service providers. This will reduce dependencies on a singular source and make the process multidisciplinary, within which all providers work as a team. Increasing investor demands, more frequent NAV reporting and compliance/reporting guidelines (to some extent, future regulatory enforcements) will hasten collaborations across the industry - and it is in this direction that the industry is headed.

Note This paper expresses referenced facts where possible and opinions of the author. It is not meant to reflect the practices of any of his employees or to show them in any negative light.

References

(1) Mark to market is the act of assigning a value to a position held in a financial instrument based on the current market price for that instrument resulting in an unrealised gain or loss on that position.
(2) See http://www.sas70.com.
(3) See http://www.sarbanes-oxley.com.
(4) See http://www.ey.com/global/content.nsf/International/Asset_Management_Global_Hedge_Fund_Survey.
(5) For futures contracts, the final value will not be available until the maturity or expiration of the contract; for accounting purposes. it is periodically assigned a value that it would fetch in the open market at that given time and that is its ‘mark to market'.

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