Fees in play as more administrators see consolidation

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Christine Waldron believes fees will drop because of consolidation.

Consolidation among alternative fund administrators is expected to continue over the next several years, which sources say will mean higher costs for asset owners in the short term. But some say in the long run, costs could decrease.

Industry participants and consultants, while not speculating on which firms would be ripe for acquisition, agreed consolidation among fund administrators will continue for a variety of reasons — the continuing pressure to reduce fees as well as the added costs that come from technology upgrades and heightened regulation.

Peter Laurelli, vice president at eVestment LLC, Marietta, Ga., said such changes won't be “game changers” for those investing in hedge funds or funds of funds. But he added there will be “several big headlines” in industry consolidation that could impact those that invest in hedge funds through separate accounts, which are expected to see higher fees in the short term.

But that will change as consolidation continues.

“You'll see bidding wars,” said Susan A. Crotty, senior vice president and senior consultant at Marco Consulting Group Inc., Chicago. “We've seen that in custody, and it's certainly possible in hedge fund administration. The fewer there are, the better the cost structure might be.”

Reduced fees resulting from industry consolidation might seem counterintuitive, with fewer options normally expected to reduce competition and increase fees, but “I think we've been observing that consolidation makes prices go down,” said Christine Waldron, executive vice president and head of alternative fund services at Milwaukee-based U.S. Bancorp Fund Services LLC, which on Nov. 15 acquired Dublin-based hedge fund administrator Quintillion Ltd.

“There'll be a smaller group, but they'll be more competitive,” she said. “There's better knowledge of what others are doing in the marketplace. There'll be fewer firms, but they'll be more transparent.”

Along with the U.S. Bancorp-Quintillion deal, SS&C Technologies Holdings in October purchased Prime Management Ltd., and Mitsubishi UFJ Financial Group Inc. acquired administrator Butterfield Fulcrum Group in June.

Last year, State Street Corp. (STT) acquired Goldman Sachs Group (GS) Inc.'s hedge fund administration unit, and in 2011, Northern Trust Corp. acquired Omnium LLC from hedge fund Citadel LLC.

5 to 10 could be left

Sources said when the dust settles from consolidation, probably in the next three to five years, there will be anywhere from five to 10 hedge fund administrators in the industry. There were 71 single-manager and fund-of-fund administrators as of June 30, based on responses to a survey by eVestment.

Administrators on the selling block come from two camps, said Virgilio “Bo” Abesamis III, executive vice president at Callan Associates Inc., San Francisco. One group is large investment banks that are unloading their fund administration units to divert capital to other lines of business, particularly because of new regulatory requirements such as the Dodd-Frank Wall Street Reform and Consumer Protection Act and Basel III. The other consists of smaller hedge fund administrators “strapped by the inability to put their resources to grow and scale their businesses,” Mr. Abesamis said.

Those smaller administrators, while courting some pension funds, endowments and foundations for business, could be overwhelmed, for example, by the huge amount of data aggregation associated with hedge fund investments for one large public fund, said Mr. Abesamis. That pension fund's investment could total 75% or so of the firm's assets under administration. “It's just the nature of the beast,” he said. “Large public funds demand more transparency, and smaller firms may have a difficult time doing that.”

“As a result of downward fee pressure, administrators have had to grow revenues through acquisition,” said David Gold, New York-based senior investment consultant, manager research, at Towers Watson & Co. LLC. “More investment managers and investors have put more pressure on service providers to offer more services the same or lower cost.”

“It's fair to say” that the costs of compliance and technology were the impetus for Quintillion's sale to U.S. Bancorp, said Ms. Waldron. “With the regulatory framework and the investment they would have needed, it would have taken (the firm) a lot to comply. It made this an optimal time to be acquired. It's a lot easier to seek a buyer now.”

But Mr. Gold disagreed that fees would be reduced through consolidation. “It doesn't mean that (fee decrease) trend will continue,” he said. “If there are fewer players in the space, with consolidation driven by increasing market share, driven by fees going down, at some point you hit the trough and fees are going to go up. ... Measuring that is more art than science due to the scope of services provided to the fund.”

Rahul Kanwar, senior vice president and managing director at SS&C in New York, agrees. “I don't subscribe to that fee timeline” of short-term hikes and longer term declines, Mr. Kanwar said. “There's always been competition on fees in the market. We're not trying to win on price, but we don't get to win without the right price, and that's driven by the market. There's always going to be a competitive market. But as we get better service and more scale, and the ability to provide services as add-ons, we'll see economies of scale.”

Handling such scale will require larger capabilities, so potential buyers of fund administrators would be custodians and “megafund administrators” — those with at least $100 billion in assets under administration, said Mr. Abesamis.

“Let's face it, the massive institutional investor is late to the game in the alternative space. The die is cast; it's been unfolding over the past five to seven years,” he said. But that late entry has unleashed a flood of assets in alternative investments, and “what administrator would be large enough to handle the transparency, the data aggregation required by those huge pension funds?” he asked.

“At the end of the day, it's all about who can do data aggregation. Those big investors need consolidated statements, with both traditional and non-traditional classes.”

This wouldn't be just from the giant public plans. For example, the $10.5 billion Orange County Employees Retirement System, Santa Ana, Calif., launched a search last month on behalf of a group of California public funds with assets ranging from $5 billion to $25 billion each. The group is searching for a private equity fund-of-funds manager to run potentially up to $500 million, partially in an effort to reduce fees (Pensions & Invest-ments, Nov. 25). “The question is, does the administrator have the bandwidth and the business model to do all that?” Mr. Abesamis said. “The traditional hedge fund and private equity construct - can it handle this massive amount of administration? How will that play out?”

Marco Consulting's Ms. Crotty concurred. “The custody business is thought to be the driving force on consolidation,” she said. “It just makes more sense for an institutional investor to have a one-stop shop. I think it's a trend you'll see continue, with hedge fund administrators buying other hedge fund administrators as a subtrend.”

Institutions have input

SS&C's Mr. Kanwar said pension funds and other institutional investors do have input with hedge fund managers in administrator selection. “A lot of what we do is talk with the (fund) investors,” he said. “Institutional investors do their own due diligence on the administrator as well as the fund's investments.”

Eric Nierenberg, senior investment officer, hedge funds and low-volatility strategies, at the $53.9 billion Massachusetts Pension Reserves Investment Management Board, Boston, said the cost of consolidation to the pension fund is “uncertain, depending on whether any potential savings are passed on to clients. It is an issue that we will continue to monitor.” MassPRIM has a 10% hedge fund allocation.

“We currently do not participate in the choice of administrators by our hedge funds,” Mr. Nierenberg said. “However, we are examining the feasibility of hedge fund managed accounts, and if we decide to pursue this avenue further we would become actively involved in the administrator choice, in conjunction with the managed account service provider(s). We would be concerned if the number of administrators shrank to a level where it altered the competitive landscape.” n

This article originally appeared in the December 9, 2013 print issue as, "Fees in play as more administrators see consolidation".