Increasing investor expectations and new government regulations are just some of the factors driving the widespread move toward third-party fund administration across all fund strategies. For debt funds, the advantages of outsourcing fund administration are even more striking. With versatile fund administration architecture in place, fund management can scale up quickly, seize opportunities, access senior-level operational expertise and maintain a competitive advantage in an asset class that is more crowded than ever. With investment fund sponsors pursuing a variety of strategies each with particular operational needs, outsourcing the management of the complex fund administration role can help significantly. However, the choice of provider is key.

Debt funds represent multiple growth opportunities, but in order to seize them, managers must be able to keep up with the demands of back-office processes. Fund managers may be skilled at originating and distributing deals, but if they lack the necessary fund administration capacity, they will find it difficult to service investors and assets. Debt funds are operationally labor-intensive and back-office experience and technology are important considerations.

Opportunities in debt investments each come with unique fund accounting requirements.

Technology for Specialized Fund Administration

Fund administration firms that rely on antiquated technologies or manual methods when managing complex debt funds can result in soaring fund administrative costs and a significantly increased risk of operational errors. Debt fund managers often suffer from the inability of fund administration firms to track loans effectively. Some loan tracking is a significant operational challenge beyond the ability of typical fund administration technology. It is one of the top three most frequent operational issues for debt funds.

In-house fund administration is not a viable option. The expense of adopting and maintaining a specialized fund administration system for a debt fund, adapting it to a specific debt strategy and training in-house staff in its use is unaffordable, a major departure from the core competency of fund management and involves significant risk. There are off-the-shelf fund administration applications, but they are rarely sufficient without extensive and expensive customization. Then there is the necessary training for internal fund administration personnel in the features of these systems. All of this is comes at significant cost, not to mention the expense and hassle of maintaining a large and growing operational workforce as the fund grows.

Debt fund managers clearly benefit from an integrated third-party fund administration platform encompassing fund accounting, financial reporting, transfer agent services, investor relations, tax services and payment processing as opposed to paying the costs and assuming the risks of maintaining in-house fund administration staff – but an experienced, capable and well-equipped fund administration firm is required.

Full-Service Administration ensures consistency, efficiency and data security.

Modern Systems for Fund Administration

In order to remove paper-based procedures, automate transactional chores, better utilize data, increase compliance, and provide more thorough, customized reporting, the alternative investment industry as a whole has started to place a greater emphasis on technology. Debt funds have an even greater need for investment in fund administration technology than funds of other asset classes due to their dynamic structure and added complexity.

Complex features of debt funds may include:

  • Complex clauses and loan amortization plans
  • Every interest day counting practice
  • Paid-in-kind (PIK) interest • Original issuance discount (OID) tracking
  • Term shifts (including interest rates and PIK components)
  • Amortizing revenue from fees
  • Loans with variable interest rates and moving base rates
  • Revolvers and delayed draw loans
  • Unpaid obligations
  • Covenants governing loans and necessary collateral

Both seasoned and new debt managers may find it challenging to obtain adequately specialized fund administration. It is challenging to set up an internal fund administration staff with the necessary expertise to manage the intricate and constantly changing needs of a debt fund. It is also challenging to find the necessary competency in a third-party fund administration firm. This competency should include the ability to customize reports, account for non-standard debt instruments, operate with fund administration software designed with debt funds in mind and be aware of the specific reporting requirements of debt funds.

Lack of prior experience is among the most frequent problems sited with in-house fund administration. Numerous debt fund managers claim that this is a significant issue. By outsourcing fund administration, fund managers can gain access to the fund administration expertise they need to service debt funds, even those that are more complex, if they are able to find a fund administration partner with the necessary diversity of experience and technological capability. Operational expertise based on experience is the primary justification for private debt managers outsourcing fund administration. Another is the issue of key person risk.

Key Person Risk

A significant obstacle to debt fund managers’ productivity and reputation can be back-office turnover. For investment fund firms of all business models, a significant area of vulnerability is the lack of operational back-up in the event of a key employee departure. The systems used to administer funds can be a severe liability when an employee departs the organization, especially as the most seasoned personnel are the ones who are most likely to be persuaded to leave.

Any halt in the processing of administrative functions can have disastrous effects. For computations to be accurate, loan terms must be kept current and covenants must be monitored to ensure that the portfolio firm is in compliance. The abrupt absence of a key member of staff can have such a potentially devastating effect that redundancy is required meaning additional in-house headcount which may represent overstaffing in the absence of such a departure crisis. The staffing flexibility of an outsourced fund administration provider obviates this risk. Additionally, at the discretion of management, third-party fund administration can be designated an expense of the fund as opposed to necessarily a payroll cost to management for in-house fund administration staff.

In conclusion

Outsourcing fund administration is a wise and increasingly popular practice among private equity and venture capital funds. Debt funds, however, must approach the decision of a fund administration partner with particular care. Specialized technology and experience with the wide variety of debt instruments is essential for an adequate fund administration partner. And debt fund sponsors should consider the possible operational requirements of any future strategy. Whatever additional fund structures, new debt instruments or investor types a sponsor might choose to pursue in the future, the fund administration partner should be able to follow, with technology and experience suited to whatever the client may decide to do.