The world of private investment funds has radically changed over recent decades and so has fund administration.
Limiting Operational Risk
Back-office risk has always been a concern for private funds but high-net-worth individuals, institutional investors and regulators are more sophisticated today and more alert to operational risk than ever. The same is true for retail investors. They have many more options in alternative investments today and are more sensitive than ever to failures and errors on the fund administration side. Back-office missteps are seen as an indication of a fund sponsor’s overall competence. For these and many other reasons, outsourced fund administration is increasingly considered a requirement for private funds.
The Fund Administration Role
At the core of the fund administration function must be hard work, diligence, promptness and compliance on behalf of the client fund. These virtues are essential to minimizing risk and maximizing the reputation of the fund.
The accounting, reporting, investor communications and processing of fund administration firms are increasingly under scrutiny. Operational inadequacy, whether of an in-house team or a third-party fund administration firm, carries significant financial, regulatory and reputational risk. Fund sponsors must protect themselves from operational risk. A deliberate process of due diligence to identify the right fund administration partner is necessary.
Fund administration that delivers maximum responsiveness, efficiency and transparency represents a major competitive advantage not only in terms of risk. When investor capital is in high demand and short supply, fund administration that carries out its obligations effectively and exceeds the expectations of investors contributes to a reputation that attracts more capital to that sponsor.
The people and the reputation of an investment fund sponsor are most of its precious assets. Fund administration that mirrors these assets and complements the expertise of fund management with back-office precision, dependability and responsive customer service augments the reputation of the fund sponsor and substantially enhances the overall success of the company’s funds over time.
The most important factor in the new focus on fund administration excellence is imperative to raise capital. It is becoming clear to more and more fund sponsors that a track record for creating value for investors is no longer enough. Investors will always be attracted by a fund’s performance in generating returns, but if the operational track record is inadequate and back-office execution is a frustration it can be enough to make investors explore options to reinvesting.
Institutional investors are particularly unwilling to tolerate poor fund administration. Many consider in-house back-office operations an intolerable operational risk. A growing number of institutions consider third-party fund administration a requirement for portfolio funds.
Even if managers have an administrator in place, many institutions perform thorough due diligence on the fund administration provider for a prospect fund. They are concerned with data security, reporting capability and adherence to audit standards they require. Institutions may require fund administration to have a service organization controls (SOC) audit of their processes. They may require the provider to be an SEC-registered transfer agent and be able to produce the reporting package recommended by the Institutional Limited Partner Association (ILPA).
This due diligence may not be a one-time event. Institutional investors that have had bad experiences with faulty back-office processes may conduct ongoing due diligence. Having conducted their due diligence on a fund administration firm in the past, they may have found in day-to-day operations that non-compliance or service issues were problematic anyway. A fund administration provider for an institutional fund today expects an annual service process review as well as a required SOC 1 process audit.
Reputation is Priceless
The fund administration partner is at the center of the fund sponsor’s back-office architecture. The ability and inclination of the fund administration provider to communicate data, meet reporting demands, interact effectively with all industry entities and favorably represent the client sponsor is essential for the fund sponsor to establish from the launch of their first fund. The appropriate alignment of vendors for a fund places the fund administration partner at the center of an intricate machine that supports the needs of investors, financial advisors, management and all the relevant outside entities. Effective fund administration minimizes operational risk for the fund sponsor and communicates a reputation for performance and professionalism that is of inestimable value.