It comes as no surprise to us that most fund managers are making use of a broad array of different service providers, including administrators, prime brokers, custodians, auditors, consultants and lawyers. It is standard operating procedure. But is enough attention being focused on what these service providers are doing, whether they are doing it properly, and whether they are charging for it correctly? It is the responsibility of the fund manager, both as a provider of investment management services and fund promoter to his clients, and as a business manager in his own right, to ensure that his service providers are being managed correctly.
All external service providers are playing some kind of role in managing the business and its underlying products, and ultimately they are affecting the overall fortunes of that business. The questions many fund managers should be asking themselves are: have I put together an effective team, and are they providing maximum value?
The days of 30% annual returns are over: fund managers are increasingly having to revisit their bottom line in an effort to reduce their funds' fees. Single-digit returns are enforcing a new climate of austerity which is tempting some COOs to choose the cheapest solutions on the market. This can be a mistake. Yes, managers have a fiduciary obligation to make the most they can for investors, but this can be comprised by poor external service provision. Following are some business areas where a review of service provider relationships could improve overall efficiency.
Assuming good performance is being achieved, sales and distribution is the lifeblood of any fund management business. If making use of partners in distribution and sales, fund managers have to make sure these partners are actually meshing well with your overall distribution strategy. This can cover a wide range of activities, including fund registration, jurisdiction-specific tax calculationsand whether transfer agents properly linked with the major clearing platforms (Euroclear, Vestima, FundSeattle, SWIFT)? Is your transfer agent providing Internet access for both information and dealing? This will become more important, as investors - especially institutions - focus on dealing and reporting efficiency. Can some of your providers use their contacts to introduce you to new distribution relationships?
Working with the right service providers can add crucial basis points to performance. Good stock lending and cash management from your prime broker or custodian is one of the best ways of achieving this. Banks should be able to provide sweep vehicles with decent returns, and custodians offer competitive FX rates. If you are a fund of hedge funds, are you getting competitive leverage facilities?
Fund managers and investors are now dealing with a much wider range of managed investment products. As an industry, we have graduated from basic cash, bond and equity funds to an expanded range including exchange traded funds (ETFs), manager of manager, hedge and venture capital funds. Now UCITS has become exciting, allowing leverage and financial derivatives, resulting in funds ranging from enhanced credit to 130/30. Individual managers run both traditional and hedge funds, and are routinely looking at developing new products, and need their service providers to keep up with them in this respect. Service providers should be playing an active role in product development, and also helping to define risk management within these products. Can they assist with VaR, for example in a sophisticated UCITS offering?
Service providers can also help asset management firms to better manage their range of products. This can include help with local and foreign filing requirements and product registration. Without appropriate local knowledge it is still easy to fall foul of red tape. As product ranges grow in size, and international distribution from Europe to Asia to South America becomes more common, even amongst medium-sized firms, there is an important product-driven role to be played by the service provider that is serious about its clients, and clients that are serious about their service providers, for that matter.
Investors are becoming more aware of the issue of operational risk within fund management companies, and this increased level of scrutiny is being extended to service provider relationships. External service providers should be able to advise on appropriate best practice, but should also be responsive themselves to information requests from their clients' potential investors. Poor feedback from a service provider could lose a client for a fund manager.
As if increased scrutiny from investors were not enough, fund managers - and hedge funds especially - are facing more oversight from local and international regulatory bodies. Again, some of this attention is going to reflect on the service provider community, and again, fund managers will be partly judged by the efficiency of their third party operational set-up. Service providers should be able to help their clients put the processes in place - SLAs, documented procedures, pricing, risk management processes, and so on - that will ensure proper compliance. Fund managers need to be sure they will receive active cooperation from service providers as they grapple with UCITS III requirements, MiFID, and other as yet unknown regulatory challenges.
Good service provision, which includes the efficient processing and reporting systems of your administrator and custodian, should be able to help you reduce the costs of running your business, not increase them. Proper systems integration should mean speedier transactions, more accurate and timely reporting, fewer bodies in the back office.
Generic systems, like SWIFT files, can be fantastic in terms of helping with trade communications. You don't want to be in a position where such integration becomes the apron strings that hold you to your service provider, but again, if you choose wisely, you should not need to worry about it: you will be with the best service provider for your business. If, as a firm, you manage large volumes of trades, then automation is more than worth it.
A formalised risk management process is now an established requirement by the UK's FSA and the major accountancy bodies. Although investors might accept a loss due to volatile markets, they find it much harder to deal with losses incurred by poor operational set-ups. Service providers, especially the administrator, prime broker, or custodian, are a critical part of the overall operational process, and therefore should understand where they fit into this equation, and what will be required of them, and what they can offer in return.
Appropriate operational documentation that affects them should be in place, and kept up to date. Changes of personnel will not be considered an excuse for operational failure by investors or regulators. But service providers - including fund directors - should also be able to play a role in formulating a risk management process, and should be aware of breaches in this policy when they occur.
Being a fund director is not simply about turning up to a board meeting - if they value your business and you value them, they should be prepared to go the extra mile for you. But this is also a case of managing all relationships, and expectations. Directors and auditors should not be considered as simple regulatory requirements: they can bring valuable business experience to the equation, be it knowledge of good governance, risk management, or quality control of financial statements. They should be helping the fund manager to stay abreast of current developments, and have the courage to speak up when they think a policy or strategy may not benefit the business or investors.
A good service provider should be able to tell their client about issues they have not considered or things they might have missed. For example, a new local regulatory requirement that might affect a given fund, but which the manager is unaware of, might be in the pipeline. You should feel that you are important to your service provider, that they have the depth of management, experience, and systems to meet your requirements, and that they will be able to keep up with your business as it develops.
Service providers, be they administrators, auditors, lawyers, or a prime broker, need to be clear about what is expected of them. Where they sit, dealing with multiple asset managers, they may see a lot of issues and developments which might affect their clients' businesses, which their clients ought to be made aware of. Some service providers are able to slot into this active role easily, thanks to the depth of knowledge, experience and proactiveness they offer on the part of their senior personnel.
Many COOs at large fund management businesses are successful because of their ability to manage their service provider relationships, and see this as a large part of their job. By visiting service providers, you will get to know the people that operate their businesses, and achieve a better insight into the way they manage your affairs. It will also help you to monitor performance more effectively, and ensure you are getting value for money.
John Donohoe, CEO and Principal, of Carne Global Financial Services, business adviser to the international fund management industry