Consolidation in the fund administration market has been rife over the past 18 months. Neuberger Berman kicked off the trend in February 2016, spinning out its administration arm to Japanese financial group MUFG Investor Services. That deal was followed by the first of Sanne Group’s five acquisitions, when it bought Chartered Corporate Services in Ireland the same month.
Among the most recent larger deals were Northern Trust’s purchase of UBS’s fund services unit in February. Estera was the latest firm to widen its net, acquiring Heritage, which has offices in Guernsey, London, Belfast and Malta, in June.
There are three main drivers of consolidation, according to market sources. The first two are the quest for scale and a global footprint, says Thomas Seale, chief executive of European Fund Administration, a Luxembourg-based firm.
“A large part of the fund administration industry is securing economies of scale. It’s a volume business,” he adds. “Administrators want to establish strong businesses where their clients are. An example of this is the UBS sale of its fund services business to Northern Trust. Northern Trust had smaller operations in Luxembourg and Switzerland – the acquisition gave them the geographical reach they were seeking.”
It’s worth noting that, so far, this is largely a European phenomenon. In the US, where regulation has not had the same influence on managers, cost-efficiency has kept administration in-house. Only one-third of US managers outsource administration, says Tim Andrews, director of the iD register, an online platform for centralized due diligence and reporting, compared with two-thirds of European managers. But he believes this will change as more US emerging managers hit their growth spurts.
“The challenge in the US is that the fund administration market doesn’t have scale. You can get away with administrating small funds in-house, but not vehicles with thousands of LPs. That means larger GPs using a smaller number of fund administrators, but this has its limits,” said Andrews.
The third factor driving consolidation is administrators’ desire to expand their offering. Among Sanne’s five acquisitions was a listed fund and corporate services firm, for example.
On the sellside, fund administration businesses are being divested because their valuations are high, says Ethan Levner, group head of corporate development at fund services firm Estera, which span out of Appleby Law in January 2016.
“Accountancy and law firms, such as Appleby, are focusing on their core advisory services and have come to the realization that they are no longer the right owners for the fund administration and fiduciary businesses. They are seeking reputable partners with the scale, resources and expertise to develop the business further,” says Levner.
In the future, market innovation and technology will continue to drive the future development of fund administration, Seale says.
“Fund administrators are like the platform. The asset manager is the decision-maker. Innovation in the market, to me, looks like administrators expanding their services to reduce the workload for the manager. On service expansion, it’s offering mid-office services, distribution management, regulatory reporting services, risk consulting,” says Seale.
While automating processes is important, technology needs to go much further to retain clients.
“The information fund administrators hold on clients is increasingly standardized and regulation is driving the need for a standardized system,” he says.
“You’re never, as a fund administrator, in complete control over the whole industry. It’s more interesting to have fund administrators talking to each other and making their processes more efficient as a whole. The fund administration industry has developed out of paper, PDFs and Excel sheets, to needing one central information exchange platform,” Andrews adds.
Leading the pack in expanding client technology are Heritage, Colmore and Augentius, who have all released tools this year.
Colmore, which spun out of private equity firm Capital Dynamics in January, launched an in-house fund reporting tool in April. The Fee Allocating Incentive Reporting service aims to tap into limited partners’ desire for more transparency on reporting data.
Augentius’s product, meanwhile, is predominantly aimed at GPs, assisting with data collection and workflow management.
“Where the technology needs to get to is GPs providing LPs with a pool of data, from which they can extract what’s pertinent to them,” a spokesman for Augentius says.
Expanding to full-service, full-capacity global firms may be the ideal for administrators, but what do their clients think? One chief financial officer says that administrators which chase larger managers leave mid-market managers with fewer options.
“We do have a desire and need to be working with an administrator who can send a mid-level person on site now and then,” says Joshua Cherry-Seto, chief financial officer at Blue Wolf Capital, a US private equity firm.
“As an emerging manager to a growing group, there is a need to not just manage the books as they are, but to be a partner in building out and improving processes. A mega [private equity] shop may not have that higher-touch, relationship-management mindset. I do think some administrators are trying to figure out how to onboard more small shops to secure relationships which grow into large shops, but not sure they are there just yet,” he adds.
On the technical side, administrators requiring investment firms to use their proprietary systems is also a potential downside for fund managers.
“Requiring managers to get on a platform is problematic; it is overkill. We’re operating well with the simple systems we have,” says Cherry-Seto. “Many large shops require onboarding to their platform as their compliance controls require ownership of the system and can’t be more flexible. A concern is keeping control of your operations as you are growing, and third-party platforms adds unnecessary complication.”
“For managers running pure private equity firms up to $1 billion-$2 billion in assets, niche strategic relationships with fund administrators are more helpful. As a small firm grows, the limited transactions don’t warrant hiring internally, so it is the niche firm, personal touch in developing systems and scaling of resources that’s required, rather than simply processing of transactions,” he adds.
Fund administrators’ ambitions show no sign of abating. In an environment of weak growth, more acquisitions should be expected. But in the race to expand their footprint and scale, fund administrators should remember to prioritize expertise and the specialist services that make their targets so sought after. ?
Large private equity firms are well-positioned to take advantage of the economies of scale enjoyed by growing fund administrators, but for new funds, or small firms, there are advantages to outsourcing to a fellow small operation, according to industry sources.
“As a boutique fund administrator we are able to give personalized guidance and support, and can act as an extension of the back office,” James Orrick, managing director at Private Equity Administrators, tells pfm.
PEA adapts its own systems and processes to fit a new fund manager’s needs and requirements and appoints a client relationship manager to each firm, who is responsible for all administrative processes.
“It’s a relationship-driven business and we take on client risk, too; we don’t require upfront payment so there are no immediate costs to the client. Upfront invoices can create barriers to entry to new market participants,” Orrick says.
And even the rapidly expanding fund administrators recognize there will always be space for smaller firms.
“If a Big Four emerges in the fund administration business, we would want to be one of them. But there will always be a space for boutique firms,” the private equity director of one large service provider tells pfm.