Does bigger mean better? That, in a nutshell, is the challenge facing the fund administration industry where barely a month goes by without a new acquisition or tie-up.
The fact that third-party administrators are flourishing isn’t exactly a surprise given the spectacular growth of the alternative assets industry over the last decade. The 2018 eVestment survey of the fund administration industry showed double-digit growth in assets under administration across every asset class.
Even first-time funds are preferring an outsourced option from the beginning now. “We’ve been around for 10 years now, and finally reached a size where we felt we couldn’t manage the process in-house anymore,” says Joshua Cherry-Seto, CFO of Blue Wolf Capital. “It’s different now. A lot of firms are outsourcing from their debut funds, as some of the groups spinning out of larger firms already have relationships with administrators.”
But the dramatic expansion of the industry isn’t just about having more assets to manage – it’s an indication of the growing complexity of the tasks they manage. Building and maintaining technology can be hard for smaller players to do profitably, so they are open to being scooped up.
“As managers become larger, they look for partners that can match the breadth and complexity of their businesses,” says Rahul Kanwar, the president and COO of SS&C. “This includes asset class coverage, jurisdictional and regulatory requirements and demand for leading technology.”
That means that all administrators need to invest in talent and technology to meet their clients’ needs. For example, one service provider noted that no matter the size of administrator, they still need to invest in data security software to meet the requirements of institutional LPs, and that costs the same whether they administer $12 billion or $120 billion in assets. The shop managing the latter will be able to spread that cost over a wider customer base.
So when a larger administrator comes knocking to buy a smaller peer, there’s good reason to answer the door. The past few years have seen a wave of M&A deals in the industry, as firms like SS&C, Apex and Sanne have been on the hunt for acquisitions and bagging plenty of them to expand their geographic reach and service offerings.
Some suggest the landmark acquisition of the era was in 2015, when SS&C acquired Advent Software. “Advent was a platform that many of SS&C’s competitors used, so it was a great strategic move,” says Alan Meaney, chief executive of Fund Recs. “It went for a high multiple, but no other deal disrupted the market as much.”
Developing technology in-house can be quite costly, so acquiring a tech firm or an administrator with a great tech solution can be more cost effective in the long run.
“We prefer to acquire companies for a unique capability, a technology or a service we don’t currently provide,” says Shankar Iyer, CEO of Viteos. Several fund administrators pride themselves on not relying on acquisitions to add customers.
For example, Apex, which has been closing on a slew of deals over the past few months, isn’t looking for market share alone. “Our priority is to create the strongest product offering we can, not just growth through acquisition,” says Peter Hughes, Apex’s CEO and Founder.
Instead, Hughes is focused on whether his firm expands its product offering, and whether Apex can help the acquired company serve its current clients better. Apex is also looking for targets that can blend well with its systems. “If it’s a firm in a new geography that also uses complementary technology, that starts to look attractive to us,” says Hughes.
Not just clients anymore
Even with fund managers outsourcing more than ever, not all administrators have the deep pockets or ability to raise sufficient debt to make these acquisitions themselves. Private equity is playing a major role in this wave of M&A activity, not just as new clients, but as investors. Genstar acquired Apex, Permira owns Alter Domus, and Public Pension Capital and FiveW Capital back Viteos, just to name a few.
“Our acquisition strategy has been in place since Genstar invested in us in 2017, and it was predicated on building the broadest product mix,” says Hughes. “They understand that’s what drives organic growth.”
And they are bullish on the sector, as one administrator admits getting calls nearly every week from buyout firms asking about their growth plans and looking to invest. The nature of private equity, no matter the era, is to deliver returns after a finite period of ownership. Which begs the question, how much of the current shopping spree is for the long-term viability of the administrator, and how much of it is part of a roll-up play for short-term growth and a sale?
Of course, fund administrators argue that being able to operate in more jurisdictions and service more asset classes can only better serve clients, and with the benefits of scale, costs stay reasonable. But the nature of fund administration complicates matters.
The continuity question
“When we were looking for an administrator, one of the largest firms in the market gave us a price that was 30 to 40 percent less than the other bids,” says Cherry-Seto. “But we were looking for more of a partner, who was truly devoted to the middle market space. Cost is always a factor, but we were able to find that niche firm big enough to have both expertise and scale.”
One CFO admits that larger administrators may make sense for the mega-firms that are looking to merely access technology and outsource tasks, but administrators also act as kind of outsourced operational teams. In lieu of adding a vice-president of finance, or other more managerial level roles, they require a close collaboration that boutique firms offer as a core value proposition.
And a fund administrator argues that while GPs like exits, they don’t always appreciate changes in control at their service provider, especially if it changes the operating model that they chose in the first place, or requires getting a new team up to speed on their own processes.
“We appreciate continuity because there will always be a learning curve when bringing on an administrator,” says Cherry-Seto. “Some portion of a firm’s business will be unique to their investments or history, and that means outsourcing will make more work before it makes less.”
PE-backed administrators appear sensitive to the situation. “When we acquire a business, we perform the commercial diligence to ensure that their clients are happy, and we make sure to incentivize client-facing staff to stay,” says Hughes. “If we don’t force a new technology on them and maintain the same level of service, but with a wider product mix, clients continue to be happy.”
Even the largest players are aware of how important service is. “We take a very customer-focused approach to integrating a new acquisition,” says SS&C’s Kanwar. “We meet a lot of customers, and solicit their feedback to shape our product plans, integration plans and development initiatives. Customers quickly gain access to our broader set of services and improved technology, which improves their overall experience.”
The reality is that every administrator is under pressure to keep up with their clients’ increasing size and complexity, either by acquisition or by building what they need internally. That takes money, which may favor larger administrators.
How much margins get squeezed by those investments remains to be seen, but technology is due to play an outsized part in that. Iyer expects that in the next five to 10 years, over 50 percent of their work will be automated, and that will mean they can do much more volume with current levels of staffing.
“Some administrators have begun to realize that they’re in a technology business that leverages great people,” says Meaney. “And while we’ve operated more at the gross margins of a consultancy business, between 35 and 40 percent, a lot of us are looking at how to evolve closer to a software company, which enjoys margins closer to 85 percent.”
That may seem like a moonshot, but given the amount of capital and interest in the industry at the moment, someone might happen upon an innovation that truly revolutionizes the space. Until then, they’ll be aiming to strike that balance of being large enough to be handle a client’s business, and attentive enough to meet their expectations.