United States: Fund Administration Ripe For Outsourcing

Last Updated: January 19 2007
Article by Janet Parkhurst

The confluence of continued growth in the fund market (in terms of assets under management, complexity and number of active funds), a dynamic regulatory environment and increased market competition has created an environment that is ripe for both business process outsourcing (BPO) and information technology outsourcing (ITO). Just as was the case in the broader financial services marketplace - where the market dynamic of increasing competition and globalization has lead to a wave of BPO and ITO deals over the past five years - several recent transactions in the fund arena are evidence that the economic and operational considerations will combine to make the outsourcing of basic fund administration services and the IT backbone inevitable.

Globally, the hedge fund market has reached approximately $1.3 trillion in assets and is expected to grow to $2.38 trillion by 2009.1 Estimates as to the number of hedge funds vary, but to date, there are in excess of 8000 active hedge funds.2 In the mutual fund space, assets under management grew to $10.28 trillion in November, 2006.3 While the success of these investment vehicles depends in large part on the skill and acumen of the manager(s), virtually all funds are seeking a more efficient and cost-effective operating model in order to remain competitive in today's marketplace.

Many other types of businesses, from manufacturers to financial service organizations, have turned to business process and information technology outsourcing in order to mitigate risk, streamline processes, and reduce operational costs and capital expenditures. Funds should be no different as they begin to confront the market conditions described above.

As is the case with respect to outsourcing in other verticals (i.e., information technology, human resources, benefits administration, and finance and accounting), fund administration outsourcing provides multiple benefits to the customer. By utilizing an experienced third-party provider (or multiple providers) to provide all or portions of a fund's middle- and back-office daily operational and administration activities (including cash services, NAV calculations, shareholder interaction, secretarial services, record maintenance, reporting, document custody services, and settlement reconciliation), a fund can take advantage of subject matter expertise, economies of scale and state-of-the-art technology platforms, often without large capital investments.

Outsourcing can also assist funds in ensuring regulatory compliance and accurate reporting and record keeping. Mutual funds are subject to regulation by the Securities and Exchange Commission (SEC) which imposes requirements with respect to reporting, pricing, and management of funds, among other activities. While today most hedge funds do not currently register with the SEC as they operate within exemptions allowed by the Investment Company Act of 1940, the hedge fund regulatory environment remains uncertain.4 With a number of recent SEC fraud investigations and the fall of hedge fund behemoth Amaranth Advisors in September 20065, there has been a renewed call for regulation of the hedge fund industry similar to the mutual fund industry. Service providers are typically better situated to adapt to a changing regulatory environment than individual entities as they are able to leverage resources and implement common processes across a number of customers. In addition, well documented and established operations typically implemented by an outsource provider will help a fund demonstrate strong internal controls necessary to satisfy investors as well as the SEC.

This outsourcing trend is manifested by several recent transactions. In February, 2006, JPMorgan Hedge Fund Services acquired the middle- and back-office operations of Paloma Management Company. As part of that deal, Paloma also outsourced its daily operational services to JPMorgan.6 Following on that deal and leveraging the newly acquired platform, in May, 2006 JPMorgan entered into a deal with Henderson Global Investors pursuant to which JPMorgan will provide daily operational services and fund administration services in support of Henderson's 14 hedge funds representing approximately $2 billion of assets.7 In September, 2006 State Street Corporation was appointed by Evergreen Investments to provide operational services "including, trade matching and confirmation, data management, reconciliation, performance measurement and portfolio recordkeeping."8

This trend of fund administration outsourcing is only likely to continue as service providers continue to invest in their technology platforms and talent and hedge funds and mutual funds continue to feel the pressure for improved operations and returns on investment as a result of competition, regulation and globalization. In short, outsourcing is a natural evolution for the fund market and provides greater opportunity for well-defined, consistent administration activities, improved investor relations and reduced operational risk.

Janet Parkhurst is a Senior Associate in the New York office of Milbank, Tweed, Hadley & McCloy LLP, practicing in the Strategic Sourcing & Technology Group.


1 Celent, "Trends in Hedge Fund Administration," Celent LLC Press Release, 2 August, 2006, http://www.celent.com/PressReleases/20060802/HedgeFund.htm (accessed 31 December, 2006).

2 Adam Shell, "Some hedge funds hit a slump this year," USA Today, 18 September, 2006, http://www.usatoday.com/money/perfi/funds/2006-09-18-hedge-cover-usat_x.htm (accessed 1 January, 2007).

3 Investment Company Institute, "Trends in Mutual Fund Investing, November 2006," Investment Company Institute Website, 28 December, 2006, http://www.ici.org/stats/mf/arctrends/trends_11_06.html (accessed 8 January, 2007).

4 The District of Columbia U.S. Circuit Court of Appeals in June, 2006 vacated the SEC’s proposed "Hedge Fund Rule," in Goldstein v. SEC, _ F.3d _ (D.C. Cir. June 23, 2006). The Hedge Fund Rule would have required many hedge funds to register under the Investment Advisers Act of 1940 by interpreting "client" to include investors within a pooled investment fund.

5 Jenny Anderson, "After Loss, Hedge Fund Will Close," New York Times, 30 September, 2006, http://select.nytimes.com/gst/abstract.html?res=F50C12FA3C540C738FDDA00894DE404482 (accessed 2 January, 2007).

6 JP Morgan, "JPMorgan Worldwide Securities Services to Acquire Paloma's Middle and Back Office Operations," JP Morgan Press Release, 13 February, 2006, http://www.jpmorgan.com/cm/ContentServer?c=TS_Content&pagename=jpmorgan%2Fts%2FTS_Content%2FGeneral&cid=1139403950394 (accessed 8 January, 2007).

7 JP Morgan, "Henderson to Outsource Servicing for $2 Billion of its Hedge Fund Assets to JPMorgan Hedge Fund Services," JP Morgan Press Release, 30 May, 2006, http://www.jpmorgan.com/cm/ContentServer?c=TS_Content&pagename=jpmorgan%2Fts%2FTS_Content%2FGeneral&cid=1148646355754 (accessed 8 January, 2007).

8 State Street, "State Street Appointed to Provide Investment Manager Operations Outsourcing Services to Evergreen Investments for $150 Billion in Assets," State Street Press Release, 23 October, 2006, http://pr.statestreet.com/us/en/20061023_1.html (accessed 8 January, 2007).

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