Headwinds and Tailwinds Set To Impact Fund Administration Market in the Short Term but Overall Outlook Solid

12/6/2023

The Future of Alternatives 2028, a recent report from alternative investment data and analytics provider, Preqin, forecasts assets under management (AUM) for the alternative investment industry to hit $24.5trn by 2028, up $8trn, or around 50%, from the estimated figure for the end of this year ($16.3trn).

Good news for fund administrators, who tend to charge based on a fee structure of basis points on AUM. The higher the AUM, the more money they make. But they also often charge per fund, so it’s not only the AUM that matters, but the number of funds they administrate. So, more fund launches, as well as higher AUM, is good for the space.

But the journey towards these extra dollars for fund admins over the next few years will be perhaps as challenging as it has ever been. 

Many eyes in the market are on the proposed SEC cybersecurity regulations for RIAs and funds. Specifically, the new rules call for funds to ‘Adopt and implement written policies and procedures reasonably designed to prevent violations of the Federal securities laws by the fund, including policies and procedures that provide for the oversight of compliance by each investment adviser, principal underwriter, administrator, and transfer agent of the fund (“named service providers”).’

Assuming that these rules are passed and become law in the United States (which won’t necessarily happen in 2024, but they likely will eventually), fund administrators will be exposed to the SEC for the first time (it is not a regulated industry at present). That’s a risk that brings with it a potential for negative column inches; any significant cybersecurity breach at a fund / fund manager will have to call out the administrator publicly, so there is an increased burden being placed on the admin to implement tighter cybersecurity controls.

These extra costs come at a time when margins are being squeezed by increasing competition from new entrants, and fund managers generally trying to cut costs in the face of an ever-larger regulatory headwind. Furthermore, fund administrators are increasingly investing in new technologies such as artificial intelligence, robotic process automation, and cloud computing to automate tasks, improve data management, and enhance investor services. These technologies are expected to play an even greater role in the industry in 2024, increasing costs again.

Despite the challenges, plenty of structural tailwinds exist to support those of a bullish disposition in the fund admin space. While the hedge fund space has a high degree of penetration of fund administrators, that degree is lesser for private equity and venture capital funds, as they tend to need to provide NAV calculations less frequently than their liquid fund cousins, making the spend less justifiable. But LPs in the private markets are increasingly requiring their GPs to have an external administrator. There is also increasing interest from the independent sponsor cohort in hiring a fund administrator, as they look to not only professionalize their offering to current and potential investors, but to accelerate their journey to ‘institutional readiness’ as they look to launch a pooled investment vehicle. And the growth and emergence of hybrid funds, both liquid and illiquid, means that external admins are preferred to those in-house as the task becomes more time consuming and complicated.

Middle and back-office functions of a fund management company, like fund administrators, receive less attention in the media than the investment strategy– a hedge fund making (or losing) millions on a stock, or a venture capital firm doing the same thing with the next great start-up gets the media coverage. But for those in the space, the journey to securing some of that extra $8trn in assets under advisory is set to be as eventful as it has ever been.

 

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