06/04/2011 Author: Will Wainewright

Merger motives

Consolidation within the hedge fund administration space is on the rise, with conventional wisdom suggesting larger firms are best placed to respond to the increasing operational standards expected of post-crisis funds. But many still see smaller admin firms as having an important role in the evolving service provider space. 

Few industry observers were surprised to read reports of Northern Trust’s agreement to purchase Omnium, Citadel’s fund administration arm, last month. It could be, after all, the latest in a line of consolidations to have occurred recently within the crowded admin space, a sector currently rife with speculation as to who will make the next move. But what is driving this activity and what does it mean in terms of the service offered to hedge funds?

David Aldrich, managing director at BNY Mellon, whose fund admin unit was the third largest in HFMWeek’s November survey, with $261.80bn AuA, says M&A in the sector has three main drivers. Asset gathering and capability expansion by admins looking to rise up the league tables are central, as is interest from asset-hungry private equity firms, looking to build economies of scale in a still-fragmented service provider group. 

According to Aldrich, the trend towards bigger firms is a good thing. “Managers need to utilise multiple domiciles and the fund administrator needs to be both domicile neutral and multi-jurisdictional,” he says. GlobeOp’s president and CEO, Vernon Barback, agrees. “We have developed powerful technology to provide our clients with tailored and high-touch, high-service solutions which are based on standardised processes and controls.” Ranked sixth in HFMWeek‘s November league, the share price of GlobeOp – still rare among admins in being stock market-listed – currently stands at nearly twice its September 2010 level.

Andrew Kennedy, COO at hedge fund manager Sam Capital, echoes these thoughts. “The ability to meet your needs as a fund, together with competitiveness on cost, is the key criteria for admins,” he says. “And the economies of scale custodians are able to generate through these merger activities should allow them to get better and better at that kind of service.”

However, though the M&A trend points to a smaller number of bigger firms in the future, smaller admins, offering what they consider to be a more tailored service than their larger rivals, keep springing up. Centaur Fund Services, launched by Ronan Daly in 2009, is a prime example. “The service given to hedge funds now is, by and large, a very commoditised service,” says Daly, who ran Hemisphere, an admin that rapidly grew and evolved, until being acquired by Citibank in 2007. With experience of both, he believes in the benefits of smaller-scale firms, likening most hedge fund administration now to the kind of generic service offered to mutual funds.

He disagrees with Barback’s assertion that better technology puts bigger firms at an advantage – quite the opposite. “This process of consolidation is reducing the level of specialist, high-touch service, so there appears to be a gap in the market. The idea of launching a smaller firm was to go back to basics.”

Daly sees the rise of larger admins as an opportunity, and believes the two models can work side-by-side. “The big-guy model does work for some of the very big, institutional-type investment managers. But we find there are a huge number of independent or boutique asset-managers who definitely do not want that model.” If that is the case, the market can expect smaller admins to continue appearing to replace the larger boutiques that have consolidated. 

Others say the move to consolidation has been driven by investors more desperate than ever for accountability throughout the investment process, including from admin providers. Speaking on condition of anonymity, one source told HFMWeek: “Smaller guys can’t win big clients because when the bigger guys do their due diligence they came up short. Brand name is important because a fund employing an administrator no one’s heard of raises questions for investors.”

Opinion is also split on what the changing admin landscape means to hedge funds in terms of cost. While Daly thinks the dominance of the bigger companies will impose slight downward pressure, Aldrich believes client experience, and not price, is the defining factor. If admins provide an inadequate service, they won’t be used – however cheap they are.

And maybe that is the bottom line. Whatever form they take, admins have to provide a service funds are happy with, and the market will evolve to suit these needs. Currently, the increasing demands of investors and institutions have produced a climate of bigger firms who have more middle-office, day-to-day involvement than ever. The increased regulatory and reporting demands placed upon hedge funds provide further opportunities.

Whichever way the market moves, one thing is clear. With fund admins looking to build economies and expertise, and private equity and prime brokerage buying to find a way into the admin market, the appetite for more deals is there. Judging by the sheer number of rumours HFMWeek heard while exploring the space, the M&A trend looks set to continue.