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Providing comfort in distressed markets

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The unrelenting turbulence in the global financial markets is showing no signs of ceasing.

The unrelenting turbulence in the global financial markets is showing no signs of ceasing. Even hedge funds – which were until recently somewhat less affected – have been seeing their performance hit and their investors seeking to redeem significant amounts of capital. With the quest for alpha becoming increasingly harder and fewer new investors in sight, the last thing a fund manager needs is further trouble and distraction from the administration side.

That is why the involvement of an independent fund administrator is critical. The first and foremost mission for fund managers is to keep investors happy, and to attract new investors. In volatile and distressed markets, investors take great comfort that a professional independent service provider is preparing the books and records, and verifying the existence and valuation of fund assets.

In the current environment, redemptions and valuation issues are the primary source of operational risk in the investment management and back-office processes. This is where the independent administrator comes in, making sure that robust procedures and policies are in place, backed up by a quality assurance and internal audit function. The administrator can also conduct an independent review of the fund management fees, produce accurate and timely NAVs, and facilitate the processing of shareholder transactions while checking they are in accordance with the fund’s constitutional documents.

But a crucial role for an independent administrator is to assist in the determination and reporting of accurate asset valuations. Industry best practice guides, such as that of the investors’ committee of the President’s Working Group on Financial Markets in the US, recommend that within the investment manager, portfolio valuation should be segregated from portfolio management responsibilities to avoid conflicts of interests. The establishment of a valuation committee is also becoming an increasingly common industry standard. However, these types of control are difficult to implement for a small fund manager without an administrator to assist.

At the recent Gaim conference in Cayman, institutional investors noted that they no longer accept a black box approach from the fund manager regarding valuation, but a sound and transparent methodology backed up by an independent review – all areas where an independent administrator can add value.

Administrators can perform additional functions such as look-back pricing/back testing procedures, which can be a very powerful control activity, especially for illiquid or hard to value securities. Many administrators also review trading volume in individual positions to assess the robustness of month-end prices and systematically compare prices for a particular security across client funds. In addition, independent administrators generally send NAV statements directly to investors, reducing the risk of overstatement, which is common to many fraud cases.

In terms of cost, the fund manager can benefit from the economies of scale of an administrator administering hundreds of other funds, utilising expensive state of the art technology and highly experienced fund accountants. Certain administrators have built platforms that facilitate straight-through processing of transactions, which in itself can produce significant efficiencies.

From a risk management perspective, it is prudent to mitigate the risk of committing expensive administrative errors by engaging an experienced administrator with sturdy internal controls. By outsourcing the administration, fund managers can focus on what they do best – managing the portfolio and seeking alpha.

Canover Watson is managing director of Admiral Administration

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