Shadow fund administration to become more prolific post-Bridgewater deal, says Northern Trust

Fund Administration
07 Feb, 2013

Shadow fund administration is likely to become more frequent in light of the recent Bridgewater deal, the CEO of Northern Trust’s Hedge Fund Services business has said.

The $140 billion Connecticut-based hedge fund recently appointed Northern Trust to shadow the fund administration work undertaken by BNY Mellon, which Bridgewater outsourced its entire middle and back office operations to in November 2011.

The deal will see Northern Trust provide broad middle and back office services including replicating administrative processing, trade processing, valuation, real-time reporting, cash management, accounting and collateral management services.

While some industry watchers have described the deal as “extreme” in terms of the levels of oversight and potentially cost Bridgewater will incur, Peter Sanchez of the Chicago-based Northern Trust believes similar albeit not identical mandates of this kind are likely to become more prolific.

“I believe mandates of this type are going to become more prevalent going forward, particularly among the large multi-billion dollar hedge funds. It is something I suspect will be an institutional investor-driven affair with pressure coming from big ticket allocators such as pension funds and sovereign wealth funds,” said Sanchez.

The deal will give Bridgewater’s investors unparalleled transparency, a lack of which being something hedge fund managers have been routinely criticised for in years gone by.  An increasing number of managers already perform a degree of shadow accounting internally, yet while 90% of investors say it is beneficial to accurate valuation and reporting, just half say the additional costs are worth bearing, according to Ernst & Young survey. 

Sanchez said the costs to Bridgewater are not as significant as many would assume, although the fees were not publicly disclosed. “Bridgewater’s decision to outsource their middle and back office to BNY Mellon, and outsource the shadow functionalities to us is a cost neutral decision. Large asset managers will have teams shadowing the administrators internally, but now they can use an external provider instead so I do not believe it will add to costs,” said Sanchez.

Some could argue firms like Bridgewater are outsourcing far too much of their operations, which will not go unnoticed by regulators. Most notably, the UK Financial Services Authority (FSA) has warned it will be monitoring what hedge funds are outsourcing to ensure they are taking full responsibility for their work.  

Sanchez recognised regulators were reviewing outsourcing practices but highlighted Northern Trust was well-suited to handle the operational challenges that came with servicing a firm as complex as Bridgewater.

Striking the correct NAV simultaneously will also be a challenge for both BNY Mellon and Northern Trust, and will require additional technology. “As long as we obtain the data from various counterparties and BNY Mellon, then I believe it will be straightforward. We also have a robust technology infrastructure and we shall use that to assimilate the data accordingly,” commented Sanchez. 

Another risk could be if Northern Trust finds itself bogged down with the Bridgewater mandate much to the chagrin of its other hedge fund clients. This was dismissed by Sanchez, adding the Bridgewater deal will enable Northern Trust to expand its product line. “We are servicing a very sophisticated and sizeable hedge fund with Bridgewater, and if we can do that successfully, I think we will be well suited to service broader market sectors such as traditional asset managers and sovereign wealth funds.”

Shadowing would also enable a hedge fund to switch administrators quickly were their primary fund administrator to default, a scenario which would prevent managers from striking a NAV or allowing investors to redeem.

“Shadowing would allow for a very quick switchover and provides an extra layer of security to the manager,” said Sanchez.  Nonetheless, managers can already have pre-negotiated terms and conditions with a secondary administrator which would allow them to migrate just as quickly in the event of their primary provider failing.