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Hedge fund administration: The quest for profitable growth

In a mature industry, we believe four trends are set to drive new growth

There's little doubt that hedge fund administration (HFA), or back-office outsourcing, is a maturing industry, as over 80% of hedge fund AUM is administered by a third party. Unsurprisingly, over the past seven years, 43% of the asset growth among top 10 administrators came from acquisitions.

However, despite 27 acquisitions of hedge fund administrators since 2006 (11 involving firms that administer at least $20 billion or more in assets), M&A activity in 2013 slowed due to an increase in valuations and a decrease in the number of viable acquisition candidates.

Because HFA demand is triggered primarily by external forces - such as post-crisis investor pressure placed on hedge funds to outsource their books and records - organic growth in hedge fund administration will be challenging as firms are forced to compete for a relatively static group of clients.

What's next?

As organic and inorganic HFA growth opportunities decrease, will there be new demand for administration services? And if so, where will this demand come from?

The answer lies in the competitive forces now shaping the asset management industry. We've found that four trends in particular appear poised to drive new growth in hedge fund administration (see below).

1 Increased need for regulatory reporting Demand for regulatory reporting services, such as AIFMD, Solvency II, and Form PF, remains strong.
2 Manager and product convergence Strong growth in assets under management (AUM) is expected for liquid alternative products. Citi Prime Finance estimates that these products will exceed $900 billion in AUM by 2017.1 At this rate of growth, the administration industry could capture incremental revenue in the range of $600 million to $825 million on an undiscounted basis for the period of 2013 – 2017.
3 Cost-efficient fee operations Asset managers are looking to become more cost-efficient in response to pressure from institutional investors. Administrators may want to develop new services that help asset managers achieve higher levels of operational and cost efficiency.
4 Expanded outsourcing Opportunities exist for administrators to offer private equity administration services. The US addressable market for private equity administration remains large, at 73% of invested capital (or ~$1.7 trillion). If private equity outsourcing were to reach 50% by 2018 (it’s currently at 30% today) then the incremental revenue opportunity for the fund administration industry is $660 to $880 million on an undiscounted basis for the period of 2014 – 2018.

1Citi Investor Services white paper: “The rise of liquid alternatives and the changing dynamics of alternative manufacturing and distribution,” May 2013.

As these trends take hold, administrators will invariably follow different paths toward growth, many of which will be influenced by such characteristics as size, ownership structure and service mix.

Small, undercapitalised administrators may focus on making improvements to both cost efficiency and their core competencies as a way to increase profit margins.

And well-capitalised administrators, small or large, may pursue one or more of these four growth opportunities to the extent they are not already doing so. However, it's important for well-capitalised administrators to remember that their financial capital will enable the pursuit of growth, but it will not guarantee the creation of value. Achieving profitable growth and shareholder value creation will come from a strategy that focuses on creating and sustaining a competitive advantage.

We believe the HFA firms that define a growth strategy which complements their core competencies, activities and assets will create more value over the long term.

Contact us

Debasis Sahu

PwC (US)

Tel: +1 646-398-3450

Erich Butters

PwC (US)

Olivier Carré

Partner

Tel: +352 49 48 48 4174

Contact PwC's Financial services team

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Contact us

Olwyn Alexander

Global Asset and Wealth Management Leader, Partner, PwC Ireland (Republic of)

Tel: +353 (0) 1 792 8719

Andrew O’Callaghan

Global Asset & Wealth Management Advisory Leader, Partner, PwC Ireland (Republic of)

Tel: +353 1 792 6247

Allison Rosier

Global Asset and Wealth Management Tax Leader, Partner, PwC United States

Tel: +1 (646) 465 0474

Peter Finnerty

Global Asset & Wealth Management, Assurance Leader

Tel: +1 (617) 530 4566

Bernadette Geis

Asset and Wealth Management Trust Solutions Leader, PwC United States

Elizabeth Stone

UK Asset and Wealth Management Leader, Partner, PwC United Kingdom

Tel: +44 (0) 207 804 9678

Justin Ong

Asia-Pacific Asset & Wealth Management Leader, Partner, PwC Singapore

Tel: +65 6236 3708

Steven Libby

EMEA Asset and Wealth Management Leader, Partner, PwC Luxembourg

Tel: +352-49-48-48-2116

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