The benefits of outsourcing fund administration

8 November 2023
Alternative investing has gone from a gold-rush industry to one of market turbulence, regulatory oversight and intense competition. Given these pressures, effective and efficient fund administration is more important than ever, but fund administration itself is increasingly complicated.

What was once a relatively straightforward outsourcing of fund accounting has now become a more complex and tailored delegation of operational expertise that requires savvy professionals and sophisticated IT platforms. While hedge funds were early adopters of outsourcing, private equity managers are turning to outsourcing to increase efficiency, gain access to top tools, and focus on other aspects of their business.

The rise of outsourcing fund administration 

Today, outsourcing fund administration is a globally accepted and growing practice. A survey conducted by FlexShares found that 32 percent of registered investment advisors (RIAs) used a third-party provider in 2022, up from 27 percent in 2020. RIAs also reported outsourcing roughly 50 percent of their assets under management (AUM), while investment banking divisions outsource 39 percent of their AUM.

Joost Knabben, head of commercial at Vistra Luxembourg, says an increase in regulation and a tight labour market are contributing to the outsourcing trend. The growing complexity in reporting and regulatory requirements makes administration in-house more and more expensive, Knabben notes. He adds that fund managers increasingly use third-party fund administration providers to access specialised skill sets, enhance their efficiency, strengthen client relationships, and boost retention and acquisition rates amid global economic headwinds.

“Regulators are increasingly scrutinising asset managers to protect investors, which can lead to higher compliance costs and reputational damage for violators,” Knabben says. 

“For private equity firms, just keeping up with new and changing regulations in all areas of operation is more and more burdensome, to say nothing of actually carrying out the reporting, filing and other steps the firm must take to comply. Even if you’re able to fulfil these compliance obligations in-house, you’re often reliant on a handful of employees. If one or more leaves, the organisation can be in a real bind. When you outsource to a reliable fund admin provider, you solve the problems of finding, hiring and retaining informed, trained experts — both to understand what’s required and to fulfil the requirements.”

Scott Kraemer, managing director of alternative investments at Vistra, adds that continued fee pressures have also contributed to outsourcing’s popularity.

“Pressure related to management fees is one major factor that has fund managers looking for new ways to promote fiscal and operational efficiencies,” Kraemer observes. “Outsourcing fund administration is an easy way to save money and free up resources — money and resources that can go towards the core business of managing investment portfolios.”

The future of outsourcing

There’s little to suggest that outsourcing’s popularity is a short-term trend. AssetMark reports that 79 percent of RIAs plan to increase the amount of client assets they outsource over the next three years. Moreover, according to Kraemer, managers of emerging funds are particularly interested in outsourcing. “Many new, smaller funds are coming to market and outsourcing their setup, operations and tech support to ensure a quick and easy launch. Outsourcing isn’t just for established players anymore.”

Of course, some private equity firms continue to handle much or all of their fund administration in-house. There are various reasons for this. For instance, a firm may have concerns about the cybersecurity of outsourcing partners or simply may be overwhelmed by the prospect of vetting and hiring an external provider.

Whatever the reasons, Knabben stresses that thorough due diligence is indeed essential when transitioning to an outsourcing model.

“There’s no doubt that the due diligence process for hiring any vendor can be daunting,” he says. “But appointing a fund administration provider with a global footprint, secure platforms, and proven compliance and operational practices will in the great majority of cases reduce long-term costs, administrative burdens and risks. As these long-term benefits are becoming increasingly obvious, it will be more difficult to justify keeping fund administration duties in-house.”

Deciding when to outsource

There are a few considerations that can help you decide if outsourcing is the right approach for a fund. One factor is size. Once a private equity firm is managing several funds across many jurisdictions — and must shoulder all the compliance and other administrative burdens that entails — it’s usually time to look for a third-party administrator. 

According to Gretchen Perkins, Partner at Huron Capital, running a large private equity firm is “an administratively intensive practice.” As firms increase in size and number, talent becomes a precious commodity. Kraemer agrees, adding that outsourcing can reduce training needs and simplify staff transitions when employees depart.

Often, Perkins says, a private equity firm will outsource administration simply due to a lack of manpower, especially when it might need the resources for more important functions. Investor demand for independence and institutional-level infrastructure are also motivating factors. Plus, Perkins acknowledges that limited partners appreciate what a third party brings to the fund by keeping the books and records at arm’s length.

Another consideration is access to technology. While many fund managers still rely on spreadsheets, using an external fund administrator can defray the costs of more advanced software. Knabben elaborated on the benefits of using a third-party fund administrator’s technology and explained how having access to advanced software can boost a company’s bottom line and improve its workflow efficiency.

“Using a top-flight fund administrator gives a private equity firm access to specialised software and lets the firm scale operations without having to invest in all the technology — and testing — itself. As a manager, this will allow you to have more detailed data across jurisdictions, allowing you to spot trends, react to market changes and — due to efficiencies — stay more competitive. And take into consideration that the administrator is one of the starting points for an investor. Experiencing a smooth, tech-enabled investor onboarding process contributes to the overall perception of the manager during the fundraising process."

Advanced software can also help fund managers fulfil ESG reporting requirements. This is crucial, as evidenced by the fact that 56 percent of respondents to Vistra's most recent 2030 survey expect ESG reporting requirements to be the global norm by 2027.

“Though progressing at differing paces in various markets, ESG considerations are becoming more critical for investors and stakeholders. Access to effective ESG reporting software for some is now essential rather than a luxury,” Kraemer says. “A powerful ESG platform not only enhances transparency with regard to ESG practices, but it also puts fund managers in a good position to comply with new and changing reporting requirements as they arise. Having a partner in this journey — and an established digital solution — helps private equity firms differentiate themselves by getting their ESG houses in order so they can lower regulatory risk and attract investors who are committed to ESG principles.”

It’s important to carefully consider all angles when making the decision to outsource fund administration. Fund managers should think critically about what functions they might want to keep in-house, and which ones make sense to outsource. Of course, fund managers should examine the third-party administrator’s policies, technology and values to ensure alignment.

Whether due to increased regulation, cost concerns, a talent shortage or the growing needs of investors, it’s clear that outsourcing fund administration is a trend that’s here to stay.

This is an updated version of a previously published article.