Evidence collected by INDOS Financial Limited (“INDOS”), the UK independent depositary,
has revealed that many hedge funds have chosen not to revisit their administrative and
depositary arrangements since the implementation of the AIFMD (Alternative Investment
Fund Managers Directive) in July 2014.
“In so doing,” says Bill Prew, INDOS CEO, “some managers are missing the fact that their depositary charges are rising in line with assets under management resulting in unnecessarily high fees. In particular larger funds should demand a more tailored fee model from their depositary which reflects the work and risks involved”.
Four factors have combined to bring about this state of affairs. The first is the regulatory
burden faced by alternative investment managers following the financial crisis. “No sooner
had AIFMD bedded down than work began on preparations for MiFID II,” said Mr Prew.
“Once a regulatory hurdle has been negotiated, the papers are often filed away and attention
turns to the next issue.”
Separately, 2017 proved a generally profitable year for hedge funds not only in terms of
performance but also asset growth. Recent figures from Eurekahedge indicate net asset
inflows of some $94.7bn into the industry, a dramatic change from 2016 which witnessed net
outflows of $55.1bn. According to INDOS, this positive reversal resulted in some lessening
of the pressure to manage all costs within funds.
The third reflects the fact that the AIFMD depositary requirements in 2014 were new for
many funds. The market for AIFMD depositary services was immature and approaches to
pricing these services has evolved over time, meaning managers are able to negotiate better
pricing when buying services today.
Finally, there has been a tendency for administration and depositary deals to have been
negotiated as a bundled package, but whereas administration fee rates decline as assets
increase, the same is not necessarily true for depositary fees.
INDOS notes that the fee rate for a typical contract for hedge fund administration will
generally scale down as assets grow, perhaps from 12 basis points p.a. (on fund net assets)
down to 8bps. In many cases, however, INDOS has seen evidence of the depositary fee
being fixed at around 2bps. Thus a $250m fund would be paying $50,000 p.a. in depositary
fees and a $1bn fund would be paying $200,000 p.a. It is rarely the case that a $1bn fund is
four times the complexity, or work involved to service, than a $250m fund and a more
tailored approach to pricing is required.
“In fact,” said Mr Prew, “the industry standard, set by INDOS back in 2014 and consistently
applied since, incrementally lowers the fee rate as assets grow such that the effective basis
point charge for a $1bn fund could well be around 1.2 basis points depending on the
complexity of the fund. Therefore, a fund of that size would be paying $120,000 not
$200,000 – a significant saving.”
“At this time of the year, investor focus on expenses increases since they want to understand
what comprises ‘other expenses’ disclosed in year-end financial statements. The answer is,
where possible, for a fund to unbundle administration and depositary contracts and thus to
achieve a better deal for the manager and, more importantly, investors. And now, as MiFID
II has come into force, there should be time to dust off the old files.”