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Trends in Hedge Fund Administration 2008: New Celent Report

The expansion of third party hedge fund administration continues at a remarkable pace. With the hedge fund industry undergoing seismic shifts, however, administrators are faced with a formidable set of business and operational challenges.

The hedge fund administrator's role is evolving, and the product "fund administration" is expanding. Funds are looking to their administrators for expanded valuation and reporting capabilities as well as greater middle office functionality, collateral management, risk reporting, and compliance services. In addition, administrators are gearing up their offering to grab a share of the rapidly growing market for fund of fund administration. In a new report, Trends in Hedge Fund Administration 2008, Celent offers a broad view of the trends and drivers in this space.

Continued growth of the hedge fund industry stands out as a capital driver of the hedge fund administration market. As competition heats up, the majority of hedge funds have opted to unload the burden of maintaining a back office in order to free up resources to allocate to their core activities--trading and generating alpha. Additionally, increased fund complexity and shifting sources of capital have created an incentive environment that is highly conducive to the outsourcing trend.

Alpha/beta bifurcation and greater levels of competition have made alpha generation an increasingly difficult proposition for hedge funds. Growing fund complexity has forced administrators to adopt a broader business model. Today, administrators are providing a host of added-value services in the middle office area. More complex products and strategies have also had a direct effect on administrators' traditional suite of services, requiring them to develop a thorough understanding of new products and strategies and to enhance their valuation capabilities accordingly. What is more, pension fund money comes with demands for increased fund transparency, which raises reporting standards for administration firms.

For industry needs to be met, fund administrators are revisiting their operational infrastructures in terms of technology, organization, and staffing, as well as geographical footprint. As hedge funds have become more discriminating in their choice of service providers, the administrator's risk management and controls have been propelled into the spotlight. With fund managers' increased focus on the quality of services and operations, price sensitivity and pricing pressures have abated.

"We anticipate that, in an analogy to the hedge fund industry, the administration space will experience further 'barbelling,'" says Isabel Schauerte , an analyst with Celent's Securities & Investments Group and coauthor of the report. "The ongoing institutionalization of hedge funds will ultimately lead to a two-tiered market, with large multi-service administrators on the one hand and niche players left to service startups and independent boutiques on the other," she adds.