In this latest instalment in our Operational Leaders series, we speak with Melanie Cohen, an independent advisor who has worked with many private equity, fund of funds, and fund administration firms to build out and develop their operations. We sat down with her to talk about vendor selection and the evolution of fund administration. 

Based on your experience in running a private equity fund administration business, how have you seen the vendor selection process change? What are the major operational challenges you have experienced and how have you overcome them? 

The fund administration business has changed drastically over the years. In the past, RFPs were more meeting-oriented conversations with less formal written aspects that had to be submitted. Now, RFPs are full-out due diligence requests with extensive information required that take a lot of work to complete. 

Within fund administrators, often the people that complete the RFPs are the same people who are servicing the clients. Therefore, a struggle between balancing their day job of servicing the client and the RFP completion exists – which effectively becomes their night job. At one firm, we established an RFP database which made the process much less time consuming, as the general themes that come up are repetitive and many sections can be reused across RFPs.

Until I started working on the other side and evaluating RFPs on behalf of private equity firms, I didn’t fully appreciate what was being gained from asking so many questions. “Every fund administrator has what they’re asking for, so why do they ask it?” Subsequently, I came to realise how much value there was in being able to compare and contrast multiple answers to the same question. In a recent RFP that I ran on behalf of a client, when I looked across the five fund administration options, there was a significant discrepancy in technology offering and level of technology support. I was surprised how firms of similar size differed with regard to the size of their tech team. 

It is hard to differentiate between vendors when you don’t have a significant fund administration background. The firms all look very similar to the client. It is hard to get a sense of whether they’re really up to the job and if they are a team you can work with. After reading an RFP, the client and I would produce a list of questions for the vendor, and the client would ask where in the RFP had I gotten my questions from as they did not see that aspect in the RFP response. My questions weren’t based on the RFP, they came from my knowledge of the firms, the industry and the fund administrators in the market. Having an external party knowledgeable in the industry helps to find the best fit for each specific client. 

How are fund managers currently picking specific firms? What are the key characteristics that are desirable in the current market? 

I can share a general list of criteria, but it differs per client depending on what’s important to them. There was a client that was in a specific industry, so originally, I thought the most important characteristic was for the vendor to have expertise in that industry. After completing a target operating model for the client, I realised that the key servicing focus of the administrator was the way they interacted with their investors. You really have to know what’s important to the specific firm.

Overall, firms should be looking at:

         1) Team. This is always very important from the fund administration perspective. When you’re buying technology, you’re not necessarily dealing with the service team as much. But for fund administration, while you want them to have strong technology, you’re really investing in the people – their knowledge and client service.  

         2) Onboarding. This is especially critical if you’re an existing fund migrating business to a new provider. If you’re a brand-new fund, it tends to be less important, as onboarding for a new fund is traditionally quicker, other than your AML / KYC. If the fund is two years in however, you have to convert historical data. “How quickly can they get up to speed? How much work is it for the private equity fund team? How much time do you need from me and my team?” are key questions clients ask.

         3) The scope of the service. There are clients that will say, “I don’t have a Luxembourg entity right now, but I may have one in the future. I want to have one vendor that can work both in Luxembourg and in the US.” So, it really depends on the scope of the firm and plan for potential future services. Considering potential future scope is important because you may change where you’re going to go as a firm.

         4) Price. This is obviously important, but less important than you might think. If there are five top criteria, price tends to come in fourth. There really is not much differentiation in price between vendors. 

         5) Industry. You have clients that are managing hybrid funds, closed-ended funds with liquid portfolios that operate similarly to open-ended funds, where the clients need their administrators to be experts in things like accruals and accretions. In addition, clients like to know, if they’re in infrastructure, does the fund administrator have other infrastructure clients? The benefit of a fund administrator is not just the service, it’s the value add. On a weekly basis, I would get calls from clients asking, “Hey, we have never done a line of credit – where have you seen clients do it? Who’s the best out there? How have you seen them use it?” Knowing the client’s industry is helpful because you can ask what others are doing. If I think back to 20 years ago, there were only a few firms that did fund administration and they offered basic services. Fund administration has developed much more into a value-add service.

Have you seen that clients prefer to stick to one provider that can cover all their requirements? Or do you see more of a tendency for multiple counterparties that may be specialists in particular areas that can integrate? 

More and more firms are moving towards using one vendor for a range of services – say 75% – but you still have some that use multiple. Fund administration is a sticky service so, unless the client is really unhappy, they’re not moving the fund that they’ve given you.  At the most, if the client is unhappy, they may give the following fund to a new administrator. 

In opting for one vendor however, firms may be giving up the opportunity to partner with an expert in a specific field. That’s becoming less of an issue because there is more consolidation happening via acquisitions; if people were opting for many vendors for specific expertise, it’s going to become less of a reason.

In addition, firms that perform a multitude of services are able to be more flexible on price. As an example, at one firm, we performed custody services and fund administration for a client. As the custody work was a high margin, we were able to price the fund administration services much lower. We could afford to make less money on fund administration because custody was very profitable. We’re going to see a lot of this as firms continue to consolidate. 

When you are running an RFP process, do you find that certain questions are more revealing than others? In which areas do you see the greatest disparity?

It’s funny because if you had asked me this before I ran one, I would have said the tech questions are not of as much value, but I was wrong. I really have seen disparity there. 

I traditionally will have sections about the company, technology, functionality, onboarding, pricing and referrals – even though obviously no one is going to offer up a bad referral! They are going to give you the clients that are going to give good references. So, it’s always good to have some references that are friends that you know in the business that can give you the real feedback. In the technology section, it’s good to ask when a firm’s last business continuity test was completed. One of the firms left it blank but said that they do it annually. Turns out they had missed it; they were a year and a half late. 

Other good topics are surrounding future investment in the firm, which demonstrates the direction that the firm is looking to go in, and staffing, which shows where resources are being allocated. The last section is always onboarding. When I ran an RFP for a tech vendor, I received two vastly different answers. One vendor said they could complete it in two months, and another said it would take five months for the same type of service. It is probably somewhere in between. It actually tells you less about how long it is going to take than about the way that firm thinks about business.  

Looking to the future, as we enter a period of economic uncertainty, what impact do you think that this will have on the vendor selection process? Do you have any future predictions on how decision-making processes will change for fund managers?

I don’t think it will be immediate – specifically on the closed end side. If a fund is closed and the investors are committed, that fund is going to happen. Fund administration is a steady-income type business. The problem is going to be whether future funds are delayed. If there is uncertainty and people are concerned, I would expect fewer funds to be raised. 

The labour market is also something that will be affected. I’m pretty good at negotiating contracts, but one thing I’ve struggled with recently is negotiating yearly increases which are specifically related to labour costs. Multiple firms have said they cannot budge on the yearly increase because they will not be able to retain staff. One firm told me that not only did they have their regular 15% increases, but they gave mid-year 5% increases across the board, just to keep people and reduce high turnover. As a result, fund administrators may not be able to change prices tremendously. Unless the labour market changes, the only way they’re going to be able to reduce prices is to automate things through tech, which is where much of the industry is heading.