Shadow Accounting

Why no hedge fund can afford to be without it

Will Broadway, Sales Manager, Alternatives, SS&C Advent
Originally published in the November 2018 issue

Industry competition has sharpened to such a point that shadow accounting is becoming increasingly essential for hedge funds. The competitive benefits a robust shadowing capability can bring have long been recognised – from enhancing transparency and catching errors to delivering greater operational security and independence. Yet for all but the largest or best-resourced hedge funds, the expense of buying and running the necessary infrastructure meant the cost/benefit analysis was not always compelling enough to make sense. 

No longer. Industry demands have changed. And advances in technology and service delivery mean shadowing should now be within the reach of all hedge funds, regardless of size or complexity.

Four reasons shadowing is now a must have

So why has shadow accounting become such a modern priority? 

Investor due diligence demands

In today’s cutthroat fundraising climate, hedge funds must satisfy allocators’ increasingly rigorous operational due diligence demands if they are to have a chance of attracting inflows. Allocation processes can take years, and competition is intense. There are more funds than ever and a multitude of strategies, so firms need to stand out. 

But before the chief investment officer or portfolio manager can explain the fund’s USP, or why their strategy is better than their competitors’, investors need to know their money will be safe and is being accounted for correctly. Having the right fundamentals in place from the beginning is vital. One missed checkbox on the due diligence report is enough for a fund to be vetoed. By contrast, firms with a robust operational infrastructure will be more attractive to institutional investors.

Shadow accounting can be a valuable tool, but it is only worth as much as the quality of infrastructure that delivers it.

Client service expectations

The ability to provide allocators with high quality, responsive services in a more efficient manner is another consideration.

Increasingly, institutional investors are seeking firms that can better mitigate market and operational risks. A shadow accounting infrastructure provides oversight and transparency, enabling the hedge fund to monitor, control and reduce both risk and reliance on their fund administrator.

Allocators’ reporting expectations are evolving too. They want more information, delivered faster. Many are no longer prepared to wait until the end of the month or beyond for a NAV pack.

Shadowing helps firms meet these shifting expectations. By equipping managers with the data they need, they can create and send reports without having to wait for the official books and records from their fund administrator.

Improve fund performance

Direct access to financially accurate, real-time data from an Accounting Book of Record (ABOR) provides a hugely valuable foundation for a fund’s entire infrastructure. Any internal decision-making tools, regardless of function or end user, can then pull data from an up-to-date, consolidated data store. 

The ability to access structured and enriched holdings data and exposure reports, as well as slice and dice by strategy, amplifies the effectiveness of the management information dashboards, front-office tools and risk management functions this data feeds. Ultimately, this should improve a fund’s decision-making and ability to articulate its competitive advantage to allocators.

Operational flexibility and independence

The operational flexibility and independence that shadowing provides ensures firms aren’t beholden to their third-party administrators. This gives them valuable mobility and is another key component in mitigating a fund’s risks. 

Firms that are reliant on their third-party administrator have no independent way of knowing if they are receiving reliable information. And with mergers and acquisitions commonplace in the administration industry, maintaining a complete set of books and records ensures that, regardless of any M&A activity, your firm holds a clean copy of mission critical data.  

An accurate shadow accounting record gives hedge funds vital autonomy. They can verify the data they receive and identify and fix any errors early. Since the funds have control over all their data, they in theory have the flexibility to move providers should TPA costs become prohibitive or service levels drop. 

Not all solutions are created equal 

Shadow accounting can be a valuable tool, but it is only worth as much as the quality of infrastructure that delivers it. Equivalency, to ensure the figures are as good or better than those of the administrator, is crucial. For example, native and comprehensive asset class coverage, along with support for complex global strategies and fund structures in order to account properly for all entities, will be key ingredients to effective shadowing. 

Hedge funds also need to control the period. A closed period accounting capability – giving firms the ability to adjust the records where a trade or price needs to be changed – is critical. 

An effective and efficient reconciliation process is another component. For instance, hedge funds may want to reconcile their trial balance to the administrator’s trial balance at the end of the month when they are cutting a NAV. That would highlight where any differences exist and what they are attributable to, enabling a quick and easy resolution.

An ineffective shadow accounting platform risks allowing a build-up of errors or inconsistencies. Any slippage between the firm’s internal figures and the administrator’s records will require significant work to identify the source of any discrepancies and correct them. Rather than making life easier for the funds, as shadow accounting is supposed to do, it could instead waste time and resources. 

The Geneva® global portfolio management and accounting platform

For firms that want to shadow effectively and catch potential errors, it makes sense to use a system trusted by the administrators, rather than a pale, functionality-light imitation. 

Geneva® by SS&C Advent is one of the industry’s leading accounting platforms. Indeed, for many of the world’s fund administrators, it is the solution of choice, responsible for administering 68% of the assets under administration held by the top 10 fund administrators as of Q2 2018.

Administrators who use Geneva trust it for a simple reason: it delivers the capabilities they need, while being efficient and easy to use. Beyond this, we are constantly updating the system with enhanced functionality and new modules to ensure that will always be the case. 

For instance, Geneva has long provided comprehensive instrument coverage, spanning global equities and fixed income to derivatives and bank debt. More recently, we added support for private equity and private debt, to reflect the changes in investment activity in the market and ensure we can continue to cover any asset in any region in any structure.

Geneva incorporates a full general ledger and supports accurate daily NAV calculation. It offers investor accounting and servicing for onshore and offshore funds, and efficiently handles closed period accounting. We have also added an automated data governance tool to validate the quality of data flowing into Geneva, identifying and resolving any exceptions. Meanwhile, our Enterprise Information Store (EIS) enables firms to access real-time portfolio and accounting data in an industry standard SQL database to make reporting and data access faster and easier than ever.

For hedge funds, Geneva can generate the comprehensive shadow calculations they need, providing reliable data outputs without any of the operational headaches. All they have to do is input the same trade files they would send to their fund administrator anyway, add market data and Geneva will produce the shadow NAV. Investors trust it too. Having a well-known and respected platform like Geneva on their operational due diligence questionnaire gives institutions the assurance they need to let the hedge fund move forward to the next stage of the selection process. 

Quality matched by affordability 

Geneva® is not just one of the industry’s leading fund accounting platforms. It is now one of the most cost-efficient and accessible too.

Thanks to our cloud-based software and services delivery model, Geneva users no longer have to make the often-sizeable IT and personnel investments previously needed to run and maintain an accounting system. Implementations are fast and easy, and all system support is handled by our highly-trained experts. Any maintenance and version updates are rolled out quickly and seamlessly, with no or minimal impact on firms’ operations. Our operational services teams can also take on those time-consuming and manually-intensive tasks, such as reconciliations processing, that have so burdened hedge funds’ middle and back offices. 

The result is a true shadow accounting capability from the highest quality system on the market, at a significantly reduced total cost of ownership – leaving hedge funds free to focus on optimising performance.