Today’s fast-moving, interconnected world offers asset managers greater opportunities to generate alpha than ever before. They can seek investments across borders and utilize sophisticated derivatives and other operationally complex assets. But the search for alpha comes with the challenge of managing complex data while complying with ever more stringent regulation.

Outsourcing middle and back office services across multiple providers has become the norm among asset managers today, increasing scalability, improving efficiency, and reducing costs. While these arrangements hold multiple benefits for the asset manager, there are also risks. Asset managers must oversee their complex fund structures, deadlines, and overall activity that must be protected, but more importantly, monitor their providers and supply chains. Ultimately, asset managers remain responsible for delivering timely and accurate financial information.

Regulator and Boards Take Notice

Industry regulators are paying more attention to the risks associated with third-party administration, calling for asset managers to implement effective due diligence and ongoing oversight procedures for service providers. Regulators have indicated that further measures to secure mission critical systems, data backup, and recovery will become requirements in the future. They are also keen for asset managers to demonstrate alternative operational risk assessments, and set up crisis communication lines for dealing with a disruption.

Fund administrators have robust business continuity planning (BCP) protocols in place, which asset managers routinely confirm as part of their due diligence prior to an outsourcing engagement, and throughout the term of the relationship. However, regulators have implied it is not enough. If a third-party administrator’s BCP practices fail, and they are unable to deliver the agreed service-level data critical to the manager’s daily functions, it is the asset manager who is ultimately responsible to the underlying investors.

It is not just regulators who are asking for more oversight. Fund boards and shareholders recognize the high cost of remedial action and the even higher cost of reputational damage an error can have on the value of their business and their investments, making it harder to attract new business at a time when competition in the industry is arguably sharper than ever before.

Managers are now being asked to identify a possible contingency solution in the event of a system or a third-party vendor outage. While the request from boards is primarily around BCP, asset managers cannot wait for an unexpected event to test their contingency plans. They need a scalable, accurate, multi-administrator oversight strategy that inherently satisfies BCP requirements and proactively monitors their providers daily.

Reasonability Isn’t Good Enough

Currently, there is no uniform protocol for an oversight practice in the industry, much less a consensus around what constitutes best practice for oversight. Asset managers rely on their service provider for timely data to perform oversight functions. But this data often comes at the end of the business day or is sourced to satisfy regulatory requests. By that standard, how can asset managers detect a potential issue before it becomes an error?

Take Net Asset Value (NAV) calculation, for example. Managers use anything from IBOR data, Excel macros with administrator data, industry benchmarking, or high-level “reasonability” checks. According to a 2016 BBH Market Survey, 50% of asset managers interviewed rely on manual Excel-based controls at the fund level, and nearly 80% of asset managers interviewed perform reasonability checks that vary in methodology and timing.

Managers using Excel macros as their primary over¬sight tool most likely receive the administrator’s end of day reporting and then run a series of tests on the individual components, such as pricing, valuation, income, expenses, and corporate actions, highlighting the largest impacts to the fund. While macros can do the job, there are no formal controls around them, presenting a level of inherent risk. Macros are written and kept up to date by individuals, which can lead to input file format errors, deletions, and manual errors. From a sustainability perspective, how can a manager rely on a tool that could be lost, deleted, or locked when the expert maintaining it leaves the firm?

Reasonability checks provide even less comfort. A manager performing the check is likely using the administrator’s end of day reporting and benchmarks day-over-day NAV change with percentage moved. If they choose to research further, they may resort to an Excel macro to identify the highest movers by price and do some level of secondary research based upon that impact. The NAV may pass the tolerance but without diving into the detail, a compounding error could be missed.

In each scenario, oversight reviews are often performed the next day, which is not timely enough to prevent an error. The grid below plots these two solutions from a cost perspective, but also in terms of the complexity each can handle.
Administrator Oversight: Balancing Cost and Complexity

If an asset manager can achieve a precise independent secondary NAV used for daily oversight, haven’t they inherently created a BCP solution that is independent of the third-party administrator? The simple answer is yes, but only if asset managers are comfortable with the accuracy generated over a period of time.

A sophisticated third-party tool for accomplishing this would need to build throughout the day without the need for the manager to load, format or save files, and schedule to run. It could function as a daily primary oversight program that includes data feeds such as cash flows, expense accruals, pricing, and tax accruals. Each source has a differing level of sophistication, and the tool should be able to aggregate data feeds managers need from several different sources such as their administrators, transfer agents, custodians, and third-party data sources, and be able to normalize it. Managers need enough detail to be comfortable with the end result, such as a security-level view following the fund’s prospectus and market pricing. The tool could also capture individual securities to provide granular oversight as needed for third-party data to ensure accuracy – and to correct errors before they are published. Solutions are prevalent in the market today, but managers should be looking for one that could be used by both the fund accounting teams and management. With all this data in a centralized place, being able to perform analytics on the NAV history and key performance indicators on your firm’s ability to oversee your administrators is a way to take control and ownership of your product. While this type of solution offers far less than the hundreds of data validations performed by administrators who ensure accuracy of their own NAV calculations, it is still critical when comparing an expected NAV with a final NAV.

Precision Is the Way Forward

In conclusion, the need for daily administrator oversight has always existed, but the stakes continue to rise as firms struggle with systems stability and resiliency, which can lead to errors. This is relevant for both those in a multi-provider model and those that perform the function in-house. Managers need to validate information from their administrators in real time to avoid the financial and reputational consequences of an error being published. The real challenge is that these pressures are coming into play at a time when most asset managers are under severe pressure on margins. This limits the amount of capital that most firms can allocate to acquiring and maintaining a daily oversight program that provides full backup for critical outsourced administrative tasks. As a result, asset managers will require a scalable, technology-based solution to achieve the speed, accuracy, and scale needed to validate NAVs across their third-party administrators.

What Does a Daily NAV Oversight Program Look Like?

Independence From The Administrator

Managers should have an independent class-level expectation of what their administrator(s) will calculate for a NAV for comparison regardless if NAV production is outsourced or performed in-house.

Transparency for All Levels of Management

Asset managers do not need to recreate the entire accounting process their administrators are performing on their behalf. However, measurable reporting on fund performance is necessary at the summary view for executives, and access to detailed reports for operations is crucial.

Daily Checks

Oversight is best performed prior to, or as close to, the NAV publication deadline as possible to prevent errors from being published.

Standardization Across Administrators

Asset managers should have a standard oversight process that can be applied across the full spectrum of fund structures and accounting agents to compare to primary NAV or benchmark with share-class level views and tolerances.

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