When and How Should Hedge Fund Managers Shadow Functions Performed by Their Fund Administrators?

In 2007, hedge fund managers administered roughly 75 percent of U.S.-based hedge funds in house. Today – for reasons including the credit crisis, high-profile frauds and the institutionalization of the hedge fund investor base – the majority of the private funds industry outsources certain operational tasks to administrators. Some industries outsource administrative functions primarily for division of labor purposes, as a vendor can perform certain tasks more efficiently and for lower cost than the institution. By contrast, the outsourcing of administrative functions in the private funds industry is not so much a division of labor as a duplication of it, as many private fund managers continue to perform those same functions in house despite that outsourcing. In the private funds industry, this duplication of administrative efforts is known as “shadowing.” To shed light on the practice of shadowing, this article discusses what functions are typically performed by fund administrators; what administrator shadowing entails and reasons why managers shadow their administrators; what functions are most commonly shadowed by fund managers and the methods used to shadow administrators; what the benefits and costs of administrator shadowing are, as well as who bears the costs of shadowing; which circumstances make shadowing an administrator most attractive for managers; and what the challenges of shadowing an administrator are. See “Ernst & Young Survey Juxtaposes the Views of Hedge Fund Managers and Investors on Hedge Fund Succession Planning, Governance, Administration, Expense Pass-Throughs and Due Diligence” (Jan. 5, 2012); and “Primary Legal and Practical Considerations for Hedge Fund Managers Looking to Outsource Their Operational Functions” (Sep. 22, 2011).

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