AST: Could you tell us a bit about yourself and Meridian Fund Services?
Davis:
Well, I’m Bermudian and have been involved in fund services for my whole career, mainly at Bank of Bermuda and then later at Olympia Capital. Meridian Fund Services, which had been formed in 1996, was affiliated with an investment management company in which my brother was a partner. In 2000, I joined the firm and separated out the fund services operations from the investment management activity and I took over Meridian’s fund services operations.
In 2004, we opened our fully operational New York office because we wanted a presence in the city - I feel you still need face to face contact with the principals at the hedge fund firms. I found someone to help me set it up, Randy Troy, who had previous experience as a controller at a sizeable hedge fund. The New York operation is a very strategic component of our overall operations, and has been particularly important over the past couple of years.
In 2006/7, finding high calibre accountants in New York and Bermuda was proving very difficult. As a result, we set up an operating presence in Nova Scotia in January 2007, which was, and still is, headed by Patrick Donnelly, a twelve year veteran of the hedge fund administration industry. We didn’t want to go down the India route, as Canada is closer, has great educational institutions, and is more familiar to persons working in our industry. We also have an office in the Cayman Islands and our IT is run out of Massachusetts.
We did look at expanding into Europe in 2007 but even then we could see the chilly winds heading our way, so we held back. It’s still an option for us though and we’re keeping an eye on the development of legislation over there - the jurisdiction of choice itself will be decided based on availability of resources and the local regulatory environment.
We mostly operate within the hedge fund industry but there are some different programmes we administer that have a relationship with our hedge fund clients - for example, in Bermuda, we perform administrative services for a pension fund that uses hedge funds. Historically we have only been appointed to service hedge funds because the mutual fund sector tends to be very institutionalised and as such the large players dominate the industry.
AST: How do you feel 2010 was for the industry and for Meridian in particular?
Davis:
For us, 2010 was a good year. In the second half of 2008 and the first half of 2009 we did not lose many funds, , but because of overall hedge fund performance, market conditions, and redemptions, we saw a decrease in the asset values of the funds we administered.
But then everyone realised that “unregulated” hedge funds weren’t the main culprits behind the financial crisis - the regulated banks were. High net worth investors tended to exit the market rather than the institutions, but we started to see them come back. By the second half of 2009 the tide had turned, and at the end of the year and throughout 2010 we have seen a strong recovery for both the funds we administer and the funds that are starting up.
In the US, fund managers that traditionally performed their NAV calculations in house are now being forced to outsource that work and we have been able to take advantage of that new standard in the industry.
AST: Is the recovery coming from the growth of existing funds, or is it new entrants to the market?
Davis:
I think most of the recovery is money going to established managers, but we are starting to see new managers entering the market. As the prop trading desks in banks start to shrink or disappear, traders are moving on and setting up their own hedge funds. However, we don’t tend to see as much business from those managers as they generally have existing relationships with service providers arising from their careers at the banks.
In addition, although we are starting to see new managers entering the market, the amount needed to properly launch a fund is increasing, because the costs of the infrastructure needed to support a fund have increased.
AST: Do you feel the reputation of the industry has been harmed over the past couple of years?
Davis:
Within the offshore market, there has always been an emphasis on due diligence, anti-money laundering, and governance. The offshore fund industry gets so much bad press and has become the whipping boy for anything wrong with the financial industry as a whole. So we have almost had to assume that every dollar we work with is laundered until we can prove otherwise. The regulators in the US have constantly been looking at what we do in this respect and challenge us to prove that we have real substance in places like Bermuda and the Cayman Islands, not just informal structures that could be used to hide the origins of dodgy cash. The infrastructure is already in place and we are ready to meet the challenge.
In the last couple of years fund governance is also being scrutinised by institutional investors and with the implementation of Dodd Frank it will be interesting to see the impact that legislation has on fund governance within the US in terms of the funds organised there.
AST: How is Dodd Frank and other legislation affecting your business?
Davis:
People are looking at a division of duties. Fund administration prior to the downturn was seen as a calculation process, something that gave credence to what had already been calculated in house.
But now investors want to see fund administrators involved in the reconciliation and valuation process. We’re seeing a growing industry of firms that specialise in hard to value securities. Administrators are serving as the independent check and balance that institutional investors have recently been demanding.
AST: Are economies of scale there in the fund administration industry? Do you have to be a big firm with a global footprint to succeed?
Davis:
It’s starting, or restarting, to look that way. Back in 2008/9, it was all about survival, but in 2011/12, administrators will be asking if they need to consolidate, if they need to expand, and what they need to do to compete.
I don’t think you necessarily have to have $100 billion under administration to compete, but probably $15-30 billion to have the scale you need. Larger clients don’t want to be too big a proportion of your assets. They appreciate the extra level of service a smaller administrator usually provides, but on the other hand their investors are seriously looking into the financial integrity of the administrator - that’s the level of due diligence we’re seeing.
I think we’ll see that the main reason for consolidation is to provide a global solution. For Meridian, we can expand on our own, or we can find a European group without a North American platform and through a strategic alliance or merger offer a combined service. We need to look at Asia too. So there will be more consolidation, but will it be on the same scale as the banks? I don’t know.
AST: What’s your view of 2011?
Davis: Everyone is optimistic. There’s still risk, and we’re not out of the woods yet, but the outlook is positive. The hedge fund market in particular is quite exciting. The hedge fund industry came out of the correction of 2008 extremely well. And the role of the fund administrator is also very exciting. But it’s not the same role as we have historically seen.
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