Posts tagged "Pricing"

Custody Risk #3: Lack of accurate and timely fund pricing

July 22nd, 2013 Posted by Opinion 0 comments on “Custody Risk #3: Lack of accurate and timely fund pricing”

Pricing remains a key consideration for custodians of alternative assets. By this we don’t mean the price that custodians charge for a transaction, although the cost to process a trade into or out of an alternative fund is higher than for an equity or a bond. The main issue here is procuring the actual fund’s NAV in a timely and accurate format. This valuation is particularly important, because it is used for calculating fees.

The calculation of custody fees needs to be transparent and consistent with the other services offered by the custodian. The cost involved in procuring a price for a traditional security is negligible – many prices are free, and vanilla securities also have the benefit of a reliable security ID code. The pricing of traditional securities can be carried out quickly, with clearly defined data sources and consistent prices. For hedge funds, the picture is much more opaque.

Where to find the data?

For alternative assets, procuring a price represents a much larger challenge, as there is no single data provider that can be consistently accessed.

  • Traditional securities data vendors publish the prices of those alternative funds that report directly to them, but pricing is frequently delayed and the funds covered do not represent a sufficient segment of the universe custodians need.
  • Specialist hedge fund databases cover a much larger slice of the universe, but rely on funds to report data to them. If a fund chooses not to report, or stops reporting (for example if it closes to new investment), the data series becomes incomplete.
  • Custodians can hire a third party agent to procure prices from fund managers on their behalf, but this can be an expensive and time consuming process.
  • Alternatively, custodians can go direct to the funds themselves, but this requires considerable investment in terms of time, money and manpower internally.

On top of the above data-related challenges is the fact that accurate pricing is required for a range of tasks, including for loans, bridging finance and leverage. Pricing hedge funds effectively for such functions is still a much greater problem for custodians than it should be.

For example, no electronic feed exists that can readily integrate with other data systems, causing custodians to rely on manual processes, which are slow and prone to errors. Audit trails to prove a price is accurate are both time consuming and expensive. In addition there is a huge burden of associated documentation to be managed.

Financing can be a much more lucrative business for custodians than plain vanilla custody, but even here, lending against alternative assets can be fraught with risks because of pricing issues. Because of the illiquid nature of alternative investments, investors sometimes need to borrow against holdings that are in the process of being redeemed in order to be able to re-invest assets. Such interim funding is frequently provided by custodians because they hold the assets, but this also puts pressure on the custodian to ensure accurate pricing and a detailed picture of the redemption time horizon. Ultimately, the lack of a consistent pricing picture represents a significant risk to the lending side of the custodian’s business.

For more information on how Comada can help you with your custody related risks, please contact Stuart Fieldhouse at

Dealing blind: are you 100% confident about your trade location?

August 9th, 2012 Posted by Opinion 0 comments on “Dealing blind: are you 100% confident about your trade location?”

The parties to any single trade, be it the fund manager, the custodian, the investor or the administrator, are incorporating a degree of estimation in the course of the transaction process. It is still difficult to operate otherwise. Each participant is using different parameters to view mission critical data and communications. Each still relies on paper-based processes and spread sheets to manage billions of dollars of alternative investments. But can any of them express with 100% confidence that a specific trade is at a specific location in the transaction trade at any given time of the day? And can they put a value to it when they do find it?

At this juncture in time we stand in an industry that is becoming increasingly institutional, with over 60% of the assets being managed by hedge funds now originating from institutional clients. The client complexion of the industry has changed while the legacy technology in use within many firms harks back to an earlier and simpler era.

Technology issues are becoming a bottle neck for institutional investors, particularly with regard to managing and reviewing hedge fund portfolios. This is creating a demand for a more proactive and integrated approach to client reporting using technology that has the ability to break down the different components of the hedge fund trade. By bridging these operational processes, institutional investors can manage and review accurate data with a higher degree of confidence.

The scale of the problem facing the industry has been highlighted by Swift’s SHARP (Swift Hedge Funds Harmonisation Project) initiative. Swift identified a number of key operational issues within the hedge fund transaction process. While custodians and administrators can handle the paper trail when transaction volumes are low, the largest service providers to hedge funds now process well over 1000 transactions every month. Each order may come with up to 50 pages of documentation attached. A typical team within a hedge fund administrator might be handling 600-700 orders with a dedicated staff of a dozen or so. Apart from reconciling data with their own records, they must also ensure investors are complying with KYC and other regulations.

Because subscriptions processing is time consuming and error prone, the entire cycle from the time when the order is taken to taken until confirmation is received and accounts are reconciled can be as much as a month. Faxes of subscription agreements must be sent to transfer agents, which in turn must be confirmed by phone, with final documents being sent over by courier.

For a fund with monthly liquidity, these transactions can prove costly, particularly if the market has moved. Missing a deadline for an order could lead to a fund holding unnecessary cash, while a missed redemption deadline would leave a fund exposed to an unwanted position for another month, quarter of a year or more.

If funds restrict liquidity, or extend their lock-in periods, or raise gates, the risks of moving transactions in and out of funds grows. It is still very hard for custodians to provide funds of funds with accurate status reports, particularly when they are bombarded by faxes from administrators and transfer agents at the end of the month. For larger custodians, with dozens of service providers to deal with, the problem is only magnified.