Automating the Calculation and Reporting of NAV for Fund Administrators
Hedge Fund Administration includes functions related to the fund’s operations including regulatory and compliance, fund accounting, audit oversight, investor reporting, and tax requirements. However, one of the most important functions of the Hedge Fund Administration or more specifically Fund Administrators themselves is the calculation of the firm’s Net Asset Value or NAV. While critical, the vast majority of Fund Administrators are still managing the arduous, time-consuming task by leveraging spreadsheets to track asset prices, sign-offs, and to-do lists prior to publishing the NAV calculation.
The calculation of the fund’s net asset value or NAV, including the calculation of the fund’s income and expense accruals and the pricing of securities at current market value, is an example of core fund administrator responsibility. The reason the responsibility is so important is that the NAV is the price at which investors buy and sell shares in the fund.
The responsibility involves trade capture; security valuation, reconciliations; expense calculation; and ultimately the NAV calculation and subsequent external and internal reporting. Further, with the growth of side-pockets to add illiquid investments to the portfolio, calculating NAV involves numerous, intricate variables. This critical activity has traditionally been fraught with manual processes, time-consuming data collection which unfortunately has been fraught with errors.
As we suggested, the current solution to calculating NAV in many firms is excel spreadsheets. We know that if you are in the industry this comes as no surprise. Despite this fact, updating an excel spreadsheet to calculate NAV as well as track all of the data needed to make the calculation is labor-intensive and has been described by many fund administrators as “overwhelming.” The task is overwhelming because fund administrators must not only calculate NAV, but also collect the data from a variety of colleagues across the firm and likely across the globe for each reporting period.
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The Growth of Side Pockets Complicate NAV Calculations
Think about this for a real-life example, a leading Hedge Fund has hundreds of investors with approximately 20 side pockets created per month. For accounting, the increase in the use of side pockets has led to an increase of up to 100,000 new capital entries per month across the entity structure. Side pockets can have hundreds of investors and if each investor starts a month with up to 20 side pockets per month and 20 new side pockets are added in a month – and, to complicate things further, there may be a loan against each side pocket, the number of ledger entries further explodes by the thousands each month and compounds exponentially going forward.
Side pockets were often managed manually through spreadsheets and updated by creating new sheets and cutting and pasting existing formulas from the previous month’s sheet. It was a painstaking, time-consuming task that in one account absorbed two high-level employees for three days. However, now, with thousands of additional entries and subsequent calculations spreadsheets have grown to over 150MB in size, become corrupted, and calculations have copied incorrectly or changed over time making the valuations incorrect.
As the number of side pockets grows RyanEyes has the ability to handle not only the automation of entries and calculations, but also the impact they have on NAV, the General Ledger, and Investor Returns
When a fund manager decides to create a side pocket, one method is to allocate shares to existing shareholders in the new side pocket account on a pro-rata basis. These shares cannot be redeemed until either the fund manager realizes a portion or all of the side pocket investment creating additional challenges for accounting and fund administrators. One of the primary advantages of side pockets outside of adding leverage is limiting redemptions. Hedge funds can delay redemptions until side pocket assets are assessed and given a valuation which often doesn’t happen frequently.
Fund Administrators are Overwhelmed with Manual Processes
While automation has become a key focus for many firms’ IT requirements, Hedge Funds are struggling to adopt change because of the rules and regulations inherent in the industry. Automation is complex for Fund Administrators because the predecessor to automation is systems that can log and track all the items that are part of the NAV calculation. A detailed tracking and audit trail is required in the process of calculating NAV. Many systems that Fund Administrators use are adequate at logging what they do, but they are not good at logging what they do with other systems. To complicate matters further, information on some of the components of the NAV is constantly being updated, even after the reporting period has closed. They are effectively blind to other systems causing gaps in the audit trail thus risking compliance issues and worse, an inaccurate NAV calculation.
Top 10 Issues to Watch Out for in Calculating NAV according to Ted Ryan
|Spreadsheet formula mistakes||Asset pricing errors due to manual valuation process|
|Stale or old data||Investor characterization errors concerning the type of fee structure|
|Bypassed controls are due to fragmented sign off process including maker or Checker process being ignored||Failure to double check onboarding documents|
|Inability to “Freeze” data as of certain points for a “Preliminary Close” and then compare preliminary with final NAV’s||Data provider failure with no back up plan|
|Mapping issues of entity structure||Undocumented manual processes to alert Administrators when steps are missed|
Many of the firms that we partner with use multiple fund administrators and depend on them to manage NAV-related functions, audit adjustments and trading issues. As we suggested in the previous section, many asset management firms have goals to increase the productivity of fund administrators and according to PWC’s survey, they are using KPI’s like those listed below to measure progress:
- Timeliness of the NAV Calculation
- Number of NAV Errors
- Percent of NAV Produced on Time
- Number of Audit Adjustments
- Aged Open Items
- Prior Period Corrections
- Trade Errors
- Trade Breaks
Meeting the aggressive KPIs has required fund administrators to adopt technology and software to transition from manual, paper-oriented processes to automated, transparent and shared processes. Fund administrators are minimizing the touchpoints and maximizing the use of technology across the entire business design.
- For example, the funds are also leveraging fund administrators to handle many of the middle office functions including:Bank/Broker Reconciliations
- Price Verification
- Corporate Actions Processing
- Portfolio Accounting
- P&L Reporting
- Trade Processing
- Cash Management/Treasury
- Performance Measurement & Attribution
- Trade Compliance
- Risk Attribution
Automating the NAV Calculation will Improve Fund Compliance
Having automated systems allow Fund Administrators to track items that are critical to regulatory compliance. For example, let’s consider SOC II compliance. A rigorous audit trail will allow you to ensure there is sufficient backup and detail to the regulator’s demands for seeing how items were actually signed off.
Automation can also cue the manual review processes, alerting the appropriate folks that an item requires a signature. The technology will also keep track of when these sign-offs are completed. Using automation systems like this can not only bring consistency to a firm’s compliance processes but also alleviate some of the time pressures for compliance personnel.
As technology, automation, and transparent processes are centered around management and workflow, automating standard processes allows the fund administrator to minimize workflow friction and improve job throughput. Fund administrators are in effect empowered to focus their attention on asset and portfolio managers as well as on more complex scenarios within the firm. They can essentially transition to the role of a business partner and add value at the customer and service level.
Improving productivity through a collaborative, automated process that collects, tracks, proactively notifies colleagues including CFO’s and Chief Controllers, and ultimately accurately calculates the firm’s NAV is critical. As fund administrators become more skilled, specialized, and take on additional responsibilities across the middle and back office, automation, transparency, and collaboration tools are vital to increasing productivity. Software solutions that provide a single-pane-of-glass capability along with the ability to reduce the time required to generate NAV calculations and close the month in a streamlined manner will provide a competitive advantage for the firm.
There’s still a lot of misconceptions out there with people often just looking for a “push button” solution. This is not something that happens by accident and improving automation should be regarded as a continuous process rather than a one-time event. It is all about incremental improvements over a period of time. Automation should be set as a priority now that technology and solutions are available and easily implemented. Fund Administrator productivity enhancements directly lead to more efficient and effective fund management and in turn better performance and investor engagement.
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