December 1, 2011
Hedge Fund Partnership Accounting
As noted in our prior issue, the ‘open ended’ nature of a hedge fund requires more dynamic allocation calculations. Sharing percentages are constantly changing as investors contribute or redeem capital. Side Pocket investments become increasingly complicated as investors redeem capital, and reserve accounts need to be set up to fund future obligations.
Selecting a software application requires an in-depth review of the current fund structure and allocation process. All the requirements need to be defined to determine whether a potential system meets a particular fund’s needs. Moving forward on implementation without the proper analysis can result in costly customization and reconfiguration of an ill-suited system.
Complex Allocation Processes
All accounting systems are able to provide a general ledger, but partnership accounting systems are unique in their ability to drill down to the investor level. When booking fund level entries, it is critical to assign them to the investors in the proper order. For example, investor capital activity (e.g. contributions, distributions and transfers) must be booked first to derive the proper allocation percentage for the income activity.
As the nature of these funds becomes more complex, it is important that the accounting system tracks investor balances at a granular level. This will provide the flexibility needed to adjust the allocation methods, if necessary, in the future.
From an allocation perspective, some of the key changes in hedge funds relate to the following items:
Investments in Side Pockets
- Reserve accounts for redeemed investors
- Capital Calls / Distributions
- Investor opt-outs
- New Issue eligibility
- Complex Management and Incentive Fee calculations
Investor and investment static data will vary from fund to fund. These differences play a significant role in the allocation calculation process, making it difficult to allow for out of the box functionality. Systems that are designed to be highly configurable without the need for significant customization, will have the upper hand.
Easy to Use
As with any product the user interface needs to be flexible and easy to use. When switching from one system or Excel to another it is important that the allocation process becomes easier, more efficient and transparent.
Migrating from Excel becomes increasingly more complicated because columns, formulas and links are easily changed. When booking entries in a system the data must conform to a stricter set of rules. These rules will result in greater confidence in the data in the long run, but can make the transition from Excel more challenging.
Customer support plays an important role in the success of an application. As the larger vendors’ client base has grown, providing support becomes more challenging. This is not simply a bandwidth issue because each client has a different set of customizations and will require more personalized attention. If a vendor provides resources that are not familiar with a client’s particular requirements, any issues which might arise will take longer to resolve.
Some vendors differentiate between whether certain issues are supported by the help desk or the consulting department. If the resources are provided by the consulting department, not only will it take longer to resolve the issue, but become more costly.
As new customizations arise or existing functions need enhancement, it is important to be able to turn it around quickly. If the vendor is unable to provide updates promptly it will force certain tasks to be done offline. The results of these offline calculations will need to be fed back into the system to be able to report out to investors.
As the business changes the application needs to be able to change with it. For every instance where an offline process cannot be implemented in the application promptly, the users may become discouraged.
Partnership Accounting Systems: Evaluating the Landscape
After defining the allocation nuances for both Private Equity and Hedge Funds, the system selection process can begin. IntegriDATA has done several vendor selections and implementations for both Private Equity funds and Hedge Funds in need of partnership accounting systems. Five or six years ago, the market was dominated by a limited number of key players, but this is no longer the case.
In our opinion, Sungard Investran still dominates the market of the more complex and larger Private Equity and Hybrid Hedge Funds. It is important to note that, designed as an accounting application and serving complex fund structures, this system requires a lot of work to set up and to customize, in order to meet specific needs of a firm and provide full value. All implementations encounter some challenges, but in our experience the level of customization in some systems is so great that modications to one element can break other previously functional aspects of a system. The other big players in this market include Sungard Investier, Advent Geneva, The Next Round, and Fi-Tek – HedgeTek.
Some of the newer entrants have also earned a solid reputation and now effectively compete with the existing market leaders; among these are TKS Solutions – Penny – IT Works, eFront, Cogency Accounting, Frameworks, Koger, Archway ATWeb, HWM ManTra, and Equitrak.
During the selection process of any system it is easy to get caught up in a whirlwind of demonstrations and lose sight of the larger task at hand. This can become costly as several months may pass by before starting implementation. In order to complement our knowledge of the current market leaders we will be setting up demonstrations with the new vendors in the market. We look forward to posting our findings in future editions of the newsletter.