Shadow Accounting: Why it is becoming a must have when attracting institutional capital

Although a third-party fund administrator is appointed to calculate a hedge fund’s official Net Asset Value (NAV), the investment manager is ultimately responsible for verifying the portfolio’s numbers and reporting accurate information to fund investors. Hedge fund managers have traditionally kept a separate set of books & records to verify the fund administrator’s calculations. As reporting has become more onerous and the role of an investment fund’s Chief Financial Officer (CFO) expanded, investment managers began engaging third parties independent of the fund administrator to perform “shadow accounting” to enhance the accuracy and integrity of the NAV.

What’s prompting fund managers to outsource shadow accounting? In short, increasing complexity. Investment managers desire the ability to reconcile with the fund administrator, including verifying pricing and proper valuation. Increased complexity requires specialized technology, expertise, and time, which many CFOs do not have. However, the biggest driver is institutional investor demand. Industry competition has intensified to a point where shadow accounting is becoming essential for hedge funds. Certain investors expect independent verification of the fund administrator’s records which includes:

1. Authentication of calculations for fund balances and distributions

2. Confirmation of management fees and incentive/performance fees

3. Preparation of NAVs, including all accruals and distributions

4. Portfolio accounting for each fund structure

5. Complete financial reports and statements each reporting period

6. Review of annual audited financial statements

A recent PWC survey reported that over 80% of investment managers perform some level of shadow accounting. Despite the increased cost associated with engaging a third party to perform this function, investment managers see the value in the ability to attract institutional capital.

But not all solutions are created equal. Shadow accounting can be valuable, but it is only as good as the quality of the provider delivering it.

With decades of experience, Swiss Financial Services has the knowledge and the know-how to create a streamlined, high-quality shadow process. For more information on our shadow accounting service offering, please contact info@swiss-financial.com.