In-house vs third-party fund administration: which is best for you

The rapid expansion of the private markets industry over the past decade has created new demands and pressures on the back-office operations of private market managers.

As these firms contend with the growing complexity of talent management, technology, reporting, and regulation, Alter Domus outlines the key factors to weigh when deciding whether to keep fund administration in-house or partner with a trusted third-party provider.

This growth has been significant. Since 2018, assets under management in private markets have increased by nearly 20% annually, reaching USD 13.1 trillion by 2023, according to McKinsey.

Upgrading back-office operations for growth and complexity

The industry’s rapid growth and success have forced managers to reassess the resources and infrastructure their organizations need to meet client expectations. Investors now demand more timely, meaningful reporting, while front-office teams require deeper data and analysis to drive returns, expand investment strategies and launch new funds.

In the past, most private market managers ran single-strategy platforms with a relatively small number of funds. These modest requirements shaped lean back-offices, where small in-house accounting teams could easily handle reporting and fund administration services using basic tools like email, spreadsheets and off-the-shelf software.

But as the industry has matured, back-office teams face an entirely different scale of responsibility. Increased investor allocations and larger check sizes have created demand for more frequent, detailed and customized reports. At the same time, managers must support a growing number of funds, asset classes and investment strategies — along with co-investment structures, funds of one and specialized accounts for key investors. Added to this are ever-expanding regulatory obligations and the complexities of servicing secondaries and NAV-based financing.

The light, nimble back-office model of the past is no longer enough. Today’s managers must overhaul their operations and scale up their back-office infrastructure, technology and processes to keep pace with the demands of a larger, more sophisticated market.

Deciding between in-house and third-party administration

As fund managers review their operating models and assess how back-office capabilities will have to change to meet the demands of a larger, more sophisticated industry, the core question they will face is whether to run fund administration offices in-house, or partner with a third-party administrator in an outsourced or co-sourced arrangement.

In-house fund administration advantages

An in-house fund administration model does offer managers with certain advantages:

1. Control and customization:

Keeping administration in-house does allow managers to keep full control of their fund accounting and reporting processes, and tailor these processes to meet a fund manager’s unique requirements.

Managers retain total control over how reports and accounts are produced in an in-house model and can access information as required to answer deal team and investor queries.

2. Confidentiality and responsiveness:

The direct access to data and reporting that an in-house model provides also gives managers the comfort of keeping sensitive data and reporting closely held and confidential. It also facilitates swift internal sharing of reports and figures, without the requirement to put a request in with a third-party provider.

3. Cost Benefits:

For some small managers, running an in-house fund administration team can save on costs if managers are still in the early stages of their development and minimum outsourcing costs don’t step down far enough for smaller operations.

In-house fund administration challenges

For all the benefits that in-house administration offers, however, it also presents challenges that managers should factor into long-term planning for operational models.

Keeping fund administration becomes particularly challenging as managers grow in size, and locations/geographies, expand in new asset classes and consequently have to expand and upgrade their back-office infrastructure and technology to support this growth and at the same time still be in compliance with the increasing regulation framework.

Managers can soon find themselves incurring high, upfront capital expenditure as they make new hires to expand back-office headcount and bandwidth. Bringing in the required specialized staff to handle increasing compliance management and regulatory obligations are another obstacle to scaling an operational model at pace.

Moreover, investor due diligence often uncovers concerns when firms rely solely on internal resources for administration, as many investors view the absence of third-party involvement as a potential red flag. This lack of external validation can raise questions about transparency, operational rigor, and risk management, potentially impacting investor confidence.

Firms will also find that when they reach a certain inflection point, the cost benefits of keeping administration functions in-house start to erode, which is particularly important given that in-house staff costs are borne by the manager, whereas outsourcing costs are typically covered by the fund.

Further expenditure will also be required to keep space with the latest developments in technology. Running proprietary systems becomes costly and complicated to sustain as AUM grows, and installing and updating best-in-breed technology requires upfront investment in in-house technology expertise and systems monitoring.

The upshot for managers is that instead of investing in the core, front-office functions of investment talent and deal origination and deal execution tools, large sums of capital have to be set aside to keep back-office capabilities up to scratch.

Third-party fund administration advantages

A third-party fund administration model can deliver cost efficiencies and specialist sector knowledge that would be challenging and costly to replicate in-house.

Advantages of an outsourced model include:

1. Access to specialized expertise

Specialist third-party administrators operate across a number of jurisdictions and service multiple clients across a wide range of strategies.

They thus have the scale and global reach to build teams that are dedicated to regulation and compliance, are constantly monitoring regulatory developments across all key jurisdictions, and have the knowledge and expertise to ensure that clients are always compliant with all national and international regulation, and can avoid the risk of incurring penalties.

The expertise a third-party administrator can bring to the table is deep, as it employs highly skilled professionals with specific expertise and experience in the areas of fund administration, tax reporting, compliance, and risk management. It is difficult to provide similar specialism in an in-house model in a cost-effective way.

 Another important consideration is that third-party administrators offer flexible access to these experts as needs arise, without the burden of full-time salaries. Instead of maintaining in-house specialists for infrequent or unforeseen issues, managers can tap into a dedicated pool of expertise on demand, ensuring cost efficiency while retaining top-tier support for “rainy day” scenarios.

2. Efficiency and cost savings:

When working with an outsourcing partner, managers free themselves from the costs and time required to keep on top of internal hiring and training, as well as the overheads that come with retaining large in-house teams.

Maintaining technology infrastructure is another area where the outsourcing option can save managers high capital expenditure outlays on technology.

Third-party administrators, with multiple clients, can spread operational, team and technology costs across their client bases, which enables them to provide best-in-class service at a lower cost point than a manager administering a small family of funds with an in-house operation but also ensuring best practices execution.

3. Helping a manager to scale:

It is also much easier for third-party providers – because of their scale – to ramp up service provision and managers not only build and expand their own platforms and investment strategies, but also adjust to the rising reporting and regulatory demands associated with growing their franchises internationally, serving a more diverse investor base and manage multi-jurisdictional compliance.

The hiring cycle and training required to upskill an in-house team to manage these growing demands will involve significantly longer lead times.

The scale and breadth of experience within third-party outsourcing providers also means that they will have the experience of handling complex fund structures and bespoke investor reporting requirements.

4. Stamp of quality:

Established outsourcing providers will be known to investors, who will take confidence in the fact that a manager is working with a third-party that has a track record in the industry and can be trusted to produce transparent, objective reporting. Using a third-party provider also means that managers can benchmark fund administration costs against the market, and show investors that a fund is receiving value for money

Outsourcing administrative functions to a third-party expert can also mitigate the risk of internal errors, operational blind spots and even fraud.

5. Top technology expertise:

Outsourcing partners will work across the best-in-breed alternative assets technology platforms and are able to advise on the selection and implementation of the fund reporting, risk management, and regulatory compliance software tools that are the best fit for a manager.

Building this expertise and breadth of experience in-house is challenging, as is meeting the ongoing development and maintenance costs required to keep these sophisticated software platforms functioning and up to date.

The benefits of scale also mean that third-party providers can make much larger investment in cybersecurity, data security, and business continuity plans than an in-house team could manage.

Challenges of third-party fund administration

Even though in-house administration continues to offer certain advantages, the scale, technology expertise and regulatory and compliance experience that a third-party solution can provide for managers has seen the industry pivot decisively towards the outsourcing option, with various industry surveys showing that outsourcing is on the up and expected to continue increasing in the years ahead.

For managers who are reappraising their operational models, it is important to take a long-term view on what their businesses will require in the future.

An in-house model does offer control and customization benefits, but as the reporting and regulatory workloads in back-office teams increase, scaling an in-house model cost-effectively and at pace becomes increasingly challenging.

The scale, technical expertise, technology bandwidth, cost benefits and global experience third-party providers bring to the table are encouraging more and more managers to choose the outsourcing approach when facing an organizational inflection point.

Alter Domus is a specialist fund administrator provider that has helped hundreds of managers to transition their back-office requirements to an outsourced model and has a proven track record of delivering comprehensive, scalable, and efficient services tailored to the bespoke requirements of alternative investment funds operating across a range of investment strategies in multiple jurisdictions.

In addition to core fund administration, Alter Domus also provides extensive audit and tax support, seamlessly coordinating with other financial service firms to reduce distractions for fund teams and allow them to focus on their primary objectives.

As firms face the mounting complexities of human capital management, evolving technology, intensive reporting, and stringent regulatory demands, Alter Domus helps managers carefully weigh the benefits of maintaining in-house functions versus partnering with an experienced third-party administrator.