From the February 4, 2015 Hedge Fund Alert:
Citigroup’s plan to exit the fund-administration business underscores a failure on the part of big banks to capitalize on the unique cross-selling opportunities in the hedge fund sector.
Only 3% of Citi’s fund-administration clients also use the bank for primebrokerage services, according to an analysis of regulatory filings and other data by operations consultant Convergence. About 30% of those clients employ Citi for custody services, a low-margin business that does little for the bank’s bottom line.
While some other banks in Citi’s peer group have higher cross-selling rates — Morgan Stanley and UBS, for example — the Convergence analysis suggests that none has managed to squeeze much profit out of its administration business. Indeed, by that measure, Citi has done relatively well. About 13% of the funds that rely on the bank’s Hedge Fund Services unit for valuation, investor reporting and other administration functions have gross assets of $1 billion or more. That’s one of the highest percentages of $1 billion-plus fund clients among the “universal banks” analyzed by Convergence — suggesting that most of Citi’s peers are even less profitable. The fees administrators charge are tied to the amount of assets their clients manage.
The upshot: Contrary to conventional wisdom that the industry is ripe for further consolidation at the top, more banks may seek to spin off their fund-administration units, rather than expand them via acquisitions. “In terms of consolidation, you always thought it would be the top 20 buying the smaller firms,” said Convergence co-president George Evans. “Citi’s exit defies that. The real question for us is, what does that mean for the other universal banks? Is this a harbinger?”
Citi ranks seventh among hedge fund administrators, with $226.4 billion under administration, according to Hedge Fund Alert’s Manager Database. The ranking only counts funds operated by SEC-registered managers. The total is likely closer to $300 million, including funds run by smaller firms.
Other banks among the top 10 are BNY Mellon, which ranks fourth, Morgan Stanley (sixth), Wells Fargo (ninth) and MUFG (10th). But the ranking is dominated by non-commercial banks, including No. 1 Citco, No. 2 State Street, No. 3 SS&C GlobeOp and No. 5 Northern Trust.
For banks, hedge funds represent an opportunity to sell an unusually wide range of products and services — from trade clearing and securities lending to leverage, custody, research and asset servicing. But for most, the profits haven’t lived up to the promise.
It’s unclear which of Citi’s competitors might be interested in its administration business, though sources pointed to BNY Mellon, Northern Trust and State Street as the most likely suitors. Meanwhile, rival firms are positioning themselves to pick up business from Citi’s clients.
“We’re getting a ton of calls from folks shopping their administration business because of the ambiguity” surrounding Citi, one administration executive said.
Notable clients of Citi’s Hedge Fund Services unit include global-macro manager Discovery Capital and funds run by Blackstone, Pennant Capital, Silverpoint Capital and UBS O’Connor, according to the Manager Database.
Industry professionals said it’s difficult to put a value on the unit, given uncertainty about its profitability. Brian Shapiro, head of hedge fund data shop Simplify, said it could fetch $750 million to $1.2 billion. But, he conceded, “that’s optimistic.”