"Shadow accounting is the process of reconciling a fund's internal records with those of its external service providers, such as prime brokers and custodians. The purpose of shadow accounting is to ensure that the fund's books and records are accurate and complete, and to identify any discrepancies or errors in a timely manner.
Shadow accounting is an important risk management tool for hedge funds, as it helps to ensure that the fund's assets are being properly accounted for and safeguarded. By identifying and resolving any discrepancies or errors in a timely manner, hedge funds can minimize the risk of operational errors or fraud, and maintain the trust and confidence of their investors."
Quickness of reporting
Fund admin have the freedom to choose their own schedule because they keep their own set of books. While third-party administrators are required to abide by service level agreements, and even when they do, they frequently do not provide the turn around timeframes that senior management ordinarily expects. Owning your own systems and being able to produce reports gives you the freedom to conduct off-cycle reporting and, if necessary, real-time analytics.
With the Fund Administrator, reconcile
An outsourced administrator may have a wide range of duties. They are frequently in charge of creating the NAV, which directly affects how fees are calculated. Funds frequently want to have a separate procedure for creating these figures to compare with their administrative because there are numerous aspects that go into them.
Combining several administrators
It might be challenging to obtain a comprehensive view of the whole fund family when funds use a multi-fund administrator model. Funds can report on various separate strategies and build a comprehensive picture of their performance by keeping a shadow set of books.
Connection to reporting and risk management systems
Financial data is frequently delivered downstream as part of the broader fund technology infrastructure to enable risk reporting, budgeting and forecasting, P&L data, and other analytics. Having this data in-house may provide better data and allow for better reporting, even though it may not be the main cause of shadow accounting. Funds can become dependant on this data.
Lack of confidence/comfort
Some fund admins believe they must outsource their middle and back office functions because investors demand it. If the admin doesn't gain the internal fund accountants' trust during this procedure, the fund can feel concerned about getting rid of its internal computations and controls. It is more crucial than ever to have accurate information since incomplete filings can result in fines and penalties in this era of greater regulatory scrutiny.
Valuation precision
The opportunity to apply their pricing and valuation strategy to their portfolio is provided by the creation of a second set of books for the fund. Theoretically, this ought to align with the administration's valuation policy, but variances frequently emerge as a result of different market data sources. Shadowing the portfolio ultimately results in more wise investment valuation choices.
Allocators and investors desire it
Some investors or allocators fervently favour it when a fund shadows their administrator. It adds another layer of control and enhances the due diligence reports prepared by prospective investors. Given the amount of businesses vying for investors, it is now necessary to show increased controls through shadow accounting.
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