#shadowaccounting

"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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Over the last decade, an increasing number of hedge and other investment funds have implemented shadow accounting, with the goal of maintaining a duplicate set of books to improve data accuracy and integrity. Investor demand for openness and accountability in the wake of significant financial crimes is one factor for this acceptance. If your fund is looking about establishing shadow accounting or expanding or reducing the scope of its present shadow accounting processes, it's crucial to weigh the costs & advantages and customise your system to your risk profile. If you want to know how can  Shadow Accounting be helpful in your Hedge Fund Investments, ask yourself these questions: What is the scope of the project? In general, shadow accounting refers to a system in which two sets of financial books and records are maintained for the goal of spotting errors and inconsistencies. In the context of a fund, the word can refer to anything from double-checking a third-party administrator's Net Asset Value (NAV) computations to totally copying all of the administrator's financial records. It can be challenging to choose a system or systems to execute this role, and adequate resources should be allocated to the selection and implementation. Choosing an outsourced shadow accounting company is a similar crucial decision that should be made after thorough research. Is it better to keep it in-house or outsource it? Although many funds execute shadow accounting in-house, there has been a trend in recent years to outsource shadow accounting to a second administrator, accounting firm, or other service providers. Investor demand (investors may be more comfortable with a third party), relative costs and benefits play a role in the decision to outsource shadow accounting or keep it in-house. Outsourcing has a number of advantages, the most important of which is that it allows fund managers to concentrate on their core competencies, such as portfolio management, fundraising, and strategic planning. Internal shadow accounting, particularly full shadowing, can put a lot of burden on a fund's administrative, IT, and human resources.

Is it better to go all-in or go half-in? The shift from full shadowing to partial shadowing has been a recent trend. Certain accounting activities are becoming increasingly standardised and automated, such as NAV computations, reconciliation, and fund statement administration. In addition, most (if not all) administrators are getting SOC (System and Organization Controls)1 reports from auditors, which are reports on the design and efficacy of controls at a service organisation. This can give fund managers and investors more confidence in the performance of third-party administrators. Partial shadowing lowers a fund's costs by concentrating on higher-risk procedures like illiquid asset valuation and sophisticated fee calculations. However, regardless of the level of shadowing, fund management is ultimately liable to investors for the operations of a third-party administrator. As a result, strict supervision is required. Identifying Your Risk When weighing the benefits and drawbacks of shadow accounting, it's necessary to use a risk-based approach. Full shadowing may be beneficial for some funds to reduce risk and meet investor responsibilities. Duplicating 100% of an administrator's accounting activities — including functions that pose little or no risk — may be overkill for other funds. A partial shadowing system that concentrates on an administrator's higher-risk processes and outputs could be the most expense solution for these funds.