Shadow Accounting: Luxury or Necessity?
Shadow books, or parallel investment and accounting books of record, are invaluable tools to empower sound investment management governance. They are designed to trust, but verify, your fund admins, creating an added layer of assurance that can not only guard against risk but drive greater investor confidence. The practice of shadow accounting is gaining traction as complexity increases across the investment lifecycle, as it quickly evolves into a strategic control function. Let’s explore the history of shadow accounting, the factors that make it valuable for funds, and how to maximize its benefits.
Shadow accounting as defense: risk, control, and resilience
Shadow accounting is most commonly known as a valuable approach to oversight, a second line of defense against data management errors that may occur as a result of the exceptional complexity of today’s capital markets regime.
Shadow accounting for transparency and control
Buy-side firms are doing business with the ground quaking beneath them, a floor-to-ceiling capital markets remodeling, with new technologies, new structures, regulations, instruments, and market dynamics. The volume and complexity of certain strategies such as asset-based finance (ABF) are increasing rapidly. Allocators expect managers to deal well with the complexities of the public-private asset class convergence, hybrid business models, complex side pockets, and other structures. Varying strategies have differing fees, alpha decay, capacity, and talent retention issues.
Shadow accounting oversight includes automated data quality checks, reconciliation, automated compliance-ready reporting, and critically, reports comparing internal records to administrator-provided data. As such, shadow accounting boosts transparency, visibility, and flexibility concerning positions, exposures, and strategic financial metrics, such as NAV oversight, revenue drivers, and key ratios.
Managing multiple fund administrators
Shadow accounting can also help streamline management of information that comes in from different fund administrators — a challenge many firms face. For example, a large firm with its private equity business on one admin platform and its hedge fund business on another platform needs to be able to grab that top-level number expeditiously to evaluate risks. Fund accountants who can normalize and transform the data from each financial statement, no matter the format, and make it look neat, easy to read, and easy to access, will beat the competition to harness that data to drive alpha. Those firms will have transparency and accuracy in seeing their cash reserves available to deploy.
Checking the checker for superior risk management
There have been numerous well-documented cautions about potential bubbles and market risks amplified of late. Shadow accounting is a powerful risk management mechanism for firms, especially those running multiple strategies, asset classes, or managers. Everybody is working in private debt today, and everybody is trying to modernize methods and platforms to drive returns with significantly higher volumes.
In the case of ABF and buy now, pay later (BNPL), point-of-sale loans are being pooled and financed via private credit vehicles, requiring sophisticated risk models and the data ingestion of thousands or hundreds of thousands of individual loans. Firms must generate daily NAVs and rapidly reconcile accounts for a pool’s value. The best risk management includes real-time risk reporting, which relies on the precise tracking of sophisticated P&L allocations across all portfolios to manage liquidity and counterparty risk.
A shadow accounting program will provide critical redundancy in checking the checker, preventing errors in the aggregate value of thousands of loans that could cost clients dearly.
Cybersecurity and data protection
We cannot neglect the fact that we are working in a volatile environment, rife with geopolitical uncertainty and cybersecurity risk. Data protection risk doesn’t merely apply to one organization, but entire supply chains. Fund administrators are essential service providers. Yet, not only do most firms employ multiple administrators, but many administrators also serve multiple firms. If fund administrators are essential, independent validation via shadow books is an indispensable tool for redundancy. If a prime broker data feed or system experiences a business interruption, the shadow ledger ensures continuity of collateral and margin records.
Shadow accounting as offense: earning investor confidence
While shadow accounting is commonly viewed as a defensive function, it can also help firms go on offense, helping to turn treasury into a revenue generator, via precise cash, collateral, and liquidity management.
Shadow books for advanced treasury operations
Driving returns starts with visibility into a single view of a fund’s portfolio, to see position-level exposure, to monitor performance separated by strategy, to readily access centralized data on all collateral requirements across various strategies, portfolios, and managers. Shadow accounting can help to accurately capture margin requirements, especially in complex structures.
A parallel internal book of record acts as an independent daily margin ledger to calculate portfolio-wide offsets, which optimizes margin efficiency and capital deployment. Think of a hedge fund using a multi-manager platform structure. A parallel accounting book allows the firm to calculate the fully loaded P&L of each individual portfolio manager. Further, since hedge funds are typically on contractual settlement with prime brokers, who cover negative cash balances, leading to higher borrowing costs, using accurate data from shadow books helps managers avoid unnecessary financing costs.
Additionally, validated internal data offers firms the ability to execute advanced treasury operations like margin replication and simulation, reducing their reliance on counterparties’ margin calculations. In-house margin replication gives the treasury department the power to predict the margin calls before they happen and enables them to estimate the margin impact of upsizing or downsizing existing position movements.
Enhance operational credibility among institutional allocators
Modern investors want a highly diversified portfolio, prompt performance reporting, and they want their fund managers to be technologically savvy. Implementing shadow accounting is increasingly viewed as a best practice to investors conducting thorough due diligence, helping newer funds build credibility and sometimes accelerate capital commitments or onboarding. And, of course, investors want flawless customer service which translates to zero delays in grabbing portfolio reports. Hedge funds are addressing this, but it’s very much a work in progress. In its 2024 survey report, EY revealed that only 27% of alternative fund managers had implemented fully integrated systems that allow for real-time reporting and decision-making. But 59% said their leading drivers for tech investment were better data management for internal reporting and 48% better client reporting. Only cost reduction was a higher motivator.i
Shadow accounting books help to make funds responsive and transparent by preserving audit-ready financials. AIMA’s 2025 Investment Manager Due Diligence Questionnaire update includes refinements to the most important sections to allocators: expense disclosures, leverage/liquidity risks, and service providers.ii If a hedge fund aims to scale from $1 billion to $10 billion, for example, lacking a shadow book could be a red flag that prevents sophisticated investors from making an investment.
Elevating shadow accounting to an essential function
A decade ago, if a firm ran a shadow book, it was seen as a big shot in the investment management space. For most, the fund administrator had it covered, and that was that. Without question, the emergence of cloud-based technology solutions has widened access to affordable accounting tools purpose built for the investment management industry, including shadow accounting and investment book of record software. Parallel accounting is not your father’s tedious back-office function; it offers a bonus layer of oversight to thrive in complexity. Automation and modern cloud-based operational technology have lowered the costs of executing shadow books, making the approach more accessible to firms seeking to take more control of their own fate and instilling trust in the data throughout the organization and among the investor community.
Authored By
James DeAlto
As an Account Manager at Arcesium, James partners with leading firms across the investment management industry to optimize their data and operational strategies and generate long-term value. Leveraging his buy-side experience and deep understanding of the client perspective, he helps investment managers tackle today’s complex and rapidly evolving landscape with precision and confidence.
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[i] 2024 EY Global Alternative Fund Survey, December 11, 2024. https://www.ey.com/content/dam/ey-unified-site/ey-com/en-gl/insights/wealth-asset-management/documents/ey-gl-ey-global-alternative-fund-survey-12-2024.pdf
[ii] AIMA's Illustrative Questionnaire for the Due Diligence of Investment Managers, March 12, 2025. https://www.aima.org/article/presenting-the-2025-edition.html
[iii] Uncorrelated, May 2025. https://www.uncorrelatedalts.com/articles/the-world-is-changing-hedge-fund-due-diligence-and-risk-management-need-to-change-too
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