Australia's fledging hedge fund industry is having trouble finding specialist custodians to service its needs. The reduction of proprietary trading by banks in the past two years has pushed many traders out to set up their own hedge fund operations, but this growth has not been matched by a corresponding increase in custodians providing the professional services they need.

With only two onshore custodians – Chase and Fortis – servicing funds with more than A$100 million ($52.25 million) under management, most of Australia's 20 or so hedge funds, (with an average size of between A$10 million and A$20 million), are using offshore custodians operating out of Hong Kong. As these managers are paying US dollars for services offshore, the chronically weak Australian dollar has placed the managers between a rock and a hard place.

The lack of specialist custodians affects the more established institutions, too. An independent investment group has recently launched a fund of funds using a local custodian. The custodian was picked to administer the fund because it is the custodian of choice for the company's other, more traditional, products. The arrangement between the two went well until the custodian was required to handle more complicated transactions such as risk overlay, currency forwards, options and futures, which the custodian lacks the expertise to do. It is understood the investment group now has to double check all the transactions for its absolute return fund.

"There are a number of good organizations who can do the more sophisticated transactions really well but they're not in Australia. Even Fortis is not 100% represented here," says an alternative investment manager with a local institutional investor.

According to the manager, the lack of clients is the main reason for major custodians not setting up representative offices in Australia. "If you need a prime broker today you need to go offshore. If anyone can take the prime broking service one step further to specialist custody service, they'll do well here," he adds.