After lifting out the real estate fund finance team of Deutsche Asset & Wealth Management early this year, BNY Mellon announced a new business unit targeting further growth in these asset classes. Alan Flanagan, the newly appointed global head of Private Equity & Real Estate Fund Services at BNY Mellon, talks about this business.
What lead you to start up the private equity and real estate business?
AF: It’s been a while in the making. BNY Mellon has been making some strategic platform investments around areas that we perceive are high growth markets and that is ultimately driven by where clients are starting to make demands of us.
A number of years ago we started looking at the strategy of our alternative investments business and looked at the hedge fund market and the private equity and real estate market. In sizing both markets we saw and projected higher growth rates in the private equity and real estate space. In the hedge fund space, it is estimated that roughly 90% of that market is already outsourced and due to the stickiness of the relationships probably only 1% of those deals will change hands every year. On the other end of the scale is private equity and real estate where it is estimated that only 20-30% is outsourced. So you have a hedge fund market that is quite mature and very competitive in terms of those large managers that are willing to change, versus this less developed market, which is only starting to dip its toes into outsourcing. We very quickly realised that the latter is the space that we need to focus on from a client perspective and secured support from our executive committee to make this strategic platform investment into private equity and real estate.
We were already established in the private equity space servicing a global client base of approximately $50 billion in assets under administration. However our real estate capabilities, although developed in the U.S., had about a $5 billion book. We knew our real estate offering wasn’t something we were able to easily build global scale onto, so we started looking at strategic options, which resulted ultimately in the transaction with Deutsche Bank and lifting out their people and their assets.
What are the growth projections for this asset classes?
AF: We When looking at our alternatives business strategy, we did some work with consultants around compounded annual growth projections and we saw the projection for the hedge fund world was around 6-7% versus private equity and real estate at around 10%. So far that seems to be holding true. The pipeline and enquires completely turned around in the last three years. It’s definitely an area that’s gaining a lot of momentum and some of the transactions that have happened are forcing other large managers in this space to think about their own back office and what they need to do in terms of investing into technology. We have reached that inflection point and I wouldn’t be surprised if that 30% that was outsourced starts to increase significantly over the next few years.
[A report by PwC in June said global alternative assets are predicted to reach $15.3 trillion in 2020, with the largest increases in allocations likely to be in private equity, real estate and infrastructure].
Which services do these asset classes require and how similar is that to hedge fund services?
AF: The majority of private equity/real estate funds are closed ended as opposed to hedge funds which are typically open ended. In addition the capital structures are more opportunistic, allowing managers to call or draw down on commitments when investment opportunities arise. From a services perspective this means there is a defined investment and divestment period, funded with capital commitments, with calls and distributions, versus an ongoing subscription and redemption scheme in a hedge fund. It requires a different platform to address these particular aspects, like how much of their commitments have been called, how much of their distributions are recallable etc. So from a technology perspective we have made investments into platforms, which are tailor made for this type of asset class.
It’s very different from an underlying investment perspective, where these platforms that we use for private equity or real estate wouldn’t be platforms built for high volume securities transactions. The investment portfolios in private equity and real estate funds may be smaller in numbers but they may be bigger in ticket size, so buying a portfolio company or building versus high trading volumes around hundreds of individual securities. The difference is around the structure of the fund and that ultimately manifests itself in how you service them. The daily transaction volumes may not be as high, it comes in peaks and troughs, for example volumes are higher during the initial phase when a fund is making those investments. Most funds will have either a monthly or quarterly valuation point. In the hedge fund world you may be getting into daily valuations.
What is the key to success for this new unit?
AF: It’s a culmination of a few things. It was great to get a franchise client like Deutsche and to bring in $48 billion of assets, but the people or the human capital piece to this deal is invaluable because their expertise and understanding of the operational environments for these types of structures will drive our growth.