What’s the outlook for private equity managers in the current macroeconomic climate?
We see the continuation of a number of key trends. First, an increase in capital inflows, coupled with mounting fund complexity. Second, a growing share of non-US limited partners flowing into US alternatives, especially real estate assets — an area where we have significant experience and fund exposure. Third, we also see an increasing amount of investment activity by US private equity managers into non-US real estate assets.
We believe this continued globalisation of investors and investments offers competitive opportunities for funds who are well equipped to deal with the attendant complexities — including AML/KYI compliance and the efficient onboarding and servicing of a more diverse base of limited partners.
How vital is data management becoming for private equity managers?
Whether handled internally or outsourced, the current fund administration environment is built upon a framework of legacy applications, extensive use of spreadsheets, and little to no big data techniques or technology. Yet in an environment of intensifying competition — and demands for greater efficiencies and more robust compliance — we believe this status quo is unsustainable.
As a true financial technology company, we see data — how it can be leveraged to mitigate risk, reduce costs, increase transparency, optimise back-, middle- and front-office capabilities, and deliver higher value — as the critical differentiator in the PE ecosystem, and we have grounded our mission and our business model on that belief.
Will outsourcing become a central part of private equity models and strategies going forward?
Historical data certainly supports that conclusion. Hedge funds have fully crossed over to an outsourced administrator model, and private equity is following the same trend — though not with the same urgency that drove hedge funds post-Madoff. According to numerous industry surveys, approximately 35% of private equity funds outsource their administration, while around 65% maintain it in-house — but acknowledge they are leaning towards outsourcing where direct benefits are evident.
One GP recently stated it succinctly: “My core competency is investment management, not financial administration. The more time I spend in my core competencies, the better my IRR, and the happier and more loyal my limited partners.”
What role will administrators play in risk management strategies for private equity managers?
We believe the administrator needs to address regulatory risk, information security risk and data risk, and should also deliver actionable intelligence to reduce investment risk.
But there are plenty of developments that should give managers pause. Last year’s social engineering attack, where a fund administrator was manipulated into distributing most of the fund’s capital, comes to mind. So does the growing risk of a successful cyber-attack, with its attendant regulatory and reputational cost — especially in light of the SEC’s new focus on cyber preparedness.
An administrator should be able to provide a robust suite of AML/KYI, data warehouse and document management capabilities that provide for rapid response and minimum disruption from regulator inquiries. It should also offer comprehensive audit trail capabilities for all fund activity and limited partner interactions; ongoing data quality and data management processes; and a platform for waterfall administration that is treated with the same discipline, documentation and execution that you would typically see in software development. That said, given fund administration’s historical accounting-focused structure (as opposed to a technology-focused model), it’s unclear how robust most administrators’ capabilities are in adequately addressing these real and rising risks.
How will managers use administrators and data vendors to generate alpha?
Ideally, the administrator is well positioned to deliver what I would call operational alpha — a combination of operating efficiencies and business intelligence that enable a fund to achieve returns above levels achieved today. Ultimately, that will depend on the administrator’s big-data capabilities — its ability to aggregate internal fund data, external market data and asset-level performance data in a real-time environment that powers greater analytic capacities.
These kinds of tools require substantial investments in technology and talent on the part of the administrator. But for funds, the upside is significant. It can be measured in a fund’s ability to rapidly analyse opportunities and performance — and make faster, better, smarter asset allocation decisions.
This article is sponsored by NES Financial.