It seems institutional investors cannot get enough of private equity. Last year, global PE funds raised USD453 billion, surpassing the previous record of USD414 billion raised in 2007, according to the last figures released by Preqin.
As management groups grow, along with their AUM (Apollo Group alone raised USD24.6 billion for their ninth vintage, the largest PE fund on record), the level of operational complexity grows in tandem. This is prompting general partners to decide whether to continue with in-house fund accounting and reporting, or partner with an external fund administrator.
Given the vast sums of money flooding in, it is certainly a good time to be a specialist player.
“The average fund size now is way larger than it used to be,” says Jim Cass (pictured), SVP and Managing Director for Alternatives at SEI’s Investment Manager Services.
Moreover, at a macro level, a large number of PERE managers are running multiple products in multiple jurisdictions. “Whereas traditionally they insourced a lot of the back-office functions, increasing fund structure complexity has caused some to consider outsourcing for the first time,” adds Cass.
Tessa Smith, a Senior Alternative Operations Director at SEI’s Investment Manager Services, confirms that as managers structure a large volume of entities across different jurisdictions, it can’t help but complicate the accounting process and the allocation of income to the different investor types.
Having the ability to take that complexity out of Excel spreadsheets, eliminate manual risks and putting controls in place around those allocations to account for these more complicated structures “is a large driving force in the desire to outsource”, she continues.
Some US managers are setting up Ireland or Luxembourg vehicles which is requiring them to have a presence in the jurisdiction. This is naturally pushing them towards an outsourced model to meet the substance requirement under the AIFM Directive, which they can achieve by appointing a third party AIFM.
Outsourcing the fund administration then becomes a logical extension.
“Investors are asking for independent SOC 1 reports from their general partners to seek assurances that the assets in the fund are being properly maintained,” observes Cass. “We have a robust control environment that gets tested independently and we share those results with our clients and their end investors. When the LP gets an investor report, they can feel a lot more comfortable (in their investments) when presenting it to an investment committee.”
By using a third party, general partners need not worry about coping with increased transparency demands and complying with myriad regulatory reports. Moreover, having an independent source that can report on operating costs and expenses can really help set fund managers apart from their peers.
In a recent LP survey that SEI conducted in partnership with Preqin*, it found that more than half of all investors said transparency is an ‘extremely important’ factor when evaluating managers. Moreover, the survey found that only 25 per cent of investors were pleased with existing levels of transparency surrounding operating expenses.
Outsourcing is not a panacea, but it can alleviate some of the stresses and distractions that general partners face as they try to meet these reporting and transparency demands. Many are realising that rather than throw money at the situation, there are other options on the table.
“The push to reduce back-office staff to a minimum and focus instead on hiring front-office staff – i.e. deal sourcing experts – is a contributing factor for increased outsourcing. Their resources are being stretched and outsourcing is the most effective way of dealing with it,” remarks Chad Longenecker, a Senior Alternative Operations Director at SEI’s Investment Manager Services.
“It’s hard for managers to build all of the necessary reporting mechanisms internally. Why do it for two or three funds, or when ad hoc requests come in, when they can go to a trusted partner who does reporting for hundreds of funds and has all the infrastructure plumbing in place to handle myriad investor reporting needs?”
Part of this drive for better transparency has come from organisations such as the Institutional Limited Partner Association (ILPA), which has developed a standardised reporting template to help bring a level of homogeneity to the data being reported.
“We see a lot of LPs requesting standard reporting templates such as that created by ILPA from managers they invest with. The burden of compiling all that information for an LP is overwhelming at times, especially when you have multiple investors requesting these reports.
“We’ve seen a constant uptick in LPs requesting reporting on managers’ fees and operating expenses. Some large institutions have pushed the standard reporting agenda and we are providing ILPA templates on substantially all new products launched by our clients,” confirms Cass.
The issue of fees and expenses is something that the SEC has always looked at carefully but today there is more focus than ever before, simply because the fund structures are becoming that much more complex, operationally speaking. Regulators want to make sure that investors have a clear view into what they are investing in and aren’t being penalised as a result of fees being misapplied behind an opaque multi-layered fund entity.
As a result, more general partners are hiring fund administrators to handle the accounting and reporting work and, just like with mutual funds and hedge funds, investors are being asked to pick up some of the cost for doing so.
“Most investors understand the benefits of outsourcing, partnering with an established provider, and the higher quality of reporting that comes with it,” suggests Cass.
“Broadly, what we do for real estate funds, for example, is not that different to what we do for private equity or other real asset funds. The investor requirements and reporting are very similar. But there is a service offering that is definitely unique to real estate and each GP has their own nuance and their own competitive advantages.
“In order to better understand how service providers are handling these differences, GPs should seek out how these provides are building up their expertise, whether they’re hiring experienced talent from the industry, as well as how they’re accessing core accounting systems that handle RE assets more efficiently.”
Rather than get bogged down in internal back-office distractions, general partners are re-evaluating how much this is costing them, both in terms of systems and people, and opportunity cost, to see if there is a better lever to pull.
Partnering with a firm whose systems are specifically designed to support large numbers of managers, multiple structures and layers of complexity and who employ people with specific PERE expertise across a lot of different product types, is a decision some of the leading PERE managers are making.
“Managers are learning that they can systematise and automate a lot more than they used to think was possible. Even in a historically less outsourced industry, we’ve seen more forward thinking PERE managers looking to service providers to provide a higher level of investor reporting capability and handle the back and middle office operations. With the competition for assets intensifying, we only see this trend continuing,” concludes Cass.
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