The decision to outsource among PERE managers is complex and based on a mix of variables unique to each manager. However, there are a number of key trends which are relevant:
- Drive for greater transparency: As Investors seek to understand performance, risk and value for money (fees), there is a need to produce consistent reporting. A recent global survey of Managers and Investors¹ indicated that 63 per cent of respondents agreed transparency is “very important” – although there was little consistency about “who was responsible” across different firms.
- Expense ratios under scrutiny: Investors are demanding to know more about fees and expenses and to be reassured that answers are complete and accurate. An outsource provider can both provide a level of independence to this process as well as reduce costs by leveraging a scalable operating model.
- Other macro drivers: Increased regulation, tax reporting, cybersecurity, accessibility of data (on mobile devices), disruptive technology (e.g. DLT) is driving a need for significant investment and changing practices.
Justin Chapman, Global Head of Market Advocacy & Innovation Research at Northern Trust, tells Private Equity Wire that to capitalise on the outsourced fund administration trend, the group has developed a global strategy “to expand our alternative asset serving capability, building on the existing book of USD1 trillion in assets under custody and administration”.
“The strategy focuses on regional expansion, capital investment and talent development with specific initiatives and goals aligned to each. Examples of this include: targeting the domestic UK and Luxembourg private equity markets by expanding existing capability in the EMEA region into these locations. And the development of a blockchain platform to remove a significant administrative burden associated with partnership structures used by many alternatives managers – we believe is a game changer for the industry,” comments Chapman.
Joe Patellaro is Managing Director and Head of SS&C Global Private Equity Services at SS&C Technologies. In his view, the US market is focused on the outsourcing shift in terms of strategic considerations: fund managers both large and small are evaluating how to either grow their financial footprint infrastructure or whether there is a sophisticated and disciplined environment that can be leveraged to deliver both tactical and strategic value to their organisations.
“Certainly in the US, there’s a lot of white space in terms of PERE managers who are not yet outsourcing,” says Patellaro. “We also look at other markets that are evolving that could create opportunities and allow us to contribute value.
“Our existing clients are an important piece of the puzzle as well. We see a significant amount of product flow, either the next evolution of a fund or a manager branching out into different product sets.”
In Q3 2016, SS&C’s total AUA wad USD1.093 trillion, of which private equity contributed USD382 billion. Fast-forward to Q3 2017, and total AUA had risen to USD1.483 trillion, with private equity contributing USD552.5 billion.
This illustrates the extent to which PE funds, in particular, are becoming a key growth driver for fund administrators.
Jim Cass is SVP and Managing Director for Alternatives at SEI’s Investment Manager Services. Like SS&C, he says that SEI is very optimistic on continued growth in the PERE and infrastructure space in 2018 and beyond.
“We have a good roster of clients that already entrust us with their funds. Some of the growth will come organically as these clients launch new fund products and strategies and some of it will be inorganic as managers consider outsourcing for the first time; to help eliminate headcount and reduce expenses.
“Consultants are recommending outsourcing as the norm, which is also adding to our pipeline,” comments Cass.
There are numerous drivers that are responsible for the outsourcing trend, which will be mentioned later in the report. But to finish the point on growth prospects, it is fair to say that managers are being distracted by operational challenges and complex change programmes. This is causing them, increasingly, to seek to partner with outsource service providers who can free up their time to focus on delivering performance.
“We believe the trend to ‘outsource’ will continue – indeed, it will become a critical means of survival for many. An 80/20 ratio over 5 years is certainly on the cards,” opines Chapman.
US/Europe disparity
Part of the reason for the disparity in the percentage of European PERE managers who outsource versus their US counterparts is the legacy of regulation in Europe, and also the heterogeneity of its marketplace.
For many years, UK-based managers looking to invest across Europe, or indeed globally, have not necessarily had the capacity or the budget to set up offices in multiple jurisdictions where the investments were being targeted or structured.
This led to outsourcing, as managers launched Luxembourg-based funds or SPVs across multiple European countries.
“In Luxembourg, our services are fully integrated and include full look-through accounting down to the controlled asset level, which fits the operating model of our clients,” explains Arnaud Garel-Galais, Business Development Director at CACEIS. “In Luxembourg, when looking at cases where clients want to outsource their fund admin there are two main situations:
“Firstly, the fund is regulated to attract more institutional and less risk averse investors and therefore needs an authorised central administrator. In this case, CACEIS is often chosen as the central administrator alongside its depositary duties. Secondly, the fund is not regulated, but does not have the internal resources to perform its accounting.”
With a huge raft of regulation in Europe, managers today don’t have the capacity or time to remain in compliance with it all “and would prefer to hand it over to a specialist fund administrator,” comments Alan Dundon, Chief Marketing Officer, Alter Domus. “We’ve grown from 65 people in Luxembourg in 2003 to 700 people today.”
In contrast to Europe, there is the homogeneity of the US marketplace. Historically, PERE managers have set their back-office teams up from day one and continued to grow them, alongside their front-office teams, as their businesses have grown. This has led to a much more pervasive culture of in-house administration.
That is now changing as US managers spread their wings and launch multi-jurisdictional fund products to attract different investor groups.
“The reason why figures in the US are now moving closer to 45 per cent, and which we believe will push closer to 60 or 70 per cent in the next five years, is largely because there is an increased level of regulation. But also because their back-office and finance teams are getting just as big as their deal teams. The back-office is often viewed as a distraction and not adding value to the business,” adds Dundon.
An estimated 70 per cent of PE firms in Europe now outsource, according to PwC.2
Striking the balance
Not all PERE managers will want to completely outsource. Indeed, this is ill advised. Managers still need a skeleton staff of finance and accounting experts in-house but what outsourcing now offers, as managers become comfortable with the idea, is the ability to achieve greater operational efficiency. And a way to limit the distractions of regulation, investor reporting, providing transparency in order to focus on deal making and delivering good performance; the very services that LPs are paying fees for.
Discussing the need to strike a balance between insourcing and outsourcing, David Bailey, Group Head of Marketing and Communications at Augentius, remarks: “We will always say to a client, ‘You need to have a CFO. You need someone in your organisation that we can speak to.’ Many years ago, we were working with a start-up fund group and the quarterly investor report was circulated to every partner. We ended up doing 26 versions of the report because each partner was making changes.
“Within the GP team you need one person coordinating the financial side of the business; whether it’s LP reporting, accounting for the GP entity, regulatory reporting. Whatever it is, you need a financial expert in your group. If the GP is working around the clock on a deal, and at the same time having to work on LP reporting requirements, the chances are it will go out late and the LPs are going to get upset. So you have to segregate deal activity within the GP from the administrative function within the GP.”
Loss of control…?
In Dundon’s opinion, PERE managers worry about a loss of control but also a loss of flexibility when they weigh up whether to outsource. With respect to control, Dundon says it is important to have a clear understanding of what a client’s operating model is “to determine how we might fit in as the outsourced partner”.
“What part of that activity gets outsourced and what stays in-house? When we lift out a team we don’t take over 100 per cent of the functions, we take over the functions that are administrative in nature and not value-added to the investment manager. They will still have people within the finance team that will look at the output of the administrator – processing journal entries, processing payments, etc, which are nothing to do with control. I would argue that control and accuracy are actually increased in the outsourced model,” suggests Dundon.
Whether it is maintaining the highest reputation with regulators or delivering bespoke, responsive services to meet individual LP requests, the pressures on PERE managers are considerable in today’s environment. And despite record levels of asset raising in 2017, investors are becoming even more prescriptive and demanding of GPs before they allocate. Crucially, they do not view outsourcing in perhaps the negative way it was perceived four or five years ago.
Chapman says that managers want to keep the “high touch” made to measure service whilst at the same time respond to investor pressure to reduce costs by streamlining operations.
“This requires a strong and effective relationship between the Manager and outsource service provider where the Manager can maintain involvement whilst handing over the day-to-day operations with confidence,” he says.
Confidence is the operative word here. General partners should carefully consider the depth and breadth of expertise within a fund administrator and determine whether they have experience in working with similar fund structures to their own.
“Secondly,” says Cass, “does the administrator have the system architecture to allow for a seamless, risk-averse process to ensure the manager has the quality control environment in which to operate?
“I would suggest that people, systems and then control environment and process around how you go about delivering information both to the fund manager and their end investors are the three main criteria.”
Jill Calton is SVP and Director of Alternative Investment Operations at UMB Fund Services. She agrees that expertise is a primary consideration.
“For a general partner to go from having people in-house who understand their funds and their unique make-up to trusting a third party provider with their products, it is important they know that the external team knows their funds and have a consistent approach in how they work.
“We have a team assigned to each client to build relationships, knowledge and a detailed understanding of the products. We make sure clients know we are treating them independently and they are not just a process. We see ourselves as an extension of their office. This way, the manager outsources to people they know and trust with their books and records,” explains Calton.
One PE manager who asked not to be named told Private Equity Wire that they do not presently outsource and that all the back-office and fund administration work is done in-house.
“We believe by having these dedicated internal resources we can provide our clients with better service, faster response times, and more accurate data,” they said.
Garel-Galais believes that a cross-border fund manager should consider having a single point of contact on the service provider side for all jurisdictions and a harmonisation of processes that take into account local regulatory specificities. “This allows the client to have a consolidated view of portfolio assets as well as an overview of various investor commitments.
“The service provider must be able to continuously support its client in the face of regulatory changes and the increasing demands from investors in terms of transparency and performance reporting,” he says.
LP comfort
Matt Herzog is a principal on the Client Services team at Hamilton Lane, one of the industry’s leading PE investment groups with more than USD47 billion in discretionary AUM. He says that many of the GPs that Hamilton Lane works with use outsourced services to help manage the operational workflow of their partnerships.
“At Hamilton Lane, we have been supportive of outsourced operational services for two main reasons. First, they allow smaller fund managers to put in place the necessary support expected of an institutional-quality private markets fund. Building an institutional-quality operations staff is an expensive and difficult undertaking. There are some excellent investors in our industry that simply do not have internal resources to build the necessary checks and balances to provide large groups of LPs the proper support.
“Which leads to the second point: outsourced operational services can serve as another review of fund operations and LPA compliance.
“With additional professional support from outside accounting and valuation firms, the added oversight indirectly provides LPs another layer of comfort that their investments are properly administered.”
Fund administration has evolved markedly over the years. More than simply striking NAVs, monitoring valuation policies, verifying assets, generating financial statements and so on, today’s administrator has become more of an operational partner. This is giving firms an opportunity to leverage scale, critical mass and technical expertise in numerous jurisdictions whether they are either doing business today or may do business in the future.
“We have several clients who started in one geography and have continued to expand,” says SS&C’s Patellaro. “The ability not to have to navigate different markets individually and work with an outsourced partner who is largely able to handle that part of their operation is, in my mind, a significant part of the strategic evaluation when managers are deciding whether to keep things in-house or not.
“It is a consultative approach and outcomes can be different. The first step is to understand the client and what they need. We spend a lot of time on evaluating roles, processes and helping managers think about how to transition from an in-sourced environment to an outsourced one. We have a significant line of sight into many situations that we can apply and add value to our clients, without being prescriptive.”
The need for transparency
One of the big drivers towards outsourcing is that LPs are raising the bar, in terms of the level of transparency they receive, not just from their PERE investments but all their alternative asset investments.
Hedge fund managers have, over recent years, responded in kind to the need for more regular, granular reporting. Even though PERE investments are nothing like traded instruments held in hedge funds, LPs still want GPs to deliver more frequent reporting so that they achieve a clear, aggregate view of their entire alternative portfolio, regardless of the illiquidity of the underlying funds.
Calton believes that standardisation can be applied to PERE funds to help meet this transparency demand and make it easier for LPs to know what they are looking at across different products.
“One of the ways to achieve this need for standardised reporting are the ILPA templates,” she says. “Institutional investors want consistency and full transparency when it comes to reporting for their investments. For the capital call and distribution notices they have standard templates with a lot more information than is commonly provided. ILPA has helped improve the way LPs receive information from funds.”
The PE fund manager quoted earlier confirms that they have seen a louder cry for transparency from their LP clients. “We are doing our best, with help from our internal legal team, to make sure we share pertinent information with clients,” he says. “Of course, it’s not always possible to share everything requested, especially if certain information is proprietary, but feedback from clients is very positive as we move towards enhanced reporting.
“One thing to note: we purposely keep our finance/back office team entirely separate from our investment teams – this allows our investment teams to focus on their core sourcing and investment activities.”
Private investments have a reputation for not providing the necessary look-through to the makeup of their portfolios. Some of that derives from a long-held misunderstanding that granular private market data should be private and held close to the chest.
At Hamilton Lane, Herzog says the view has always been that while private market data can continue to be private, it shouldn’t be secret, especially from those who invest in it.
“ILPA is one standard in a sea of many, and subsets and supersets of the ILPA request have been floating around with fund managers for a few years now. Although standardisation is not a requirement, dialogue and understanding of what our partners need is.
“We feel the best path forward for our industry is having an open, equal dialogue with all market participants to ensure the best chance for meaningful change. In order to do that, we work directly with our fund managers to make sure expectations are set during fundraising and beyond for the communication, scope, and limitations of detailed fund and company-level information. As a result, we believe our limited partners enjoy some of the most transparent and accessible data in the private market industry.”
Taking confidence in technology
Another important driver to consider is the incredible pace of technological change that has gone a long way to help fund administrators become more agile in support of the many complex fund structures used by PERE managers.
Whereas before, general partners might have been sceptical about a fund administrator’s ability to provide the necessary sophistication and customised approach to handling their funds, a myriad of technology tools and platform applications has equipped administrators to bring real economies of scale to PERE funds.
“When you look at the reporting capabilities being offered by specialist fund administrators there are a number of sophisticated PERE reporting tools available on the market,” says Sean Murray, Managing Director, Alternative Assets (EMEA), SANNE.
“We have the ability to customise reporting in a lot more cases than historically. This, in addition to client portals and investor portals, allows fund managers to access their fund data and slice and dice it whatever way they, or their investors, want. It is giving them a lot more confidence around the reporting that specialist fund administrators are able to develop and provide.
“Each fund manager has their own complexities, and in some cases their own specific investor groups that require more specialised reporting, but the growth in PERE outsourcing mandates has pushed service providers like us to further adapt and invest in technology to handle those complexities.”
At UMB Fund Services, Calton is in no doubt that the more processes that can be automated, the better. The one area that she says is the most challenging is the waterfall calculation.
“Those can be difficult to programme. We have customised carried interest calculations in our fund accounting system that can meet individual needs. Everything else that relates to supporting PERE funds, in terms of reporting and accounting, is automated. Our proprietary technology handles nearly every aspect of the process.
“The structures used by PERE managers can be very complicated such that, even though you might have a system that can capture everything, you almost have to recreate it in a manual way to ensure the system is doing everything correctly,” comments Calton.
Technology has long been part of SS&C’s DNA and in that respect, building solutions to best handle complex data and fund calculations has always been important. Patellaro explains that technology should be used to continue to enhance the LP experience in terms of the delivery mechanism of reports, and the ‘look and feel’ in terms of how those reports are presented.
“Our DNA as a technology firm dictates that we will continue to be front and centre in promoting how we evolve our solution set to enhance how the industry transacts business,” says Patellaro. “The use of data for multiple purposes is making automation more important for PE funds. Larger LPs are asking for more data to evaluate things at the GP level and we need to support our clients in being able to provide that data in whatever form makes sense for the individual LP.
“The evolution of the fund administration role is moving beyond only technical support and expertise. A client has an expectation of our execution on day-to-day activities. It is evolving to be more than provide traditional back-office functions and we welcome that as we think it is part of the opportunity for SS&C to continue to lead in this space.”
Not that everything needs to be provided by the fund administrator. Firms like Hamilton Lane are making large investments, off their own balance sheet capital, to partner with best-in-class technology providers.
Herzog says that the goal at Hamilton Lane is to provide itself and its clients with the necessary tools “to monitor, analyse, and report on private market portfolios”.
“Two of our major initiatives to this end are Cobalt for LP’s, a portfolio analytics platform giving users access to advanced analysis, market intelligence, and benchmarking, and iLEVEL, which allows our clients to monitor/report their PE investment real time as a system of record,” confirms Herzog.
Whether it is increased LP demand, improved technology and a willingness to provide real customisable solutions, a drive for greater cost efficiency, or a response to the complex regulatory environment, PERE managers look set to continue outsourcing.
And with record levels of capital flowing into PERE assets, the time has never been better for fund administrators to seize the moment.
Sources:
1. Conducted in Q1 2017 by NT and the Economist Intelligence Unit.
2. https://www.pwc.lu/en/private-equity/newsletters/newsletter-march-2017/news6.html
