Data requirements drive middle office outsourcing
This past year has proven that general partners (GPs) can retain control and oversight over the various functions within their firm, even while working with outsourced partners. The shift to virtual working demonstrated that the ability to interact and collaborate across an organisation is in no way hampered by being in remote locations. In addition, the focus on data is driving the need for external support in middle office functions.
The PE operating model has historically been largely driven by in-house functions. Michael Tracy, director, Lionpoint Group, comments: “It’s not a surprise that the sector has been a laggard in terms of technology and outsourcing. PE professionals previously wanted to have full control over everything in the space. This was a hurdle the industry needed to overcome.”
In part, the catalyst for the growing role of outsourcing has been the exponential growth of the PE industry itself. Vehicles are also becoming more complex in their investment operations which results in needing to access specialist expertise.
Tracy elaborates: “To fundraise for a new strategy or to access a new source of capital, GPs would need to hire professionals to administer those functions in the middle and back offices of their firm.
“In choosing to work with an outsourced partner instead, they access professionals who have been successful at operating an efficient framework and have invested in technology to scale their clients’ business models.”
The manager will also retain a position of oversight. This is critical for that relationship to be successful. Tracy says: “Through a robust monitoring framework the managers can ensure the complex nuances of the different legal entities and structures of their investment operations are being administered correctly and the functions being performed effectively.”
The outsourcing journey
When an outsourcing relationship begins, it is often the back and middle office functions which are delegated in the first instance.
“As that relationship deepens, these models start to evolve and become more mature. That is when other functions start to come into play, under the same umbrella. For example, in the front office, you have investor relations and certain client relationship management functions which can be outsourced. Anything data related or any of the more analytical functions can be taken off the managers’ plate,” notes Tracy.
He caveats this by explaining that large portions of the front office are not usually outsourced: “This part of the business is often the ‘secret sauce’ of a firm, it’s what differentiates them and provides their clients with value-add. So, in this space it’s only market analysis and data functions which would be handed to another provider.”
Data-heavy tasks in the middle office on the other hand are prime candidates for being outsourced. Tracy notes: “External support for asset management, portfolio analytics and valuations, is a nascent kind of outsourcing framework that is growing significantly. This includes data collection for portfolio companies. In these situations, the outsourced provider collects all the financial data and operational KPIs from the portfolio companies and aggregates it within a system – be it their own or that of the PE firm itself.”
This role is critical given that the disruption stemming from the Covid-19 pandemic has resulted in a lot more data which needs to be consumed. Tracy highlights: “This is a result of the nature of the environment we’re in and also the advancements made in technology throughout the world.
Jonathan Balkin, co-founder and executive director at Lionpoint, says: “When outsourcing, firms still need to bring back their data in-house to support their oversight, fund models, track record, cash flow forecast, exit scenario modelling, carry plan administration and ad hoc reporting and other critical needs to run your business. Historically, this has been a significant compromise with outsourcing where you need that data to run your business. With cloud-based technologies and better integration options, clients can more easily ingest data from their administrator to have control and across of their data in an automated way with limited technology overhead.”
“In this context therefore, the ability to collect more data is ultimately going to drive investment insight,” says Tracy. “We’ve seen the need for PE managers to have a much more widespread, holistic view on what information to collect from their portfolio companies. The firms need to have the ability to do this both from a resource and a technology perspective. In view of this, expert outsourcing firms which are able to do that successfully, are becoming more popular.”
The technology angle has a significant role in the drive to improve outsourcing rates among PE firms. Tracy comments: “PE firms often buy-in robust pieces of technology. However, they need to evolve with them and upgrade them. They also need to make sure they have the right IT support to guarantee the systems are up to date and adding value. This is a significant investment which firms can avoid by leveraging the technology platforms used by their outsourced partners.”
Logically, there is a cost dimension to the case for outsourcing. When choosing to outsource, GPs not only save on hiring in-house professionals, but they also can pass on some of the cost to their investors.
Tracy elaborates: “Due to the way the legal documents are structured, an outsourcing agreement provides a certain element of independence in relation to the functions it governs, which investors are keen on. This also means the outsourcer fees are passed down to the fund level, which is a huge draw and benefit to the GPs.”
Further, Tracy adds: “If a manager can use their lead outsourced provider for 70 to 75 percent of the work, their job in relation to those functions is more of an oversight capacity. In addition, if they are able to utilise the providers’ technology in an automated capacity they can have a more lightweight framework and can reduce many of the expenses PE firms have historically had to take on.”
Another headline advantage of outsourcing is that it frees up time for PE professionals to focus on their core expertise. “The PE firm is therefore able to refocus on the investment vehicles, on deploying capital and on finding and highlighting the differentiating factors in their ability to source deals. In addition to making investment decisions and fund-raising, PE managers will be able to focus on marketing and business development – they can work to grow and scale their business internally,” Tracy advises.
Michael Tracy, Director, Private Markets Advisory, GP, Lionpoint
Michael Tracy’s background includes extensive experience leading global operating model transformations for top private equity, hedge funds and credit firms. As Director for Private Markets Advisory, leading the GP practice, he specialises in designing and implementing target operating models, including technology implementation, process workflow and operational efficiencies for large investment managers across credit, private equity and private market strategies.
Jonathan Balkin, Co-Founder and Executive Director, Lionpoint
With more than 15 years’ experience in private markets, including private equity, debt and real estate, Jonathan saw an opportunity to co-found Lionpoint Group, and deliver technology and operational efficiencies to the industry. Since Lionpoint’s inception in 2014, Jonathan oversees the delivery of transformational projects for global asset managers and successfully manages implementations to improve data management, workflow, controls and transparency.