Limited partners are asking for more frequent, transparent reporting from private equity managers and are increasingly assessing a GP’s operations as part of their investment criteria.
The fall-out of the global credit crisis is still being felt within the alternative fund management industry and whilst transparency has been a key theme in the private equity industry in recent years, private equity firms are still finding their feet as to how to meet investor demands.
More reporting please
“LPs have increased the frequency, detail and volume of reporting requests” says Giles Travers (pictured), Director, Alternative Investment Funds at SEI Investment Manager Services.
“Previously they’d be happy to wait for quarterly reporting and financial statements. Now, institutions are modelling investments across a range of different fund structures and they expect GPs to provide data points at both the fund and portfolio company level. Sector composition, regional split, aggregate leverage – investors want to be ever closer to their investments”.
For example, as reported by top1000funds.com on 22 May 2015, CalPERS will factor in the extent to which investment managers assess ESG factors and incorporate them into their investment process. All external managers will be expected to identify and articulate their ESG methodology.
Such examples mark a clear shift in how managers are being assessed and monitored. The upshot is that GPs of all sizes can expect LPs to ramp up the demands on how and when they want reports.
As Ben Lucas, Director, Asset Management at Ernst & Young states: “Investors are coming to expect more granular, frequent and transparent information flows as a standard. This, combined with the increasing regulatory burden and requirements set out in regulation such as AIFMD, is putting managers’ existing operating models under extreme pressure, particularly as many are considering these challenges in light of future proofing themselves for growth".
Rising tensions
The increase in reporting affects all aspects of a GP operating model – from client service delivered by investor relations teams to requesting deal information from investment professionals.
Without the right operating model this can sometimes see departments facing off against each other. As one might expect, IR teams want to be seen to be responsive to their LPs. Problem is, it takes time for back-office staff to get hold of the right information and properly scrutinize it before anything gets sent out. A CFO will never allow a report to be sent out in a hurry, no matter how important the LP; they have the firm’s reputation to protect.
“As much as firms want to be responsive and deliver good client service they need to be cognisant of the internal risks and controls in place to make sure the information is accurate and released in accordance with the constitutional documents of the fund.
“Consequently, these additional reporting pressures from LPs are causing GPs to reassess their operating models. If they are still reliant upon manual processes to retrieve, calculate and evaluate that information it is going to be a lot harder to be responsive as compared to using a reporting platform with integrated and automated workflow,” comments Travers. “GPs, especially Tier 1 managers, are now looking for best-of-breed solutions that can build on reporting their investors are familiar with and enhance data requests through the latest technology in warehousing, workflow automation, interactive reporting and mobile capability.”
The industry itself is also trying to address the issue. One of the initiatives to move towards a more automated interaction between LPs and GPs is AltExchange. AltExchange is an industry alliance that defines and promotes standardized formats for the transfer of data between parties investing in private equity and alternative investments. The AltExchange data standard enables fund managers to efficiently produce reporting data to LPs and is helping establish a common framework, which is a step in the right direction.
However whilst such initiatives develop fully, GPs still find themselves under pressure to ensure their operations can handle existing reporting trends and future proof their reporting methodology against further iterations of industry data standards.
Operations is now an investment criteria
As a consequence, back-end reporting is increasingly being addressed by LPs up-front in the investment process. In years gone by, GPs rarely had to worry about their back-office set-up as it was often not part of an investor’s due diligence questionnaire. The focus was primarily on the manager: their track record, their risk management process, their investment philosophy and so on.
That has now changed. Investors are making a point of assessing a GP’s operations before they allocate and have incorporated as a key element of their investment criteria. Ernst & Young’s 2015 Global Private Equity Survey notes that CFOs “must demonstrate that their internal operations are both effective and efficient”. Indeed, investors have added a new layer to their definition of ‘performance’: proven operational excellence. They want to see operational performance embraced in a GP’s own back-office.
“LPs are making GP operational due diligence part of their investment process and expect firms to be able to demonstrate a back and middle office infrastructure in line with their AUM,” says Nick Moore, Executive Director at Lionpoint Group, an independent consulting firm specialising in alternative asset management operations. “In turn this pressure from investors is empowering CFOs to deliver wholesale operational change across their firms.”
For PE COOs and CFOs there has been a transformative amount of choice and technology in the industry. The challenge is defining a strategic road-map for operations and being able to get buy-in from the senior management of the firm for change. “Many GPs are looking at legacy systems and internal processes to see if they can enhance these to meet the increased reporting requirements. Most don’t want to reinvent the wheel, they just want to fit faster tyres,” says Travers.
Private equity managers need to therefore strike the right balance between technology, internal resources and outsourcing to meet LP demands.
