Scaling private equity investment systems

By Paul Whapham | 12 September 2017

The Private Equity (PE) sector is enjoying strong growth and experiencing significant change, against a backdrop of a continued search for allocations outside the public equity markets, and a greater confidence in the PE asset class provided by regulatory and sector governance.

The Asset Servicing industry is a critical component of Private Equity investment management, playing a key role in the sector operating model, supporting middle and back-office operations of the world’s private equity funds. Demand for PE Asset Services is strong, but there are challenges ahead for Asset Servicing firms if they are to respond to the evolving needs of PE.

Paul Whapham, MD of Framework Private Equity Investment Data Management, explored the impact of growing allocations to PE in a discussion with Paul Bratch, a founding Director of consulting firm Knadel, who act as ‘strategic advisor’ to senior management in the investment community contemplating or executing large-scale, complex projects.

“Tomorrow, increased activity will mean more and larger funds with larger single allocations being made to those funds,” said Whapham. “Already a $1bn fund is not unusual, and if you start to extrapolate a Fund of Funds (FoF) investing in ten $1bn funds, that soon adds up to a lot of investment monitoring, mandate complexity, and associated administrative and accounting activity.”

Whapham noted that to meet the needs of their growing client base, the Asset Servicers will need to have scalable operations, supported by systems which cope with growing volume and increasing complexity.  He said the focus today needs to be on data architecture and the delivery of technology which improves the investor and investment manager experience and, critically, improves controls and efficiency.

Bratch is not convinced that firms currently have an operating model robust enough to support increasing volumes of increasingly complex allocations. “For many of our clients it is clear that their underlying systems and processes are unable to scale.  It has been reported that there has been in excess of 60% growth in allocations to the sector over the past five years, which for firms who have not solved the scalability challenge simply means a 60% increase in workload for all parties; 60% more people, 60% more office space, 60% more spreadsheets!  That is not a long-term solution.”

Increasingly complex regulatory environment – as ever

The ability to scale is complicated by a changing and increasingly complex regulatory environment. This is an opportunity and a challenge for Asset Servicers. The opportunity: to enrich the service offered to investment managers. The challenge: to manage the investment data to meet changing compliance demands.

Regulatory demands are challenging, with each jurisdiction requiring more and varied returns. In addition, the investors themselves, through ILPA and other routes, are demanding consistent data standards and reporting formats across the sector.

Investors are looking more closely at their PE mandates, their allocations, including whether the performance of those allocations in line with mandate. “Patient capital” has a growing interest in the timeliness of the increased frequency of investment reporting.

Bratch agreed: “While Asset Servicers manage higher volumes with greater complexity there is no relaxation in the regulatory or investor reporting timescales.” He noted: “Current activity levels are exposing the limitations of current operating models and the ‘systems’ which support them; the work-arounds, the manual processes, from the portfolio system to the banking interfaces to the management of documents, to the duplication of effort by Asset Servicers and Investment Managers, to the inflexibility of database reporting.  Each of these hand-offs are barriers that get in the way of the dream of straight-through-processing in the PE space, preventing scalable operations or quicker, more flexible reporting.”

Bratch added that historically there has always been a level at which “additional discretionary effort” by fund administration and accounting teams has been “enough to muscle any reporting cycle over the line”. However, as activity increases there is now simply “too much that can go wrong if the whole process is not structured and supported by a decent systems infrastructure”.

Whapham wanted to understand the reputational impact on an Administrator or General Partner (GP) which cannot produce timely regulatory or investor reporting.

Bratch noted: “Big investors with big allocations want to deal with investment managers who can respond to their reporting needs. Understandably, they would rather not work with ‘roll-over’ figures.  Instead if they can get ‘actuals’ then that helps their decision-making and, over time, while mean that those who can provide more timely and accurate information will attract larger allocations.”

Bratch added: “Six monthly reports have given way to quarterly reporting, with monthly reporting becoming the goal. Who is gearing-up for that today?”

Failing to meet reporting deadlines has a real and negative impact on Administrators’ and GPs’ reputations and adversely affects their relationships with their investors.  Bratch noted that: “The good news is that the evolving environment is encouraging larger allocations to Private Equity.  So the Asset Managers and Asset Servicers who invest in systems to support this new world will win a bigger slice of a bigger market.”

Market maturity 

The Private Equity sector is maturing: driven by wider acceptance of the asset class by investors, the impact of regulation, and the diversity of investment opportunity. With maturity comes the need for firms to compete in terms of differentiation (asset class, instruments, deal-type, cycle times, etc …) and scale (efficiency and economy, and the ability to cope with complex mandate management). 

Whapham responded: “If you take the traditional asset management industry as a model for how a market sector can mature, then Private Equity has a long way to go. Looking back, it was the investment in systems infrastructure which enabled the Tier 1 traditional asset managers to scale and achieve the position they have today.”

Off-the-shelf or bespoke technology?

Paul Whapham said: “Build or buy? This is the key question we are hearing debated by decision-makers. The big players want to be bigger but the constraints on growth are all too clear: fragmentation of data and best of breed systems which do not talk to each other.”

Paul Bratch observed that: “Asset servicers are looking at the next wave changes taking place in the PE sector and trying to understand where they fit. Inevitably in today’s market firms need to build their business around ‘best of breed’ solutions across the investment management lifecycle, this creates a need for technology ‘glue’; solutions which can ‘join up’ the best of breed applications.

Whapham: “At Framework, our particular approach is to join the dots - link the best of breed solutions to deliver an integrated, scalable solution.”

The need for investment in technology and sophisticated data architecture is clear.  Asset Servicers are looking hard at their local and international operating models as they seek to standardise then deploy scalable solutions across geographies to achieve efficiencies and consistency of service.

Players who do not invest in their operating model and supporting systems to meet the demands of the maturing PE investment sector risk becoming obsolete.