Fund Administrators are not currently as big a presence with Private Equity and Real Estate funds as they are with Hedge funds.
But Private Equity and Real Estate funds should take note, because Fund Administrators are becoming increasingly critical to how they go to market.
Fund Administrator penetration of the Hedge fund market is somewhere north of 80%, and having a Fund Administrator has pretty much become a requirement for Hedge funds of virtually any size. With around 11,000 Hedge funds in the US, we are talking about a large base of funds that are using Fund Administrators.
There are close to 4,000 Private Equity funds in the US, and the growth of these funds has been enormous. Private Equity assets have risen from $30 billion in 1995 to around $4 trillion in 2015. All indications are that growth will continue to be steep, as around 64% of LPs plan to increase their allocation to Private Equity funds, which is up from 26% just 5 years ago.
Despite this dynamic in Hedge funds, Fund Administrators have not penetrated Private Equity and Real Estate funds in the same way. Estimates are that penetration by Fund Administrators of Private Equity & Real Estate funds AUM is only around 30% today, and projected to increase to 45% by 2018.
I think this growth projection is understated, however, because many of the reasons that compelled Hedge funds to begin using Fund Administrators also apply to Private Equity and Real Estate funds.
Here are 3 key reasons why Hedge funds had to begin working with Fund Administrators and why these also apply to Private Equity & Real Estate funds:
- Investor demands for greater transparency
I think that this is going to be the biggest driver that will force Private Equity and Real Estate funds to use Fund Administrators. Investors are increasingly demanding third party validation of AUM and Net Asset Values, as well as greater transparency in reporting.
Particularly when institutional investors are factored in, the process of operational due diligence of a fund is occurring earlier in the RFP process. Institutional investors and/or large individual investors want to have confidence in the middle & back office capabilities of the fund, which generally means a strong accounting and reporting practice.
If these investors don’t have confidence in the management company, then they will increasingly pass on the opportunity. One recent Private Equity study shows that 64% of LPs are increasing the level of operational due diligence that they are performing on GPs. In fact, this same study showed that 71% of respondents stated that the most obvious change occurring in recent years has been the rising demand for transparency, providing more visibility into risk, operations, performance, and valuation than ever before.
2. Increasing Regulatory & Compliance pressures
This really started to materialize in the aftermath of the Bernie Madoff scandal, with acronyms like KYC, AML, FATCA and others fast becoming part of the lexicon.
The conventional wisdom that I’ve heard is that Regulatory & Compliance pressures aren’t the same for Private Equity and Real Estate funds because the level of activity is less frequent. I always find this argument to be short-sighted, because some of these regulations already apply to fund types beyond just Hedge funds. Indications of the impact of regulatory costs are already materializing in Private Equity, with more than 8 out of 10 GPs saying that compliance costs are climbing faster than other operating expenses.
“Adapting to new regulatory regimes” was listed as the top concern in a recent Linedata survey of fund managers and fund administrators, coming in nearly 20 basis points above the next closest concern.
3. Technology as a requirement
Technology is already a means of differentiation among progressive Private Equity and Real Estate Fund Managers. My feeling is that technology should be a requirement for all of these fund managers.
Technology can provide an effective means to address points #1 & 2 above, but how technology is best employed can be tricky.
When it comes to technology, there are two typical approaches that are taken. The first approach is often for the management company to try handling it on their own, including attempting to build out technology themselves. The second approach (often after having been unsuccessful in the first step) is for the management company to manage an external technology vendor/platform on their own.
Either way, the experience often ends up with the same result: handling technology on their own takes more time, personnel, and money than they initially expect.
Private Equity and Real Estate fund managers should instead look to Fund Administrators to implement and manage technology that they need. Fund Administrators are better suited to adopt and manage technology given that it is required by all of their fund manager clients. This is also a more cost effective solution for fund managers, because Fund Administrators are better suited to bear and spread the cost of technology across their clients.
Fund Administrators are already getting the message about the importance of technology, as evidenced by a recent study from Longitude Research that shows that 4 out of the 5 “Top Trends” that Fund Administrators listed that will shape their future between now and 2020 relate to technology.
Fund Administrators as the answer
Private Equity and Real Estate Fund Managers that still think they can go it alone without the help of Fund Administrators are going to quickly fall behind, and lose out on growth opportunities.
Beyond the points made in this article, Private Equity & Real Estate Fund Managers should listen to the words of Kevin O’Neill, managing member and co-founder at Broadscope: “If you have a strong back office, it won’t necessarily win an investor, but if the back office is weak, it’s very likely that you won’t get the job.”
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- “The $64 trillion question: Convergence in Asset Management”, February 2015
- Hedge Fund: Tiburon CEO summit materials. Private Equity: 2015 Preqin Global Private Equity & Venture
- 2020E AUM. PWC Asset Management 2020 - A Brave New World
- Pensions & Investments: “Private equity firms embrace outsourcing. More managers go with outside administrators, driven by sophisticated strategies, client needs”, March 2014
- HedgeWeek: “Convergence drives strategic operational partnerships”, October 2016
- SEI “The Future of Private Equity”, October 2016
- Linedata “2016 Global Asset Management & Administration Survey”, October 2016
- Longitude Research “From Coal to Diamonds: 2020 Vision – The Future for Fund Administrators”, 2016