This article is sponsored by AltaReturn.
Healthy M&A and IPO markets. Robust fundraising. Low interest rates. High double-digit IRRs. Indeed, these are good days for the private capital markets.
On the other hand, increased regulations, more data and reporting requests from LPs, growing complexity in the back office and a cloudy global economic environment are keeping CFOs’ plates full.
Earlier this year, AltaReturn commissioned a survey of private capital CFOs to gauge their thoughts in four distinct areas: outlook, role, accounting and LPs. The goal of the survey was to take the pulse of what private capital CFOs are thinking about these days – from their most pressing issues and how they see their roles evolving, to current pain points in the back office.
As much as investment teams are focused on the economic environment and the impact on their portfolios, the same concerns are not lost on CFOs. “Economic conditions” is the biggest concern for CFOs over the next 12-18 months – well ahead of other responsibilities that typically fall under the CFO’s domain, such as hiring personnel and regulations. What to make of this? While CFOs have the underlying responsibility to “run the business,” staying in tune with both internal and external forces that can affect the portfolio is clearly top of mind.
With regards to how CFOs are looking at their operations and technology, a significant majority (69 percent) identified improving portfolio monitoring as their most important initiative going forward – higher than cybersecurity (29 percent) and fund accounting (20 percent). While this might seem surprising at first glance, when you take into account the challenges and inefficiencies fund managers face in this all-too-important process, the focus in this area makes sense. Often the domain of spreadsheets, new cloud-based technologies have paved the way for quicker and more efficient information transfers from portfolio company management to GP.
As the private capital markets have grown, so too has the role of the CFO. The most common theme heard from survey participants is that there is simply so much more to do as the role evolves from being accounting-focused to having a broader operational perspective. The other point often made is that the complexity of the job has significantly increased as well. Certainly, a primary driver of these changes is the result of growth – people, investors, vehicles and portfolios. However, the changing regulatory landscape, both in North America and Europe, is requiring a significant amount of attention from the CFO/COO role. In the US, the SEC has stepped up oversight and enforcement of private equity firms, including the establishment of a private equity-oriented taskforce in the Office of Compliance Inspections and Examinations. In Europe, the fallout from changes in MiFID II and GDPR is, hopefully, in the rearview mirror. Changes in AIFMD with regards to “pre-marketing” and reverse solicitation are currently being reviewed, with the potential for major implications in how European investors are approached by GPs.
As recently as 2017, it was estimated that approximately 30 percent of private capital firms used a third-party administrator (by contrast, over 90 percent of hedge funds use an administrator). With over 55 percent of CFOs stating that they currently use an administrator or are considering it, there has certainly been an uptick in TPA usage. How GPs work with TPAs varies greatly though. Some GPs will completely outsource the back office to an admin, while others will “shadow” their admin by continuing to run their own books and records. As one large GP is quoted as saying: “We replicate 100 percent of the administrator work internally, as we cannot rely on third-party work alone given the complexity of our funds.”
Some GPs will utilize what’s called a “reverse outsourcing” model. In this scenario, the GP maintains the technology, data and processes in-house, and the TPA logs into the GP’s system to perform what back office support they are tasked to do. In this way, the TPA acts as a true extension of the GP’s back office. The benefits of this model solve two pain points: 1) the GP gets to make use of the expertise and support that comes with using a TPA, and 2) the GP maintains “ownership” of their data and processes.
Is there a point of a diminishing ROI in using an outside admin when funds grow to a multi-billion size? With the potential for exponentially complex fund structures and a revenue base with which to hire a dedicated staff, managers at this size seem to favor the in-house approach, particularly when compared with smaller funds that might not have the resources to build their own back office teams. However, with almost 30 percent of larger funds considering the use of a TPA at some point, attitudes among bigger funds might very well be changing as GPs continue to actively manage their margins.
In the history of the private capital markets, it’s not all that long ago that end-of-the-quarter reporting consisted of stuffing envelopes with hard copies of capital account statements, printing mailing labels and heading down to the local post office to send them on their way. Of course, email changed all that. But, just like snail mail, email is beginning to see its utility in this function begin to fade away. With the advent of cloud computing and related technical advancements, establishing an investor portal to share information, documents and data with investors (and prospective investors) is quickly becoming the norm.
According to the survey, 68 percent of GPs utilize some kind of portal technology, with 32 percent relying on email or other methods. Why do CFOs use an investor portal? Because fund managers are running up against that long-debated topic in the private capital community: transparency. LPs want it and managers need to figure out the best, most efficient way to deliver it. The two main factors that CFOs cite for using an investor portal are that the technology has advanced to the point where it is easier to use than email, and CFOs have (rightfully) deemed sending sensitive information to LPs using an investor portal is more secure than email.
It’s also interesting to note that many LPs have moved beyond the “PDF syndrome” and are asking their managers for the underlying data that supports their investments. In this way, LPs can incorporate their private market investments into the entire portfolio – for risk analysis, exposure analysis, portfolio modeling, etc. The emphasis on the “quantitative” means GPs have to continue to drive efficiencies in how they service their investor base.
With the possibility of economic storm clouds on the horizon, private capital CFOs know the time is now to ensure their operations and processes are up to speed. With so many GPs having seen substantial growth in assets over the last few years, getting the proverbial ship in order in the face of any downturn is priority number one.