The private funds industry has faced myriad challenges over the past year, including, but not limited to: rising inflation, hikes in interest rates, valuation challenges and general macroeconomic uncertainty.
Against such a backdrop, private funds are evaluating their internal operations to ensure that their firms are equipped for the future and assessing whether they will need to bring in outside help. Here, we set out three key trends that are likely to dominate market discussions over the coming months.
1. Finding the right balance on outsourcing
Private funds have historically been reticent to rely too much upon third-party providers for their fund management and administrative needs. However, this sentiment has been changing in recent years as technology providers and fund administrators have built out ever-more sophisticated offerings, and as the regulatory burden has continued to increase.
The Securities and Exchange Commission has set its sights on tightening rules for the private markets when it comes to outsourcing, and with SEC records showing more than three-quarters of private funds using at least one third-party administrator, the issue seems to be front-of-mind for the industry. One such proponent of outsourcing is Melissa Dickerson, CFO of Genstar Capital, who says: “It makes sense [to outsource].
“Outsourcers have simply gotten better, offering good value, services, and solutions, with reliable internal controls and cutting-edge technological tools.”
As third-party providers look to satisfy the need for more administrative help, they are winning over some outsourcing skeptics.
Private fund leaders say that finding the right balance of keeping some functions in-house while using third parties for more cumbersome or tech-heavy tasks has become increasingly important.
Some fund leaders, however, maintain that using wholly in-house solutions is the way forward for their firms, instead focusing on developing their own technology that services their firm’s specific needs.
The bespoke nature of private funds will likely continue to create challenges for firms looking to minimize the costs associated with using third-party providers while keeping up with the latest regulations and remaining competitive. However, private funds seem to be making inroads when it comes to finding the right mix for their own firms when it comes to considering external expertise.
2. The cybersecurity challenge
Increasing regulatory scrutiny surrounding outsourcing contracts are not the only area of concern for private fund leaders. Cybersecurity continues to rise up the agenda for regulators, including the SEC, and investors are getting involved in the conversation surrounding private funds’ cyber-risk management policies.
“We are seeing LPs ask us more detailed questions around our approach and business resilience in general,” says Patrik Bless, chief information security officer at Partners Group.
But Bless adds that this sentiment is to be expected in the current environment. “Cybersecurity is one of the big risks for many industries today – it’s likely that someone somewhere is being hit at any point in time – and so the increased scrutiny by regulators and LPs is absolutely justified.”
Fred Shaw, chief risk officer and global head of operations at Hamilton Lane, says: “There is increased regulatory scrutiny, although I’d say that the proposed SEC cyber-rules are more of a baseline. Companies should be doing all this already – it’s no longer best practice; it’s table stakes.”
But the importance of bolstering portfolio companies’ resilience against cyberattacks has taken on increasing weight in the past couple of years, says PwC cybersecurity partner James Rashleigh.
“Larger houses have been looking across their portfolios for a while now, but many others are now doing this,” he adds. “They are looking for common gaps and risks in their portfolio companies. There is a strong case for them to buy an instant response retainer and potentially detection services negotiated across the portfolio. That way, they are in a better place to respond to an attack.”
Private funds professionals across the board are quick to establish, however, that even the latest technology to stop cyber-criminals would be hampered if staff were not adequately trained on the risks.
Jeff Schneider, partner and chief operating partner at Victory Park Capital, says: “You can have all the technology in the world, but you have to educate your employees that this is a real risk.
“[Multi-factor authentication] is great, but if someone blindly approves a request, the whole system is circumvented. We take the view that we’d rather be super-cautious than not careful enough.”
3. Pay and culture are priorities in recruitment
When discussing the future of the fund services industry, it would be remiss to overlook the question of who exactly will be leading on decision-making in the years to come. The question of how best to attract and retain talent in the private funds industry is coming to the fore for many firms, with fund leaders saying it is becoming an arms race to get the best candidates.
Data from EY’s Global Private Equity Survey 2023 shows that a majority of large and mid-sized firms are placing greater emphasis on retaining talent for fear of losing them to competitors, while hiring the right talent takes precedence at smaller firms.
Pay hikes in adjacent industries are also causing headaches for private fund leaders.
“The last two years have been quite challenging,” says Jason Howard, chief financial officer at Headway Capital, a London-based secondaries firm. “The banks have been putting up remunerations to try to retain staff and that’s been our normal hunting ground for the next generation. This has had a knock-on effect and we’ve had to calibrate our remuneration packages.”
It’s not just pay that recruits are looking at, according to Aparna Ramaswamy, chief human capital officer at VC manager Techstar, who says culture is becoming an even more important factor when it comes to talent choosing one firm over another.
“Finding great talent that is aligned with our culture and values continues to be a challenge – I don’t see this changing,” she says.