Outrunning the risks

Eight years ago, Anne Anquillare was on a panel at an industry conference along with a portfolio manager from a large US pension system. The LP bluntly told Anquillare, co-founder and chief executive of fund administrator PEF Services, that the pension did not believe in third-party fund administration because they were more concerned about fund performance than the state of a GP’s back office.
Recalling this conversation during an interview with pfm, Anquillare noted just how much the tide has turned since then. “It has changed dramatically. Now, we get due diligence questionnaires (DDQs) from clients’ LPs specifically targeting back office operations,” she says.
PEF provides fund administration services to venture, buyout, mezzanine, debt, real estate, special purpose vehicles and fund of funds, with expertise in emerging manager and SBIC funds, typically between $200 million and $2 billion in assets under management. The firm’s main objective is to provide their 130 clients with operating leverage and best practices.
Anquillare notes that LP reception to fund administration has shifted so much since that conference that PEF even receives separate DDQs from LPs assessing PEF individually. LPs now want to know not only about the fund’s back office, but about the quality of the fund administrator too, whether it has its own disaster recovery, cybersecurity or business continuity policies.
Indeed, it’s undeniable that the use of outsourced fund administration is on the rise in private equity. For years, the hedge fund space has been a more prominent user of outsourcing, with nearly 100 percent adoption of the third party administrator model.  While lagging hedge funds, private equity is quickly catching on. In the US, approximately 30 percent of US private equity invested capital has been outsourced to a third-party administrator, according to a recent report from PwC. As back-office pressures continue to mount, outsourcing levels are expected to increase from 30 percent to 50 percent or more over the next five years, the report indicated.  
In 10 years, Anquillare predicts, the private equity universe will be right up with hedge funds close to 100 percent. One of the biggest reasons for such a shift is the increased task load that fund administrators are taking on, in order to mitigate the increased risks that GPs are now facing. When PEF began 13 years ago, the primary function of the industry was accounting. Over the years, technology and compliance have become paramount offerings as well, as cybersecurity and data integration have become top of mind for evolving firms and increased regulatory burdens from the US Securities and Exchange Commission (SEC) are making for growing compliance concerns. 
Without the support of an third party fund administrator, more and more GPs are finding their firms subject to more mounting risks, notes Anquillare. 
“It’s like putting up bumper lanes when you’re bowling—we’re helping to mitigate risk by not only knowing what the best practices are but being able to fit them to the needs and resources of the particular client,” she says.

Taming four risk factors

When handling the demands of a growing private equity shop, the limits of the back office team can be a common setback. The typical operations staff at a small or mid-sized firm is somewhere between three and ten people, notes Anquillare. The loss of one member would mean losing at least 10 percent of the staff, which could be especially daunting if that member is the chief financial officer (CFO) or controller.
Having a fund administrator builds up that back office staff, acting as a safety net for any possible turnover. Third-party administrators are also essential for another personnel-related risk—scalability.
When a firm launches a new fund, or brings on a new demographic of investors (moving from high-net-worth individuals and family offices to public pension plans, for example), the new reporting requirements and increased level of sophistication expected can be a large burden for a small team. Similarly, when the SEC announces new regulations or updates Form ADV reporting requirements, as it did in May, small back offices expected to deal with those issues are often at a loss.
“It’s hard for a single firm’s back office to hire three people to deal with a certain problem if they’re already only three people strong, it’s just hard to scale up quickly,” notes Anquillare. Luckily, a fund administrator can provide that extra coverage, while also offering input on how to deal with such issues from their historical experience and mass of client knowledge.
Indeed, knowledge obsolescence is another risk firms take when choosing not to outsource certain fund admin functions, notes Anquillare. When the PEF staff members attend conferences, they are required to make presentations to the entire team and provide updates on what was discussed so that both PEF staff and clients can stay abreast of the constantly evolving industry trends.
“If you’re a single shop, knowledge obsolescence can happen very quickly,” says Anquillare, who also posts insights from various events and conferences on the PEF website so that clients can easily catch up on useful information they otherwise might have missed.
Obsolescence is not only a concern when it comes to industry knowledge, however. A more rapid and intimidating form presents itself when GPs face innovations in technology. As soon as a firm installs a system, it seems like there is a newer and better version available, and being able to stay on top of all the developments can be difficult. PEF has proprietary web-based applications customized for private fund financial reporting, investor communications and data management, with a dedicated team of IT programmers providing support so that a firm’s back office can focus on their dedicated tasks rather than the ever-changing tech landscape.
The independent advantage
PEF provides defense against these four firm-wide risks (turnover, lack of scalability, knowledge obsolescence and technological obsolescence), but by virtue of being a third party, fund administrators also provide a valuable risk mitigation tool for individual CFOs—independence. 
The main point of contact for an outsourced fund administrator is typically the CFO or controller, the voice of internal controls at the firm. The person holding that position, especially at smaller firms, can often feel like they’re an island, notes Anquillare.
Fund administrators help to back up that solo voice by providing a wholly independent perspective. PEF, for example, has successfully completed its SSAE 16/SOC 1 Type 2 exams for five years. The exam (SOC 1 for short) provides independent, third-party verification that a service  provider’s policies and procedures related to new client set-up and administration, fees and expenses, money movement, IT security, data backup and business continuity meet or exceed industry standards. 
That kind of independent verification of quality in back office services is not only something LPs appreciate, notes Anquillare, but something CFOs can rely on when voicing concerns to the rest of the firm.
“We can add our stories to their voices and say, ‘This is why this is important. We have seen this before’,” she says. “Those are powerful stories to help align the internal resources with the firm management if they’re doing it the right way.”
In certain sticky situations, this is essential in order to keep the firm running smoothly. When a CFO has to clean up internal due to/from accounts or wants to question a valuation, for example, a verified voice from a third party can make all the difference. 
And when that same CFO calls with a question, having an independent team who has worked on more than 130 funds to answer is a massive comfort, notes Anquillare.
“Sometimes most reassuring thing to hear is, ‘We’ve seen this before, and this is how we handled it,’” she says.