The outsourcing debate is changing

Fund administrators are having an easier time convincing CFOs of the value of outsourcing. 

Private funds CFOs and COOs have heard all the arguments both for and against outsourcing. Many settled on a decision of what works best for their firm long ago.

But when we ask CFOs and third-party administrators about the rationale for moving certain functions out of house (which we do regularly), we tend to find both parties weighing in with certain biases, making it difficult to objectively determine when outsourcing makes sense for a firm.

What we mean by that is CFOs and COOs are stewards of the back- and mid-office. And when it’s your name that’s responsible for any operational slip-ups, you tend to want as much control over the process as possible. Relinquishing some of that oversight to a third-party administrator can feel like a leap of faith.

On the other hand, outside administrators have a compelling case to make that their expertise and familiarity with capital call notices, distributions, investor reporting services etc. can provide significant value to GPs. This after all is the core focus of their business. But explaining this value-add to prospective clients can seem little more than just a smooth sales pitch. At least it has often seemed so in the past. Now change appears to be afoot.

A few weeks ago pfm sat down with an even mix of fund administrators and CFOs to discuss the latest benefits and costs of outsourcing – see our July issue cover story for the full report – only to discover that the CFOs we invited to our gathering were mostly on board with administrators’ arguments; namely that outsourcing is currently the most attractive option to reduce their workload and cost of internal infrastructure. From what we gathered, there’s a couple of important reasons as to why.

Firstly, the CFO’s work is getting “more chunky”. A one-off capital call notice or quarterly statement has always produced a spike in work, but the CFO's irregular work flow is becoming even more stressful as GPs pursue increasingly complex deal structures and diversify their LP bases. Tax is a prime example of where the problem can manifest. In recent years, deal partners have become comfortable with the idea of investing in portfolio companies organized as flow-through entities (such as limited liability companies) for tax purposes – but often not considered is how the tax efficiencies achieved are resulting in more work for the shop's finance unit.

“CFOs are only just coming to realize the additional administrative workload these structures create as fund tax returns become dependent on K-1s generated by portfolio companies – and the mountain of state tax return notices these flow-through investments are resulting in at the fund level,” one CFO noted at our roundtable before praising outside administrative support as a way to smooth the work out. 

Secondly, the size of the CFO’s staff has not kept pace with this increasing workload, including regulatory reporting and LP meetings. Accordingly CFOs are searching for efficiencies in fund accounting and tax to free their time for more “strategic” functions like valuation and direct interaction with investors. Administrators, who tend to invest more resources in the latest accounting and tax software, are often better suited to automate these functions where possible.

Need it be said, our roundtable was only a sample of CFOs and administrators. But industry-wide data supports their experiences. Total private equity assets under third-party administration – including infrastructure, private debt, real estate and fund of funds – grew 23.7 percent year-over-year, reaching $1.58 trillion by end of 2014 (outpacing the 15.5 percent growth rate of hedge fund assets under administration) a study from eVestment recently found.

But relinquishing control is still a scary prospect for many. As much as 70 percent of private equity and real estate fund assets may still be administered in-house, eVestment found, meaning this debate is far from settled.

(To hear more, including a discussion on how administrators treat certain LPA terms open to interpretation, see our July issue, available to subscribers soon.)