The transparency illusion

What LPs really want isn’t necessarily more transparency, but insights, writes Graeme Faulds. 

Transparency has become one of the biggest buzz words in the private equity industry of late, but perhaps it is actually obscuring the true picture. What is meant by transparency and who is demanding it?

The call for greater transparency has come from outside the industry itself, driven by regulators, politicians and journalists. These groups had always wanted to see behind the veil of an industry whose very name hinges on the concept of privacy. Following the financial crisis there was a demand for greater scrutiny of all aspects of the business world and this inevitably brought attention to private equity.  After all, how more secretive could an asset class be than one beginning with the word ‘private’.

However, having worked in the industry for over 15 years as an institutional investor, it has always struck me that the flow of information between industry participants has been effective. Yes, fund managers were not always rushing to volunteer information, but when requested they were obliging. 

Now, in an attempt to be more “transparent”, fund managers have taken to producing glossy annual reports, better suited to the wider public audience than the investors to whom they’re sent.

What those within the industry need is not necessarily greater transparency, but greater insight.  Transparency is about seeing through something, whereas insight is about perceiving clearly, or understanding deeply, a complex situation.

A good example of this is private equity performance. There has been much said about the need for greater transparency and this has manifested itself in the focus on better benchmarking. A number of organizations, including industry bodies, now compile industry benchmarks. Such data is aggregated and anonymized making it perfect for public dissemination and the drive for greater transparency.

Benchmarking, though, can only take you so far. As private equity diversifies in terms of fund structures, assets managed and geographies/sectors being targeted, it’s increasingly hard for investors to make ‘apples to apples’ comparisons. To do so they need transparency but also the opportunity to achieve real insight.  

To that end, they fundamentally require more accurate and consistent calculation methodologies being applied to private equity performance. After all there is significant variety in how fund managers chose to calculate and present their track record. Some provide daily cash flows, some monthly or even quarterly data and the data itself could be to the nearest hundred thousand. Something as simple as vintage year can be open to interpretation, which is particularly relevant when selecting the appropriate benchmark to compare against. 

The desire to improve transparency is a worthy objective for the industry externally, but that should not be a distraction from the need for greater insight within.

Graeme Faulds, who was an industry LP for over 15 years with fund of funds firm SL Capital Partners, is now the co-founder of TopQ Software – which helps investors identify top performing private equity funds.