Beyond the gold standard
As the global economy turns back to growth, private equity and real estate investors are filling their coffers. Record distributions have left LPs flush with cash – cash that they’re looking to reinvest into alternative assets.
A recent global EY report on the industry showed strong investor demand for the asset class, with 46% of investors looking to increase allocations, 46% intending to maintain current allocations, and only 4% planning a decrease.
But with more funds than ever raising money—2,252 globally, according to recent Carlyle data—GPs must differentiate themselves to gain an edge. While financial performance will always be front and center, funds are beginning to see LPs place a premium on operational excellence too. The EY report showed that after performance, 49 per cent of investors stated “operational excellence” as the factor that most concerned them. After high-profile scandals like Madoff, transparency and clarity have become key concerns.
The quality of reporting is critical. Investors want to be closer to their investments than ever before. According to that same EY report, 66% of investors feel that the transparency of reporting could improve. Using a third party to assist with reporting not only reduces the operational burden on GPs, but also gives investors piece of mind.
But a more pressing concern for fund managers is the frequency with which investors—and regulators—are demanding reports and the detail that they’re demanding in them.
Another industry survey, which polled more than two hundred GPs and LPs across more than twenty countries, reports some GPs receiving more than 9,000 LP inquiries in a single calendar year. Additionally, it notes the disparity between what LPs want and what they’re actually getting: 90% of GPs surveyed said that they provide their investors with all the information they need, a reality that less than half of LPs agreed with.
This disconnect is down to the nature of private equity and real estate investors and the size of the allocations they commit to funds. In public equities and hedge funds, with their multitudes of investors holding very liquid positions, standardized reports are generally accepted. But of course LPs investing in private equity or real estate demand more. The typical fund will have tens, rather than hundreds, of investors who all expect the level of attention and care that their sizeable commitments dictate.
Improving the timeliness of reporting solves this challenge to some extent. But more difficult is serving the growing number of LPs that want to dig into fundamental financials at the investee level. For the large GPs with sophisticated back office functions, this poses an operational challenge, as more resources will have to be channeled to reporting processes and data collection. Investment in new systems and internal change are likely to be necessary, generating the potential for considerable costs. For mid-size firms, however, these requests can prove almost insurmountable across a diverse base of LPs, as may be the cost of installing and operating enhanced technology.
Standardization in the data collection stage of reporting certainly has a role to play here. Reliance on manual processes is no longer sufficient. Technology that can source and collate data quickly and easily is of paramount importance for funds that need to process LP requests effectively.
While standardisation is being driven by investors themselves based on their own needs and priorities, it does also marry with the direction of regulation both in the US and Europe. In Europe it fits with the aims of the AIFMD (Alternative Investment Fund Managers Directive), now in effect, which requires alternatives fund managers to become authorised with ESMA in order to market their funds to investors within the EU. Authorisation involves meeting far more onerous standards re: the volume, regulatory, and depth of reporting to regulators, in a way that echoes what investors themselves are increasingly demanding.
But standardization alone is not enough. The age of the pdf is dead. Investors increasingly require tailored reports, in a format that can be automatically downloaded to their own systems. This will become the norm as LPs start to dig deeper into company-level data across their private equity portfolios. In fact, standardization is only one step in the process to developing more customized solutions.
LPs are starting to see the value they can derive from their fund reports by asking for specific data points. As this trend continues, and as LPs develop individual preferences as to how their fund data is broken down, GPs will be faced with a huge range of different requests, all of which require time and attention. That care and attention, of course, distracts GPs from their core business of deriving value from their investments.
Without a function—either outsourced or in-house—that has the time and resources to tailor reporting to individual investors, GPs will lose a key element of differentiation against their competition.
Private equity and real estate will always be a bottom line business, and LPs will always clamor to get into the highest-performing funds. But GPs that can supplement performance with sound operational processes and a tailored reporting function that adds value to LPs’ investment process, will position themselves well in the competition for capital.
Ian Kelly is CEO of Augentius