Institutional investors face a conundrum. Many are increasing allocations to private equity to raise the prospects of long-term net returns, and in some cases close the gap in projected funding shortfalls due to factors such as increased longevity and inflation. However, scaling up a private equity program raises the stakes in terms of disciplined and efficient investment management. Otherwise investors risk swapping the potential of higher returns for unexpected losses, or public embarrassment from failing to track fees, expenses, or portfolio-company charges at an adequate level of detail.
While an inconsistent level of disclosure from fund managers is certainly a challenge, a fragmented view of information is also to blame. The latter stems from the sheer number of service providers employed by limited partners (LPs) including fund administrators, custodians and advisors, as well as software and data providers. Each player owns part of the picture of an LP’s investment portfolio, held in various formats that cannot easily be brought together. In FIS’ recent industry survey, 81 percent of LPs said that dealing with a multiplicity of service providers is limiting their ability to manage data and reporting, to some degree.
The solution is not as simple as cutting back on the number of service providers. In addition to fulfilling various critical functions, these service providers ensure an appropriate separation of duties. In many cases, an advisor is involved in investment decisions to ensure independence, cash is held separately with a custodian and the accounting book of record is maintained by a fund administrator or managed internally. Furthermore, LPs’ internal systems hold additional information, contributing to a fragmented picture of the portfolio spread across multiple systems maintained by multiple parties.
As LPs grow their private equity portfolio, the need for a deeper, more integrated view of investment data becomes critical in order to improve portfolio management, report regularly at a sufficient level of detail, and respond to ad hoc requests from internal and external stakeholders.While transparency into fees is one area of scrutiny, another very important challenge concerns the timeliness of valuations and the impact this has on managing risks and exposures. Since funds report to investors three months after the end of the year based on valuations of portfolio companies performed one to two months before year-end, the information contained within fund financial reports is based on underlying data that is nearly five months stale. A fund investment has additional lag built into its reporting process which further compounds the issue.
However, there are ways to mitigate the problem. For example, the LP can adjust the last report received from the manager for capital called or distributed by the fund since the report date, current pricing for any publicly held companies and the latest foreign exchange rates (for companies held in foreign currencies).
Producing more accurate interim valuations and increasing fee transparency are two key areas of focus. However, technology can help LPs run efficient investment management programs in other ways such as performance reporting, forecasting and cash management. Many LPs are therefore hoping technology will help them address a range of challenges. Some 57 percent of LPs in our survey said they believe technology will help them scale up while allowing staffing levels to remain constant. An overwhelming 96 percent of LPs said they think technology can provide efficiencies so they can best use the skills and competencies of their staff.
Here, LPs are on the right track, but the strategy they adopt is critical. Launching separate initiatives to improve areas such as performance reporting, benchmarking and underlying company analysis may not make sense when these initiatives rely on overlapping sets of data. A centralized, clean source of data would not only help meet these objectives, but could also power a series of leaps in efficiency across LP activities.
Clean, centralized data is a strategic asset and one that will allow LPs to grow while keeping costs low. Not only will it provide transparency and enable an efficient investment management program, it will also position LPs to best leverage their human resources.
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