PE fund administration: Slowdown leads to more outsourcing as GPs trim fat

Key Takeaways

• Tough fundraising, budget squeezes force GPs to embrace technology
• LPs want more data to drill down into portfolio company-level cash flows
• Administrators pursue differentiation in treasury, reporting, HNWI fundraising

Exit markets have seized up globally, prompting private equity firms to explore creative, non-traditional paths to providing distributions to LPs. This is a disruption to any investor’s game plan. More prosaically, it’s a practical, operational challenge someone has to pay for and implement.

Continuation funds and GP-led secondaries are bespoke procedures requiring reviews of LP agreements and commercial mechanics that are difficult to automate. Reporting and accounting processes are therefore more complicated and more difficult to manage in-house, but not out of the existing skillset and comfort zone of fund administrators.

In other areas, such as distributions in-kind, the paperwork of the slowdown has presented a tougher challenge. In these situations, shares in un-exited assets are delivered to LPs in lieu of cash. Theoretically, after GPs and LPs have negotiated the terms of the transfer, managers need only issue instructions and obtain account numbers from LPs, but it’s not that simple.

LPs may not have a suitable platform to take on the assets in question and if one LP is less keen on the transaction than another, it might be slow to provide the account details. If the distribution is delayed, the administrator responsible for the allocation path must answer whether it is holding the asset on behalf of the fund or the LP.

“It’s not like GPs can come to us with a distribution in-kind and just give us an instruction, then we book it in and send it out,” said Andrew Read, a partner and head of Asia at fund administrator Langham Hall, who is tracking an uptick in this type of transaction.

“There are a lot more steps and stages to actually take the conceptual and commercial plan and make it into something that is actually going to result in those shares really changing hands and ending up in the security brokerage accounts of the LPs.”

The observation helps illustrate a paradox in the current private equity environment: Fewer distributions, fewer capital calls, and less fundraising activity have increased the workload for fund administrators.

Back office complexity

Eight fund administrators contacted by AVCJ for this story said that, in the past two years, their business has expanded in terms of assets under advisement if not the number of clients, as complexity in their core deliverables has increased and adjacent business lines have emerged.

Longstanding, secular trends such as stricter environmental, social, and governance (ESG) reporting requirements and rising cybersecurity threats in the handling of data remain underlying contributors to the phenomenon.

However, there is a sense that the cyclical retraction in fundraising and deal activity is meaningfully accelerating the transformation of fund administration into a broader asset services industry that is internally more competitive.

The biggest changes have been around the edges of core services. As managers pause for breath amidst the slowdown, they have used the time to focus on streamlining back-office functions. This has coincided with greater LP demand for transparency and timeliness in sharing performance and valuation metrics.

GPs have responded to some extent by converting from in-house to outsourced administration. More significantly, it has been a story of deepening ties with existing service providers. The shift is being driven by managers’ shrinking income.

“When you’re raising a new fund every two to three years, the operational budget is not an issue – you just hire more people,” said Henry Lin, founder and CEO of Linnovate Partners.

“Now the pace of fundraising has slowed, and management fees and other income has slowed, but managers’ costs to do reporting, audits, and valuations have increased. Managers have to do these things more frequently, accurately, and efficiently because they need a rationale for why the returns are not there yet.”

Neil Synnott, chief commercial officer for Asia Pacific at IQ-EQ, observes that budget pressures on managers have led to his firm increasingly seconding employees to private equity firms on temporary contracts. The key ploy here for GPs is to transfer a rising burden in recruiting costs to an existing fund administration account.

“Instead of paying for your staff out of your management fee, you can charge it back to the funds, which are getting bigger,” Synnott said. “Therefore, fund administration fees are actually less problematic on a USD 500m-USD 800m fund than they are on a USD 200m fund.”

In response to an ever more complicated compliance environment, IQ-EQ is also developing a new business line in financial reporting not just for funds but for fund management companies themselves. A pending corporate services bill in Singapore is expected to drive more of this secretarial work from small operators to consolidated service providers.

Industrywide, emerging service areas for fund administrators include investor portals, LP communications, tax accounting, internal audits, and know your customer (KYC) checks, as well as anti-money laundering (AML) and counter-terrorism financing (CTF) monitoring. There is also rising interest in services around setting up first-time funds in parallel asset classes such as private credit.

Some GPs want more still. The biggest gap in ancillary services provided by fund administrators is impact measurement and management, according to US-based Impact Capital Managers, a network of more than 120 GPs. This is followed by compliance, portfolio management, data and performance management, and lines of credit.

Data dynamics

The overarching theme is a greater demand for data and more drill-down into cashflow details. At the fund level, inputs as mundane as invoices are increasingly seen as relevant to the overall return. In individual portfolio companies, exit outlooks hinge on key performance indicator analyses around financial metrics more nuanced than profit and loss.

LP demand for deal-level data is also motivated by a desire to understand markets better – thereby reducing risk – and transition into more direct investment-oriented strategies. It reflects the downturn in the sense that LPs are under increased pressure to reduce management fees.

Eric Chng, head of alternative solutions for Asia Pacific and the Middle East at State Street, said that more GPs and LPs were relying on his firm as a data researcher. This includes a significant increase in requests for public market equivalent (PME) benchmarking services.

“Increasingly LPs are looking for more information pertaining to the portfolio. How are deals being liquidated? Are GPs really maximizing the returns for the fund? Is it because they are desperate to sell something to pay distributions?” said Chng.

“These concerns are driving LPs to scrutinize fund managers a lot more. We sit in the middle of that supply and demand of data, so we’re helping shape the collection methodology to be more frictionless.”

View full image

CSC Global has predicted that a lift in the setting up of special purpose vehicles (SPVs) will further drive outsourcing to administrators. In Asia, it expects this to be most felt in Singapore, Japan, and China.

In a recent report on the trend, CSC found that about 93% of private market managers currently use one to three outsourcing partners to set up and administer SPVs. In five years, it projects that 94% will employ three to five vendors to manage their growing SPV reporting and compliance workloads.

Momentum here is symptomatic of a difficult fundraising environment in that GPs are increasingly obliged to court LPs in jurisdictions with unfamiliar tax and regulatory regimes. Often this means fielding more detailed due diligence questionnaires, higher frequency reporting, and complying with requests for specific reporting templates that would not have been entertained in a stronger market.

Capabilities upgrade

For fund administrators, this is more work, if not harder work, and not seen as a major driver of business globally. However, the trend of GPs diversifying their LP bases is more pertinent in Asia, where the pullback in global allocations is arguably biting hardest.

“Implementing robust AML-CFT processes and adapting KYC procedures to regional standards is critical. Fund administrators must have keen knowledge of local laws and cultural sensitivities, along with strong data protection policies, like GDPR and PDPA [EU and Singapore data regulation] compliance,” said Agnes Chen, CSC’s Asia Pacific managing director for fund solutions.

“Overall, the evolving complexity of fundraising from diverse geographies has necessitated a more sophisticated range of support from fund administrators, including advanced regulatory and legal expertise, due diligence, multi-currency cash management support, data protection policies, and technological know-how.”

Fund administrators are investing in technology to support their expanding remits. Apex Group, which has made more than 40 acquisitions in the past seven years, exemplifies the urgency to upgrade.

First on the agenda is the idea that dragging cashflows out of the general ledger to manually figure out the status of investments is a painfully ad hoc and unreliable process. Fund performance now needs to be updated faster than the flow of information from portfolio companies or the deliberations of valuation committees. And this still requires a significant manual labor input.

“People think of this automation technology as being off the shelf, but it’s customized a thousand different ways,” Alexander Traub, chief commercial officer at Alter Domus.

“So when you pull that data in different formats and different systems, you can put that in a repository or lake, but ultimately, to give that back to the manager in a format they can use, there’s still a lot of human intervention to make sure the right data points line up.”

The advent of automation tools for fund data management raises the question of whether GPs will be more inclined to keep operations in-house or wash their hands of increasingly arcane systems that are not core to their business model.

“The worst-case scenario – and I don’t think this is too farfetched – one of your competitors gets good results from an AI plug-in based on your data,” said one fund administrator. “You think of it as being kept confidential, but nobody knows because nobody can monitor the training on such vast datasets. They essentially train themselves, so who would know? That’s a concern.”

The clamor around getting the right technology and the right people to implement it betrays an intensifying competition amongst fund administrators. As larger GPs benefit from the flight to quality that comes with a period of macro uncertainty, so have larger fund administrators that can leverage their scale to quickly diversify their offerings.

How to be different

The trend has fuelled an imperative to emphasize differentiation. State Street, for example, claims to leverage its capacities in traditional treasury and banking functions to provide newly needed services around capital pacing. As deployment has slowed, more LP money is sitting idle when it could be put to better use.

“Normally the cash will sit in an operational account, and the LP is happy for us to manage it there, but with high interest rates, that whole paradigm has become more complex,” State Street’s Chng said.

“Why waste cash sitting in a custody bank account if you can get a 5% return on it? So, we’re increasingly asked to do cash sweeps, forex, and related services to bridge that capital gap, which we can do as a fund administrator because we’re also a bank.”

IQ-EQ, which has most recently added services in data, ESG, and investor reporting, observes that LPs increasingly expect managers to work with global fund administrators that can operate on a 24-hour basis. The firm positions itself as differentiated by an unusually scaled-out regulatory compliance offering with more than 100 professionals focused on the function in house.

“Regulators and investors now expect to do deeper dives into the quality of service providers, their ability to meet the regulatory requirements, and whether they’re running an efficient and operationally resilient business,” said Philippa Allen, head of Asia regulatory compliance at IQ-EQ. “Fund administration companies are effectively being asked to strengthen their operations broadly.”

Apex claims differentiation in its infrastructure for running high-volume transfer agency services in public markets, mutual funds, and other open-ended structures. For Liam Woods, the firm’s head of business development for Asia Pacific, this toolbox represents a competitive edge in the most exciting new service area for fund administrators – democratized fundraising.

Large global GPs are leaning into this theme heavily, targeting private wealth clients. And while money mostly flows through aggregators, fund administrators might be asked to onboard thousands of individual LPs.

Apex has made several investments in this space, including Unitas, an in-house aggregation service, and Bite Investments, a software platform that helps high-net-worth individuals (HNWIs) access alternative investments.

“It might not sound like a fund administration activity, but to do this you’re probably going to be launching hybrid type funds which a lot of people haven’t done before. It’s a bit of a system upgrade, but it’s also a market engagement strategy,” Woods said.

“It might mean you acquire businesses, technologies, or groups that are able to facilitate that process, but that’s all part of fund administration today. Fund administration is a catch-all term for general asset servicing.”

Apex took the concept to the extreme earlier this year by acting as a transfer agent and fund administrator to a USD 3.8bn tokenized private markets fund managed by Hamilton Lane. The fund is being launched in partnership with Sygnum Bank, a digital assets specialist.

A digital experience

Vistra has also invested heavily in technology to support digital investor onboarding and subscription processes. It claims to offer a suite of apps for streamlined investment monitoring by private wealth clients.

Abdel Hmitti, global head of funds at the firm, said administrators have to accommodate more frequent valuations and thus require solid procedures, a scalable and robust operating platform, and the expertise to support higher volumes and investor requirements – all alongside the increasing regulatory burden.

“Investor onboarding, and anti-money laundering and know your customer in particular, are critical aspects that fund administrators have to do well to tap into this trend,” Hmitti said. “Fund administrators need to offer a digital experience for investors as well as develop automated solutions to support the required reporting and do all of this at a reasonable cost.”

Alter Domus likewise has built out systems and processes to onboard large numbers of investors in the past two years. This activity has focused significantly on developing products to be ready for the next iteration of ELTIF, a regime that gives European retail investors access to alternatives funds.

Luxembourg is the second largest fund domicile after the US by some margin but is still used by enough GPs either as a main fund or a parallel or feeder to suggest ELTIF could add real momentum to wealth segment fundraising as an area of fund administrator diversification. The extent to which this idea will come to Asia in the near future is less clear.

“There is potential for this to be a bigger story here in Asia, when you think about it being the fastest growing wealth market where a lot of the largest global GPs are appointing dedicated distribution teams,” Traub of Alter Domus said.

“But raising money from that segment may be more challenging in this region because wealth clients typically don’t use advisory within private banks. You have to convince them about the product.”