The private funds industry may be on the cusp of an outsourcing explosion. Once slow to embrace third-party service provision, the prevalence of outsourced fund administration and investor reporting has soared over the past few years, as complex regulation has proliferated and increasingly sophisticated LPs demand a more streamlined approach.
As an initial reluctance to cede control of operational functions wanes, a desire to get back to the core competencies of raising and investing funds has blossomed. James Yates, CFO at IK Investment Partners, says: “There is a trend to outsource, and not just in fund administration, but also in IT services, regulatory compliance, tax compliance and HR-related matters.”
Nikolaos Perros, head of private equity services at Citco, meanwhile, is seeing greater demand for value-add services, such as accounts payable management, performance fee calculations, investor portals and data integration services.
He believes that in the next wave of outsourcing private equity will adopt services that are already being used successfully in other areas of financial services. “For example, online subscription tools have proved very successful in the UCITS and hedge funds industries and are now being implemented by the top private equity managers,” he says.
The scale and speed of technological innovation lies at the heart of outsourcing adoption. For all but the very biggest private funds houses, the cost of buying or building in-house tech solutions can be prohibitive.
“We all acknowledge that technology is the way forward, but the ability to buy requires liquidity and the ability to build requires speed, skills and financial capacity,” says James Ferguson, head of Americas at Intertrust. “We even see large banking institutions seeking to outsource rather than build given the time and scale it requires.”
Investor demands are also imperative to the outsourcing process as LPs eye efficiencies. “LPs play a significant role,” says James Duffield, head of business development at Aztec Group. “Investors increasingly want to work with GPs that are able to focus all of their time on investment decisions and leave the back-office operations to a team of experts.
“This approach minimises direct operational costs and the administrator can provide considerable economies of scale across functions, such as accounting, reporting, compliance and AML [anti-money laundering].”
“Business continuity plans are being played out, showing that the ‘office’ may become a thing of the past”
Yates notes that the most sophisticated LPs are looking to make sure outsourced services are clearly segregated between fund and GP in order that costs are borne appropriately. “There can also be a tendency for LPs to want outsourcing where the GP is smaller and may not have the in-house resource or capability to provide a best-in-class service itself,” he says.
LPs are also increasingly interested in the efficiencies that automation can bring and have often been a key driver behind private funds firms’ tentative steps towards digitisation. “There is inquisitiveness around the large number of technology firms coming to market, some offering a specific product plug, or those with a wider global operating impact,” says Ferguson. “LPs are having the discussions around efficiency; should a firm spend on highly paid accountants in New York to do portfolio NAV accounting for example, or explore letting a machine complete the task at a third of the cost? It is definitely something to consider.”
Indeed, according to Citco’s Perros, LPs now expect outsourced administration as the standard. “When that standard is not applied and administration work is done in-house, GPs can expect a significant increase in LP due diligence,” he says.
The impact of the covid-19 pandemic will only accelerate the demand for outsourcing. The outbreak and subsequent international lockdowns shone a spotlight on individual firms’ – and administrators’ – business continuity plans and automation capabilities.
“The top GPs have understood the value of their data and are working to use it to differentiate themselves. They are also starting to expect operational functions to remove the old manual ways of working and move to the new digital world,” says Perros.
“The current global pandemic has forced these issues forward at an even greater pace, as everyone is having to rely on the new world order of 100 percent online solutions,” he adds, citing Citco’s emphasis on providing curated data to GPs’ systems, which can empower managers to make timely, data-driven decisions in challenging times, as well as putting digital tools into the hands of GPs to help them improve their own operations.
“For example, through the use of an online board pack production and presentation tool, and a digital signing tool, we have been able to fully digitise the processes of preparing a board meeting, hosting it and approving the documentation,” he says.
Meanwhile, asked what services are likely to be outsourced in future, Ferguson replies: “The short answer? Everything. We believe the industry is about to go through a shake-up, maybe not in a year, but in the next one to three years. Business continuity plans are being played out, showing that the ‘office’ may become a thing of the past. This means home technologies, scanning, printing, signing, links to government and regulatory agencies, auditing, legal work, invoicing and billing, for example, will all need to be accelerated on the technology front by service providers.”
It remains to be seen how significant and long-term these changes to the way we work and live will be. But it does seem likely that the international travel and face-to-face meetings that have always been integral to private equity fundraising and deal-making will be drastically cut back for the foreseeable future – and indeed, with a parallel escalation of interest in preserving the planet, perhaps for good.
For outsourced service providers, this is likely to mean opportunity, with managers eventually adopting fully cloud-based, outsourced operating models where all collaboration between administrators, GPs and LPs takes place online.
Will the lockdowns have lasting impacts on the way private equity firms operate and their willingness to outsource? “That’s the million-pound question,” says Duffield. “Challenges can be reframed as opportunities, and every LP, GP and administrator will be keeping a close eye on how working practices evolve after lockdown so that they can quickly make the most of opportunities that present themselves.
“It seems likely that an element of home working and remote meetings will continue, with possibly less regional or international travel required. If that happens, there will be a knock-on effect for communications and security. Challenges for sure, but also opportunities to be uncovered.”
For Perros, the answer to the question of whether the challenges endured during lockdown, and the alternative ways of working that have emerged, will accelerate outsourcing trends, is emphatically “yes”. “The ability to collaborate online has been pushed to the top of most people’s agenda in these difficult times. Across the board, GPs are looking to do things digitally,” he says.
“Hosting investor presentations via video, a critical need to sign everything digitally, a huge growth in the use of online communication platforms, a reliance on cloud-based document-sharing tools – these changes were happening slowly in the industry but, if there is a silver lining to the current situation, it is that we have been forced to move forward to a new digital age.”
Leaders and laggards
The industry is still only at around a 40 percent saturation point when it comes to third-party administration services, according to an independent study commissioned by Citco. And that’s despite an increase in the outsourcing of service provisions. So which firms are already outsourcing and which have yet to take the plunge?
It can be challenging for established managers to move to an outsourced model. This often happens gradually as their fundraising and investment cycles permit, according to James Duffield at Aztec Group, which typically takes on one or two established managers deciding to outsource for the first time every year. New managers, meanwhile, almost always choose to go down the outsourcing route.
James Yates of IK Investment Partners sees a clear divide based on assets under management and team size. “It is likely there will be more outsourcing of risk management and compliance roles to third-party specialists, particularly for smaller houses struggling with the volume and complexity of reporting requirements,” he says. “This may also be the case for tax compliance.”
Larger houses are more able to bear the costs of putting in place the infrastructure and resources to provide the relevant services that some smaller houses will need to outsource, Yates adds. “There is also a feeling that US houses are happier to outsource some fundamental services and maintain a streamlined central corporate structure.”
For Citco’s Nikolaos Perros, however, the real power of data and digital tools is that they are usable from any location or by any size of manager. “It’s a given that the largest and most technologically sophisticated managers will build or buy their own platforms, but the rest of the market would still benefit from these solutions and so will search for an outsourced provider who can deliver them ready-made,” he says.
“We have already experienced different regions accelerating guidelines or implementing different regulatory changes, causing firms to consider their options,” adds Duffield. “So, firms, either local or global, will need to determine their revised operating models. It will be more a case of those who do not react finding that they have lost a window of opportunity.”