Global Custodian Private Equity 2018 | Page 26

[ D E PA R T M E N T | H E D ] H edge funds have been much maligned for their incon- sistent performance over the last decade, but even the asset class’ sternest critics concede the industry has made profound improvements to its once fairly ramshack- le, pre-crisis operating model. Cognisant investor allocations were not going to be as free-flowing as they once had been, nor regulators as acquiescent, hedge funds cleaned up their act and started institutionalising their businesses, stabilising AuM in the process. Private equity barely excelled during the financial crisis either, as firms laced with excessive debt and leverage acquired assets at vastly overvalued prices, leaving them exposed as markets tumbled. However private equity performance since 2008 has been far superior to that of hedge funds, meaning the asset class has not been subjugated to anywhere near the same torrent of investor pressure to reform its operating model. Private equity takes time to adjust Following some shocking conflict of interest breaches during the crisis and a series of well-documented frauds such as Bernard Madoff, self-administration rapidly became a relic in the hedge fund industry between 2008 and 2010 as investor due diligence teams increasingly vetoed managers who adopted the practice. Despite the shock that followed Madoff and the glaring flaws it exposed in self-administration, private equity remained un- swervingly committed to the ritual of overseeing administration in-house. “Private equity took longer to transition to third party admin- istration than other asset classes. I would argue self-admin- istration is more wedded at US private equity managers than European firms,” said Sarj Panesar, global head of business development at Societe Generale Securities Services. The logic went that unlike managers who traded daily, private equity only made a few deals per year, so it was perfectly do-able to perform reporting and valuations in-house without outside intervention. “Private equity managers do not operate in the same way as hedge funds, because the lifecycle of a fund can be 10 to 12 years, so there is no need to meet constant subscriptions and redemp- tions. Equally, hedge funds have a fairly defined methodology “These new strategy sets introduce complexities and business challenges which often go beyond the aptitudes of existing middle and back office staff and Excel software.” CESAR ESTRADA, SENIOR MANAGING DIRECTOR, HEAD OF PRODUCT MANAGEMENT FOR PRIVATE EQUITY & REAL ASSETS FUND SERVICES, STATE STREET AIS when calculating profit sharing and management fees whereas private equity structures are more complex,” said David Bailey, co-founder at Augentius, a private equity and real estate admin- istrator. Private equity procrastination around externalising adminis- tration is down to other factors too. The industry traditionally had little faith in the competences of third party providers, assuming their off-the-shelf products and technology would be unable to service their bespoke portfolios. Most significantly and unlike hedge funds, the private equity industry was never really 26 Global Custodian Private Equity Issue 2018 asked by its investors to consider inde- pendent administration…until now. And so…the business evolves Investor demographic changes have played a major role in forcing private equity managers to outsource their administration. Large institutions– hav- ing dabbled in hedge funds post-crisis to diversify their portfolios – are be- coming impatient with the asset class’ flaccid returns and flabby fees, leading to reallocations into private equity. These same investors who led the charge against self-administration in hedge funds 10 years ago are now turning their sights on private equity practices. “Investor due diligence teams want assurances that ad- ministration is being done independently to that of the manager,” commented Panesar. Other forces are at play as well. Private equity’s growth is well-documented, but a side-effect of this has been an explo- sion in reporting obligations, swamping middle and back office staff with an inordinate amount of paperwork. Equally, institutional investors want managers to supply customised reports while some large clients expect to receive the ILPA standardised fee template. “Ever since the SEC laid out its findings on private equity fees, investors have been asking for great- er transparency,” highlights Bailey. Post-crisis regulatory reports such as Form PF, Annex IV and EMIR deriv- ative reporting are stretching internal resources. “Regulations such as the AIFMD, FATCA and the OECD’s Com- mon Reporting Standard (CRS) have been the primary drivers behind private equity moving away from self-administration. The amount of regulatory work which has now been loaded onto private equity businesses is too much for a single CFO to handle,” said Bailey. This is prompt- ing more managers to outsource to third parties. Private equity strategies have also evolved recently as well, and many need external support to cope. The successful managers are now expanding away from their narrow focus on buyout strategies, and branching into credit, distressed debt, infrastructure, SME (small to medium size enterprise) lending, social impact and ESG investing, and even hedge funds, a point made by Cesar Estrada, senior man- aging director, head of product manage-