[ D E PA R T M E N T
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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-