Private equity enjoyed a surge of growth over the decade leading up to 2022, fueled by an influx of institutional capital, attracted by returns that far exceeded the public markets. Private company valuations soared. Funds and fund managers proliferated. And fundraising broke records with each succeeding year. Not even the pandemic could disrupt the market’s momentum.
More recently, however, private equity is encountering headwinds, as economic uncertainty has tempered investor enthusiasm. In Coller Capital’s 2022 year-end Private Equity Barometer, 27% of institutional investors surveyed claimed that they planned to increase private equity allocations over the next year, compared to 42% six months earlier. 1 In 2022, 481 new funds launched globally, according to S&P Global Market Intelligence—down more than two-thirds from the previous year. 2 And, alternatives research analyst Preqin forecast a 22% drop in global capital raising for the year.3
Notwithstanding this slowdown of the market’s trajectory, there’s little question the private equity business has transformed significantly from what it was a decade ago. Institutional investors became the most influential factor in the market and are likely to remain so. Or as Pitchbook put it, “PE will remain a core asset class in institutional portfolios” despite uncertainty over nearterm allocations. 4 That will continue to have operational implications for private equity fund managers.
Standing out in a crowded field
Another trend from the growth decade of private equity is likely to continue as well: more competition for both deal flow and capital raising. Indeed, competition may well intensify as capital inflows tighten. JP Morgan sees potential opportunities for investors as company valuations decline and pricing becomes more attractive, but also asserts that “focusing on manager selection will be more important than ever in the years ahead.”5
Given the macro climate, what can you do to differentiate your business in a crowded field competing for a smaller capital pool? A track record of delivering results is important, to be sure, but firms must deliver something exceptional to win investor trust and loyalty. As the consulting firm Deloitte put it, “PE firms that excel at building and deepening relationships with three key stakeholder groups—their own workforces, portfolio companies, and limited partners—will likely be best positioned to cultivate and maintain growth in the long term.” Deloitte’s analysis further underscores the importance ofkeeping investors happy. “While performance may be the primary driver of LP satisfaction, transparency, fee control, flexibility, and focus on social responsibility also contribute to LP satisfaction.” 6
Institutional investors are likely to be even more rigorous in their operational due diligence. To compete effectively, private equity managers need to be able to demonstrate strong operational integrity on top of investment performance. And that’s a challenge. Despite the inherent complexities of accounting for and reporting on private equity investments, the industry has historically not been subjected to the same level of scrutiny as traditional public equity asset managers. With the private markets attracting larger amounts of capital and gaining greater influence in the global financial system, regulators have taken notice. Private equity firms have had to adapt to a changing environment and elevate their operational standards.
Operational challenges for private equity
The growth and diversity of private equity funds—with their complex fee, payment and return calculations—presents substantial operational issues. Accurately allocating profits, losses, expenses, and tax impacts among every investor over the lifetime of a fund entails a specialized mix of expertise and technology from deal management to portfolio and investor accounting and reporting. Demand for greater transparency and standardized reporting simply compounds these challenges.
Changing investor expectations raise three major issues that PE managers and their administrators need to address:
1. Look-through to underlying investments. There was a time when private equity investors had to participate in every deal in which a fund engaged, without the option of opt-outs. These days, as noted earlier, limited partners expect greater flexibility on the part of general partners. As a result, managers now offer options for investors to opt out of specific fund investments. To make that possible, you need the capability to provide investors with detailed look-throughs to the underlying assets, enhancing transparency into portfolio composition and the different companies’ contributions to performance. This requires the ability to seamlessly integrate investment and investor accounting within the technology infrastructure.
2. Managing multiple closes. The life of a private equity fund involves multiple rounds of investments. Whenever new investors come in, the fund must rebalance all its profit and loss since inception, as well as capital calls and distributions to investors. Without the right system functionality, calculating those rebalances can be a tedious manual process with a high risk of error.
3. Reporting. Investors today demand more detailed and more frequent reporting that offers greater transparency into a fund’s strategy, holdings and returns. Many investors may also have specific requirements they want included in their reports. The Institutional Limited Partner Association (ILPA) has led the effort for private equity managers to provide more detailed reporting in standardized formats to enable comparisons across funds and firms. To generate ILPA-compliant reports, you need to be able to track all the different P&L components, management fees, partnership expenses, capital calls and drawdowns, and waterfall calculations.
Do you have the right system functionality?
How private equity firms manage, account for and report on their funds is essential to client satisfaction and regulatory compliance. It’s also increasingly important to their ability
to compete and grow. Resilience and efficiency through automation may well determine how well a firm can manage risks and drive profitability.
Fundamental technology requirements for a modern private equity shop include:
-Support for Complex Strategies and Structures
Private equity funds often employ diverse structures and sophisticated strategies. The technology infrastructure needs to be able to support varied and often unique structures while delivering consisting investor accounting and servicing.
-Comprehensive, Granular Investor Accounting
The particularities of private equity fund capital flows—with their investment commitments, capital calls and drawdowns—require an ability to track a fund’s committed capital and unfunded commitments. With unprecedented amounts of dry powder waiting to be invested, accurately tracking, accounting for and reporting on these flows is vital. Distribution waterfalls, to determine how capital gains are allocated among partners, add a layer of complexity, especially considering the trend toward closed-end funds in which distributions are highly customized. A sophisticated waterfall calculator will enable the investment manager or fund administrator to automate the calculation and allocation of the different tiers in the waterfall schedule. Tracking and calculating funds’ management fees can also be time consuming and error-prone without automation. Management fees may be based on commitments or contributed invested capital, which in turn can be calculated by either cost or market value of the investments to each investor. The only way to arrive at an accurate fee calculation is to have detailed look-through from an investor to the investments.
-Transparency
Portfolio management and investor accounting need to be tightly integrated to provide total transparency into each fund from the investment to investor level. If a fund has separate investor and portfolio accounting systems, getting them to talk to each other is a complex issue. If a change is made in one system, how will data flow downstream to the others? A single, end-to-end portfolio investment and investor accounting solution removes those integration, data communication and reconciliation headaches. By monitoring and controlling the relationship between each investor’s capital flows and ultimate investments, the resulting transparency will enable firms to track their investors across multiple investments. This allows firms to easily offer opt-in and opt-out capabilities on specific investments, with control at the investment level, rather than at the fund or portfolio level. Firms can also run exposure reporting showing investors exactly where
their money is going.
-Reporting
Reporting demands have become increasingly complex, with investors pushing for fast, detailed, and accurate reporting on all aspects of their investments, including fees charged and returns generated at every phase of their relationship. A system that can automatically track the multiple information components that go into the reports, and generate reports in line with ILPA guidelines, will ease the investment manager’s operational burdens while helping strengthen investor relationships.
-Automated Close Rebalancing
As noted earlier, rebalancing after every investment close is often a time-consuming, error-prone, manual process. A system that can automatically rebalance your book following the close of each investment round is more time- and cost-efficient. It will help reduce operational risk as well and improve client servicing by minimizing errors.
-Seamless Migration Capabilities
When migrating onto any new IT platform, private equity funds cannot simply conduct a point-in-time conversion using their positions at that particular moment, unlike other types of investment funds. Instead, they need the fund’s full history to accurately track all the capital commitments and drawdowns, allocate management fees, and generate waterfall calculations. Transferring that data is a sizable job fraught with potential error points. An experienced system provider with a proven migration program can ease those concerns. Specifically, leveraging a managed
services solution will enable you to draw upon the provider’s experience and expertise to smooth the migration, and ensure the resulting data is accurate and complete.
-Scalability
The private equity fund universe is expanding. Investment flows and transaction volumes are up, and all indicators point to those trends continuing. A solution with proven scalability will ensure you have the capacity to keep pace with and profit from the market’s growth—enabling you to expand effectively and efficiently, without increasing operating costs.
-Keeping Investors Happy
With navigating a shifting private equity environment, gaining and sustaining investor trust is essential to staying competitive. Institutional investors expect high-quality servicing throughout the lifetime of the relationship, and fund managers must jump through stringent due-diligence hoops to prove they can deliver. A controlled, auditable operating environment demonstrates that fund managers can meet their investor and regulatory compliance responsibilities, improving their chances of attracting allocations. Having the operational expertise and infrastructure to compete at this level will is a key determinant of a firm’s ability to capitalize on investors’ growing appetite for private equity.
1. Coller Capital Private Equity Barometer, December 7, 2022. https://www.collercapital.com/coller-capital-global-private-equity-barometer-winter-2022-2023
2. Zeeshan Murtaza, Dylan Thomas,“Fund launches cratered in 2022; private equity’s share of terminated deals grows,” S&P Global Market Intelligence, January 6, 2023.
https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/fund-launches-cratered-in-2022-private-equity-s-share-of-terminated-deals-grows-73723322
3. Jacobus, Arleen, “Private equity fundraising to dip 22.5% in 2022, Preqin says,” Pensions & Investments, December 14, 2022.
https://www.pionline.com/private-equity/private-equity-fundraising-dip-225-2022-preqin-says
4. Hamlin, Jessica, “Will public pensions stick to their PE targets in 2023?”, Pitchbook, December 13, 2022. https://pitchbook.com/news/articles/pensions-allocations-private-equity-2023
5. JP Morgan Asset Management Investment Outlook for 2023. https://am.jpmorgan.com/us/en/asset-management/adv/insights/market-insights/investment-outlook/
6. Henry, Patrick et al, The growing private equity market, Deloitte, November 5, 2020
https://www2.deloitte.com/us/en/insights/industry/financial-services/private-equity-industry-forecast.html
About SS&C Advent
SS&C Advent helps over 4,300 investment firms in more than 50 countries—from established global institutions to small start-up practices—to grow their businesses, minimize risk, and thrive. We have been delivering unparalleled precision and ahead-of-the-curve solutions for more than 30 years, working together with our clients to help shape the future of investment management. Find out how you can take advantage of our industry-leading solutions to support your business goals. To learn more about the right solutions and services for you, contact info@advent.com or visit www.advent.com to learn more.
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FINVENT Software Solutions is a producer and distributor of financial software applications and custom engineering services for the investment management sector. The firm serves financial institutions in European and African countries, including asset managers, family offices, investment banks, pension funds and hedge funds.
Finvent is the sole SS&C Advent distributor worldwide, and its products are natively integrated with those of SS&C Advent.
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