David Benizri, CEO and Co-Founder of Rivver talks about the operational challenges in Private Equity.
In my last article, I discussed how the dynamics of alternative assets are changing and why fund managers must upgrade to a more efficient and scalable operational process. Today, I will explain exactly what the operational challenges in Private Equity are today.
Market participants in Private Equity today mainly exchange information through customized spreadsheets via email, and some still communicate via phone calls, traditional mail and, even fax. A large part of a fund administrator’s day-to-day tasks include reporting, namely consolidated reporting and regulatory data reports. Since all information is stored in paper-form, custom excel sheets or on the receptionist’s sticky notes — the data gathering process is highly cumbersome. This inefficient process requires fund administrators to allocate an excessive amount of senior management time to manually gathering all information. As James C. Row of Entoro Capital, LLC wrote, senior executive time spent on oversight and handling administrative tasks can add up to $440,000 over a five-year period. In addition to that, manual processes also lead to high operational risk. Reconciling conflicts in data and resolving the whole “he said, she said” situation can costs both fund managers and fund sponsors tens of thousands of dollars per year.
Subscription documents can range from 50 to 100 pages long. Private Equity’s lack of standardized processes, data formats and communication leads to the development of a significant amount of proprietary feeds. This results in an enormous amount of work from fund administrators, increases operational risk and highly hinders scale.
Below is what is a typical subscription process in Private Equity looks like.
Private Equity is evolving from being a niche product for institutional investors, to a more mainstream investment class. Private Equity is becoming more retail-like which leads to transparency and reporting requirements highly increasing. As reporting requirement continues to increase, fund administrators will have to allocate even more time and resources towards gathering data; which will ultimately cut margins and hinder scale even further. According to EY’s 2018 Global Private Equity Survey, 73% of fund managers have experienced pressures to reduce their management fees and 31% already experienced margin erosion. Below are a few examples of regulations within the Alternative Asset space:
Hedge funds above certain AUM thresholds are required to register with the U.S. Securities and Exchange Commission (SEC), particularly if they have any separately managed accounts or maintain only investment funds as clients. There are also requirements, in some cases, for hedge funds with lower AUMs to register with a home state.
Form PF (private fund) is a SEC rule that requires private fund advisers to report regulatory AUM to the Financial Stability Oversight Council (FSOC), which monitors risks within the financial sector.
In November 2010, the European Union adopted its version of hedge fund oversight (EU Directive).
This requires nontraded real estate investment trusts (REITs) and direct participation programs to be fairly valued on a monthly basis.
This significantly increases investment advice standards for retirement accounts and imposes requirements for disclosure of all commissions, fees, and expenses.
Since all information is stored manually and in an unstandardized fashion, there is a high risk that fund administrators disclose the wrong information or send tax forms to the wrong investors. In addition to that, since most information is shared via email, it is becoming increasingly easy for hackers to access such information. According to EY, 22% of Private Equity firms have already experienced a cybersecurity breach or incident. While these concerns may have been manageable when P-E funds only had 5–6 sponsors, these security and privacy concerns will continue to become more renowned as Private Equity continues to become more and more mainstream.
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