Northern Trust anwsers ‘must-ask’ questions

The challenging global financial markets are highlighting the importance of remaining focused on portfolio performance. While the private equity industry is demonstrating resilience in these turbulent times, more general partners are seeing the benefits of being able to concentrate their efforts on nurturing their investments, while the complex operational aspects are outsourced to an administration specialist.

In Europe, where third-party private equity fund administration has become firmly established, private equity houses are becoming increasingly discerning about their appointments and the administrator’s ability to meet their immediate and long-term expansion requirements.

Meanwhile, in the United States the momentum for third-party private equity fund administration is beginning to gather pace. Recently commissioned Northern Trust research indicates about 20% of the approximate 2,096 U.S. based private equity firms are utilising external fund administrators. While this represents an opportunity for the outsourcing industry in the U.S, the figures indicate a significant market share increase compared to the generally accepted levels of a few years ago.

Historically, the tendency to conduct administration in-house in the U.S. has been linked back to general partners’ sensitivity about sharing fund financial details with outside partners. In fact large private equity firms with over US$3 billion in commitments have tended to insource their administration functions, citing control reasons. As expected these concerns have been dissipating over time.

More State-side private equity fund managers are now realising the benefits an outsourced relationship can bring and have a better appreciation of the professionalism of outsourced providers. This is evidenced on the service side by an increase in the acquisition of independent fund administrators by banks looking to broaden their servicing offerings to private equity and alternative fund industry participants.

It is likely that the distress in the financial markets, the increasing myriad of global regulations and the trend for greater complexity will encourage more U.S and European firms to consider the outsourcing route. While market penetration varies between these locations, appointing the most appropriate provider brings universal benefits.

Outsourcing has the immediate benefit of increased staffing resources to provide for future investment plans. General partners (GPs) are able to concentrate on doing what they do best while administration aspects such as capital calls, distribution notices, investor reporting, financial accounting, investor queries, board meetings and domicile issues are handled by a specialist provider on its behalf.

Further, appointing a known administrator with demonstrable experience in delivering robust, operational infrastructure across multiple jurisdictions also provides a comfort to investors, especially those considering investing in start-up funds.

In this article, we would like to explore some key questions private equity houses should consider before making an appointment.

Do you have the ability to deliver services for global investment portfolios?

As the search for rewarding opportunities continues, private equity houses are pushing into new geographic regions to seek out new opportunities for their investors. The need to undertake thorough due diligence and work with external agents in locations which the private equity house may not be familiar with requires considerable staff resources. Partnering with an outsourced firm which has experience and established links in many regions can greatly reduce the establishment timeframes and ongoing regulatory oversight for new entities and vehicles to support investments in new jurisdictions.

In response to the need for greater geographical coverage, many administrators are expanding their own operations. This enables administration partners to offer ‘on the ground’ presence to support fund launches and meet ongoing service needs in different countries. A partnership with a strategically located fund administrator can ensure general partners take advantage of all taxation benefits, to maximise investment returns and offer ‘on the doorstep’ links to their administration and client relationship manager teams.

Offering regionally tailored solutions is not just a case of transplanting existing processes, but requires a careful planning exercise.

At Northern Trust we continue to expand our global presence and knowledge in response to the drive by a number of our clients to pursue investment opportunities in new markets. Over the past 18 months we have established dedicated private equity servicing hubs in Chicago, Limerick and Jersey which build on our long established Guernsey and Dublin operations. From these locations, we are able to support client business in many other jurisdictions.

What type of structures are you currently administering, and do you have experience in other alternative asset classes?

Private equity today encompasses a universe of structures and approaches. The rise of the hybrid fund utilising a private equity structure incorporating a number of sub-funds with varying investment styles presents a number of challenges. It is not uncommon for some of the larger investment groups to be offering private equity structures incorporating multiple sub-funds spanning hedge, infrastructure, agriculture and real estate strategies.

For such fund types it is important to have an administrator who is able to demonstrate capabilities across a wide-range of alternative asset classes to ensure a robust administration model is developed. Further, if aspects of the structure are carved out to different providers this could cause potential issues with overall oversight and the co-ordination of services.

Fund administrators need to demonstrate the ability and flexibility to adapt their model over time to ensure it is able to respond to the industry’s changing requirements.

Can you demonstrate your commitment to your clients?

The long life cycle and bespoke nature of private equity funds requires a partnership with a firm which is committed to going the extra mile to work together. But how can you assess this aspect prior to the appointment beyond the technical client service level agreement document?

One measure is the length of existing client relationships, client retention, and the ongoing referral of new business.

The organisation of the servicing team is also important. This should be a focused group which understands the business objectives of the client and is able to respond quickly. A culture of ‘working with’ rather than ‘for’ a client should be present at all levels of the team.

The involvement and availability of senior staff at the highest level should also be an ongoing commitment.

What is your policy to staff retention and development?

The global fund administration industry competes strongly for talented staff. Despite the huge value of the global private equity industry, it is still a highly specialist administration field! There is no ready pool of fully trained professional to draw from.

As the key driver for outsourcing remains the ability to provide an experienced staff resource, staff planning is a key consideration. The ability to attract – and most importantly retain – key staff is important to the continuity and expansion of the relationship.

Fund administrators should be able to demonstrate a strong emphasis on the training and development of their work force offering clients the resources they require to meet ambitious targets in this rapidly expanding industry.

For example at Northern Trust, we have developed comprehensive training programmes setting out clearly defined levels of competence to better develop our staff at all levels. In addition we provide financial support for all staff undertaking relevant formal qualifications.

What technology advantage do you offer?

Technology solutions are a driving factor in outsourcing, with many private equity houses ruling out administrators who do not offer a specialist capability at the first hurdle. The technology required to meet complex private equity reporting is by no means ‘a plug and play’ proposition. Its implementation requires detailed planning and ongoing staff resources to deliver to its full potential.

Today’s technology is a far cry from the use of disparate spreadsheets and off the shelf database systems of old, offering the ability to deploy a fully integrated and comprehensive system solution covering everything from bespoke client modelling, granular and consolidated reporting tools, to integrated calculation solutions: all provided on a dedicated system.

Technologies’ capability to provide efficient, timely and cost effective fund administration in a highly controlled environment is a good selling point for attracting limited partner investors.

How do you manage the transition process?

For private equity houses considering outsourcing existing in-house funds, the transition process needs to be carefully handled, and similarly for those GPs who are considering changing administrators as they reassess if their existing provider is able to continue to offer the effective operational platforms they require.

Administrators should be able to demonstrate the attention of a focused team supported by system expertise. A detailed planning and systems testing period needs to be agreed and co-ordinated closely between the client and administrator.

What type of administrator?

The private equity administrator ‘catalogue’ is fairly extensive and includes stand-alone boutiques, general fund administration companies and larger asset servicing groups. If teams are properly structured there is no reason why the larger asset servicing groups cannot replicate the boutique feel of the smaller operation but with advantages of the support of a global infrastructure, and an integrated approach to banking, foreign exchange and secured credit services. Indeed some of the larger asset servicing groups, such as Northern Trust, can also leverage off their experience in delivering detailed reporting and administration services to limited partners’ varied private equity custody portfolios. Internally, this helps to provide a 360 degree perspective to the private equity services industry.

Looking to the future

As private equity houses focus on generating premium returns for their investors they will increasingly question the need for the substantial in-house investment in human resources, systems and experience, required for the efficient administration of private equity funds.

This will encourage further growth in the fund administration industries in both the U.S. and Europe. However, the barriers for entry and market share will be raised higher.

There will be a greater emphasis on servicing from multiple locations as well as the ability to utilise the resources of global teams to meet ambitious business expansion targets. The increasing complexity of structures will further emphasise the need to partner with a service provider who can demonstrate long-standing knowledge of the alternative investment universe, supported by a substantial operational infrastructure with bespoke technology investment.

As the job brief for a specialist fund administration partner becomes more challenging, private equity houses should consider their administration appointee options as prudently as they would their investment opportunities.