It’s obvious isn’t it? They want a profit from their capital investment at a return reflective of the risk. And it’s the last part in this sentence that creates all the excitement.
During the last few boom years, tremendous amounts of capital have been made available and investors have had to act quickly if they were not to miss out on investment opportunities. Funds were being established almost overnight, but the imbalance between this wall of cash and the number of quality investments available drove yields down leading to risk not being priced correctly. Times are different now the heat has been released.
On the one hand, there have been the high profile financial scandals and on the other, there has been the banking crisis and the global economic recession. Both have brought risk management into sharp focus in the minds of investors. Rightly so. This was borne out in a survey undertaken by the Economist Intelligence Unit on behalf of PricewaterhouseCoopers of institutional investors in which respondents confirmed that in selecting investments, after performance (1) the quality of the compliance and risk management process and (2) transparency were of equal importance and when deciding whether to deselect an investment these two were as important as performance of the investment. The report suggests that as returns moderate, investors will be more exacting and a key driver in the selection process will be on transparency and the quality of risk management
Inevitably, investors are now maintaining far greater focus on governance and the disclosure of processes and procedures. General Partners can expect more and more demands from their Limited Partners and prudent general partners are already responding to this by putting in place new measures to satisfy these demands. So how does improved compliance, risk management and transparency really translate in practice?
Many Limited Partners have started demanding more and better quality information on the performance of their capital and this very much includes the speed at which the information is provided. There is no doubt that this trend will continue with more Limited Partners expecting the same. In order to provide this, General Partners will have to put in place the very best people and the very best systems to cope with this demand. Gone are the days of over reliance on Excel spreadsheets and in comes sophisticated IT solutions. But these are expensive solutions and, whilst they might make economic sense for the larger funds, they may not make economic sense for funds managed by the niche or boutique managers. In the current economic climate, there has been the inevitable increase in the latter as teams spin out on their own to take advantage of the trough we are currently in by launching new funds. These General Partners will inevitably look to third party service providers to help provide such sophisticated fund administration solutions.
Outsourcing to a third party fund administrator makes a lot of sense. Limited Partners get a lot of comfort from this arrangement. Engaging an independent, professional administrator, who may also provide accounting/NAV services and also directors to the board, improves credibility of the fund on the one hand and improves the all important corporate governance on the other. The latter alone will drive the trend to outsource back office functions, leaving the General Partner to focus on what they do best – manage the investments. Usually the fees of the fund administrator are picked up by the fund, although in some cases they may be paid by the General Partner to be deducted from their fee.
When fund raising, potential Limited Partners will respond differently depending on the type of administrator the General Partner has chosen. The administrator must have a track record and be known for the way in which they handle communications with the Limited Partners. As a result more and more fund administrators have invested in online platforms and have installed the most sophisticated systems. For example, Mourant has chosen the best in breed Investran supplied by Sunguard. This has an integrated general ledger allowing trades and other transactions to be reflected in the accounts as they happen. This means there is no time wasted in transferring such information to an accounts system thus speeding up reporting times. Through Mourant’s secure online reporting tools, Limited Partners can also access their reports in a single depository as and when they need them. Access can be available to as wide a group as the General Partner requires. Of course, the best in breed adds to the cost of administration and may not always be required. For this reason, Mourant for example also offers the use of other systems such as Sun Systems for routine accounting and Mourant’s proprietary registrar and income distribution system STARS©.
The provision of timely and accurate reports is essential to the Limited Partner, as much as it is to the General Partner in order for both to make informed decisions. This all adds to transparency. There is also the greater expectation from Limited Partners that they will want daily access to their investment performance and more and more want this information in real time. Limited Partners are also asking for additional analysis reporting, such as aggregated portfolio reports, activities by sector, analysis of risk processes or by instrument type and the impact on the P&L.
Good corporate governance remains at the top of Limited Partners’ agenda. It is not just about what is done, it is about how it is done. Of course, they look for proven track records in the General Partner with the ability to react to changing markets, but they are also demanding a strong business model with robust financial controls. The events of Madoff recently and previously Enron and other financial scandals have brought corporate governance into sharp focus. Having the highest operational standards reduces risk of fraud and misinterpretation or enables poor performing assets to be identified sooner, thereby reducing the quantity of any losses.
Interestingly, most of the major financial scandals in recent years have typically taken place in the States where the funds did not use independent administrators. This has been the typical US model, but it is changing. Mourant has had first hand experience of this as the size of its New York office has grown quickly in the last few years as funds move to an outsource model adopting the highest possible standards in corporate governance. This trend emerging from the US has led to the demand for the same higher standards globally.
Independence on the boards of General Partners with directors having appropriate expertise is a key requirement of many Limited Partners and, in some cases, an investment advisory committee made up of investor representatives is also demanded.
General Partners can also expect to be quizzed by Limited Partners about how they have interpreted the Guidelines for Disclosure and Transparency in Private Equity (“Walker Guidelines”) published by the working group of the British Venture Capital Association (BVCA) and chaired by Sir David Walker. The Walker Guidelines were produced following initial consultation in November 2007 and was limited to private equity firms managing large portfolio companies (eg. public companies over £300 million or private companies over £500 million, with at least half of their revenues arising in the UK and with more than 1,000 UK employees).
Conformity with the Walker Guidelines should be on a comply or explain basis and also includes guidelines on the content of enhanced disclosure in accounts, the form and timing of public reporting, data input to the BVCA, specified forms of communications especially via the web, reporting to established guidelines, such as those published by the European Venture Capital Association (EVCA), the International Private Equity and Venture Capital Board (IPEV) and the Private equity Industry Guidelines Group (PEIGG).
Whilst the Walker Guidelines are aimed at companies of a certain size, they will naturally have influence over funds falling outside the above criteria. More funds are providing more information including annual reviews, and many are providing these via the web or by providing detailed brochures. However, the standard or the methods adopted do vary. Reports may provide details of the structure, track record and examples of investments together with biographies of the senior management team, but greater levels of reporting will be expected, including comply or explain statements, conflict of interest statements and the provision of audited accounts available to download.
In these testing times when raising capital is harder than ever, it is inevitable that the “balance of power” has shifted and will continue to shift towards the investor. Rightly so perhaps, as it is their money. Investors expect more in terms of transparency and this translates into improved reporting, robust corporate governance with built in independence through the use of industry respected third party advisers and administrators. Those fund managers willing to take these on will inevitably steal a march on their competitors.
Simon Burgess, Global Head of Client Services at Mourant International Finance Administration specialises in the launch of new alternative investment funds with extensive experience sitting on funds’ boards in the US, UK, Dublin, Luxembourg, BVI and the Channel Islands.