Digital Disruption Hits Private Equity & Real Estate
Digital Disruption Hits Private Equity & Real Estate
By: Michael Rucci
A successful private equity firm looks to raise its fourth fund, but then the chief operating officer sits down with her business plan and spots immediate trouble. In theory, more assets should produce better profitability as economies of scale are exploited, but fund four requires more people, technology and reporting to meet heightened demands for transparency, governance and data quality.
Meanwhile, the prevalence of sophisticated tools and reporting standardization initiatives have resulted in both fund managers and limited partners having a voracious appetite for bespoke reporting, data requests and derivative analytics without consideration of the means to their desired end.
How do firms balance these increased demands, all of which require even more investment in the face of continued pressure for fee compression? And how can firms address the need for more information derived from more data and delivered more rapidly while maintaining high levels of accuracy and output quality?
At MUFG Investor Services, we hear from clients and consultants that complex data management and reporting has gone from nice to necessary for the entire private equity and real estate stakeholder ecosystem. It has become a requirement for these stakeholders to meet their operational and performance goals. From our perspective, what the alternatives market requires is disruption; a true overhaul of current systems to meet changing demands.
The market needs a data revolution.
Private equity firms and multi-strategy investment managers understand that their operating model must evolve for them to survive. The challenge for these firms is not ignorance or indifference to this hastening reality but rather a fundamental lack of the skill set and lexicon required to attack and solve their data conundrum.
Firms are finding that it is extremely challenging to undertake an end-to-end evolution of their reporting and administration infrastructure. Major technology upgrades and integrations are often too dangerous and daunting given the enterprise risk in the event of failure. Some firm management teams have attempted to implement new technology to slow margin erosion but such initiatives are risky, rarely successful and often end up distracting from the essential functions of selecting and managing portfolio companies.
The Private Equity Partnership with Outsourcing
In today’s market, successful private equity firms are dependent on deep relationships with third parties who fully understand the challenges that the firms face and who have the ability to develop innovative solutions to meet their needs.
Over the past decade, outsourcing has continued to gain momentum in the market. According to Ernst & Young’s 2019 Global Private Equity Survey, 37% of investors have increased their use of outsourcing to mitigate margin erosion over the last year and there is a 71% level of outsourcing for regulatory reporting as compared to 25% in 2017.
It is no surprise that private equity funds are outsourcing more of their operations to third party providers. Over many years, private equity funds have found trust and immense value in their outsourcing partners for business challenges ranging from maintaining books and records to IT support and tax services thereby enabling private equity funds to avoid the costs of hiring new back office and investor relations professionals, the risks of a technology upgrade, and the task of building a data centric culture. Firms that outsource routine finance functions are better able to focus their attention on strategic, value-added activities such as the retention of talent and their investors.
Considering these successful partnerships and the implications of the extreme investment required to drive a culture of innovation, outsourcing partners serve as the perfect conduit to achieve the necessary changes.
Firms have been – and should be – looking to fund administrators to help fill in the technology gap and develop programs to assist with cost management, technology transformation, product line expansions, operational support and employee education.
The Outsourcing Curve: Digital Disruption in Fund Administration
Private equity funds can be hesitant to fully outsource as the industry catches up to evolving technology.
The reality. Fund administration has evolved into a commoditized service. The world we live in today has been transformed by technology, and the fund administration business is no exception. Fund Administrators need to be upgrading their data service capabilities in order to keep up with the changes. Modern administrators who have the ability to gather, organize, present and disseminate their data by incorporating up-to-date technology and human capital stand out from the rest.
Tackling data management is no easy feat. Many private equity firms collect volumes of data but only use a small percentage of it while the rest is tucked away and forgotten. This is mainly because even the smallest funds gather their data from multiple private market sources that are not automated or uniform which then leads firms to engage in the risky practice of manual data manipulation. Such manual data manipulation significantly increases the risk for error which may ultimately result in altering the firm’s entire enterprise risk profile. It is easier for private equity firms to just leave it alone and only use the data necessary for reporting. Furthermore, undergoing this digital transformation is just as much of a cultural challenge as it is a technology overload. Data science is not baked into the DNA of private equity firms, and too few CEOs recognize and understand the associated challenges of technology and data. Instead, Excel remains king at many private equity firms who have not kept up with big data trends and forward-looking technology strategies being utilized elsewhere within enterprise software. Therefore, it is imperative to look for an administrator with deeper data capabilities who can develop, provide and implement more sophisticated, advanced platforms to fill this data culture and capabilities gap that exists in many firms.
Digital Transformation of Private Equity
Given all these factors, it is no longer enough for service providers to merely add a few platforms and teams to improve basic IT or data functions. Today, successful fund administrators should be relieving their clients from the drudgery and inherent risk associated with internal data management that is reliant on multiple, and often incompatible, systems so their IR and operations teams can function smoothly and offer new forms of transparency.
To do this, service providers must re-weave their DNA to include technologists, solution architects, data science professionals and data integration gurus. They may even hire a chief data officer or acquire/partner with firms in Silicon Valley. Administrators and their leadership must have a clear vision of innovation, the willingness to invest in that vision and the commitment to develop new technology-centric programs that meet the evolved needs of today’s marketplace.
The private equity data revolution must start now, and it must start with a partner who has committed itself to demonstrating a culture of innovation – namely, the fund administrator.
Creating a Culture of Digital Transformation
Embracing digital disruption will continue to challenge many fund administrators, but adapting with the industry as it progresses will be worth the growing pains for both the administrators and their clients. Successful implementation of outsourced data solutions can restore the benefits of economies of scale to managers while meeting the bespoke reporting demands of sophisticated limited partners. Such an approach will also reduce risk and save considerable time and money associated with manual data management.
This is not a simple process. Leading a data revolution in a generations-old market takes more than “understanding” or “vision”. What’s required is a steadfast commitment to a culture of innovation. While today’s economic environment and increased client sophistication have posed new challenges for private equity, digital technology properly implemented by a provider that has embraced a 21st century data culture will open new opportunities and help position funds for long-term success.
At MUFG Investor Services, we have made that commitment. We live a culture of innovation. We have changed the very DNA of our organization and our people. We continue to employ some of the best and brightest within our traditional services businesses, and now we are proud to say that we have some of the best and brightest from the technology landscape leading our data revolution.