This article is sponsored by Apex Group.
What are the next 21 years likely to hold for private equity?
It is going to be an exciting time. The asset class has seen tremendous growth over the past 21 years, and we expect that to continue with an overall increase in allocations to private equity and illiquid assets. Part of that will be down to a greater number of entry points for retail investors coming to fruition. Historically, private equity has been driven by institutional investors and large family offices, but we will start to see an increasing democratisation of private equity so that the average person on the street can access the asset class.
In terms of trends, we expect to continue to see greater specialisation among GPs. The generalist buyout strategy is not dead, but there will be more focus on particular industries and even sub-sectors of industries, such as healthtech and fintech. We will also see much more of a focus on specific countries, creating an opportunity not only to make better investments but also to offer LPs the ability to allocate to certain geographies and industries via specialist managers.
The consolidation of the GP landscape will continue, with larger managers scooping up some of the smaller players through M&A activity. We will see larger managers completing much bigger fundraisings in the next few years as smaller managers suffer, because LPs will favour experience and track record during more challenging economic times. Bigger managers will be the immediate winners through the recession – we will see if that starts to change afterwards.
Larger funds also have the advantage in their capacity to deal with the increasing burden of regulation, with the cash to invest in large compliance teams. We are going to see growing government oversight of private equity, partly driven by the needs of retail investors coming into the space, whom regulators will be keen to protect.
On the tax side, there is a convergence of tax systems around the G7 countries and that will have an impact on private equity as the advantages of different jurisdictions over others for structuring play out. We may see a shift to more onshore structures than we have seen in the past.
Finally, we expect to see greater investment in technology and outsourcing on the part of private equity, supporting the data analytics that funds are looking for to allow them to make quicker, data-driven decisions.
Do you see M&A driving positive change in the industry?
Ultimately, M&A activity at the manager level is going to drive consolidation, and we see signs of that activity increasing. That will give rise to larger managers with greater pools of capital and bigger investment teams, giving them the ability to focus on both returns to investors and making a positive impact as an asset class.
Over time, large private equity fund managers are going to have the people, the capital and the scale to look insightfully at ESG and DE&I, which is maybe more difficult to tackle as a smaller manager. Further downstream, they will also make greater use of their ability to leverage influence over portfolio companies, and in so doing have the potential to play quite a significant role in driving positive change more broadly.
What developments in technology can we expect to support the asset class?
There are clearly a lot more fund managers focused on making technology investments, and ultimately private equity managers do like to use the businesses they are invested in, so that is supporting the more widespread use of tech in the asset class.
There is also a real drive for more transparency coming from regulators, and that is pushing demand for technology to capture investment data at the portfolio company level, and to push that through to both regulators and investors so that they have transparency over their full investment book.
On the front-office side, we are going to see more artificial intelligence being employed to help support investment decisions, data and technology being used to make those decisions at a faster pace than we have seen previously.
The challenge for managers will be how they capture data and ensure that it is accurate and verifiable. The technology exists to support these decisions, but managers and portfolio companies need to get comfortable with the data capture stage.
More widely, technology is going to be used to a greater extent in investor services, investor relations and the client relationship management side of servicing. Looking to the future, this will be utilised much more than in the past, and at Apex Group we saw the need to provide a single-source solution that allows managers to log into a secure central point and have access to all their information, right from their investment data, performance, scenario planning through to ESG reporting and benchmarking.
One way in which we can look at the evolution of technology in private markets is to compare where we are as an industry versus the banks, which have traditionally always been a few steps ahead. I expect that to change, and I see private markets getting to a point where everyone – whether they are an investor or a manager – has access to information and resources at the click of a button through a mobile app. That progress is going to be driven by service providers.
How might ESG and DE&I requirements evolve in private equity?
“Managers are increasingly focused on technology, but they also want to see the security and infrastructure around that technology”
There has been an increase in the pace and extent of regulatory change around ESG in recent years, but the big change has really been a cultural shift. We have seen a move away from ESG as a tick-box exercise to GPs structuring and driving their businesses around ESG strategies. That is not just driven by regulation but also by investors: we see a lot more due diligence requests around the ESG components of private equity funds and strategies, and those are not just looking at the portfolio but at the managers themselves.
At the GP level, investors expect managers to walk the walk on diversity and inclusion, the environment and governance – historically there has been more focus at the portfolio company level, but this is now moving to the GP too.
While institutional investors are starting to look at this, as private equity enters the retail market and a new generation of investors comes into the asset class, that will shift even further. These new Gen Z investors have been brought up with an understanding of environmental and social concerns, so that is a bigger part of how they view the world and how they are going to invest. It is only going to become more and more important for private equity managers to be able to answer these questions.
Do you envisage the democratisation of private equity being an important ongoing theme, as retail investors seek to allocate to private markets?
We are certainly seeing that democratisation of private markets being a theme, both in terms of retail investors coming into the asset class but also with different markets starting to invest in private equity. In those emerging markets where 20 years ago the pension funds were largely invested in bonds, they are now at a maturity level where they are allocating more of their funds to private equity. That is a good thing for the asset class and a positive development for those jurisdictions in terms of diversifying their portfolios.
Broadly, there are going to be further implications of that democratisation on the regulatory side, because we are inevitably going to see increased regulation of private equity as more investors come in. Because retail investors tend to have smaller amounts of capital to invest, fund structures will need to evolve to allow that access. We are going to see more hybrid structures holding both private equity and more liquid investments, with platforms to allow managers to hold that mixture of asset classes to facilitate access and liquidity for different types of investors.
As a single-source solution service provider, we are developing a product offering that brings together the expertise from both liquid and illiquid asset classes.
Are current recessionary trends increasing appetite for outsourcing? How do you expect that demand to evolve over the next two decades?
Given the recessionary trends, the outsourcing model is increasingly popular because it allows managers and funds to both cut their cost base and manage their operational risk. We see an increase in outsourcing happening to take some of those larger costs off the balance sheet, and that makes sense from a risk perspective.
Managers want to focus on their core investment capabilities, which means making strong decisions on behalf of investors. They increasingly want to pass anything beyond that on to a trusted service provider with whom they have a relationship. Having one provider versus working with many is also something managers are doing. They want to work with a fund administrator and a corporate service provider for the full life cycle of the fund that also have the capabilities to offer depositary, AIFM and management company solutions to further support managers with marketing their funds – a single-source solution.
Speed to market remains key in being competitive. Service providers that offer digital banking solutions speed up the process and offer managers and funds consolidation when it comes to opening accounts and doing AML/KYC (anti-money laundering and know your customer). With the uptick in crypto and digital assets, managers want to work with established providers that already have a solution in place so they are able to launch and go to market much faster.
Managers are increasingly focused on technology, but they also want to see the security and infrastructure around that technology. You need to be a business of sufficient size to support that infrastructure while also continuing to meet ongoing regulatory requirements.
The long-term trend is towards further outsourcing, and we expect a recession to accelerate that. In turn, alongside the consolidation taking place at the GP level, there is continued consolidation among service providers. We are a clear example of that, with Apex Group having recently acquired Sanne. We see the power of consolidation and how this supports global managers that expect their providers to be available in multiple jurisdictions and support them with cross-border capabilities.
David Fowler is global co-head of product, private equity at Apex Group.