Apex Group: Overcoming evolving operational challenges

As strategies and fund structures become more sophisticated, service providers must step up to support managers’ increasingly complex needs, say Apex Group’s Aman Bahel, David Ries and Kartik Shah

This article is sponsored by Apex Group.

How is the traditional focus of private equity managers changing with respect to value-creation strategies?

Aman Bahel: To a large extent the focus of private equity managers hasn’t changed, in that the core of what they do is investing in growing companies and taking them from one point to the next while effecting positive change and creating value for investors and shareholders. That, married to the success that private assets have enjoyed in comparison to public markets, continues to be a strong business case for investors to allocate capital to private equity.

What is constantly changing, though, is mapping that to the micro and macro dynamics of where managers invest and how they spend their time. The traditional sectors of industrials, consumer, technology, media, telecoms, real estate, healthcare and others will continue to enjoy investment across the capital structure and at various stages of investment cycles.

Yet the rate of change, particularly in the venture and technology space, is so fast that the strategies and portfolio companies that private equity is going into are also changing rapidly. In addition to traditional buyout funds, we are seeing a move towards digital asset funds that are supporting companies operating across the value chain of digital asset transformation. The case for investment there is a mile wide and a mile deep, from artificial intelligence tools to distributed ledger technology.

That requires a cutting-edge investment team and a sophisticated way of showcasing the business case to investors. At the same time, private equity managers are turning to a wider client base, addressing more retail investors through different platforms, and the management of those profiles requires another shift.

All this takes place in the context of broader macro trends such as the proliferation and adoption of ESG, which itself needs to be operationalised to create long-term value through well thought-out and aligned management plans that incorporate ESG values and practices.

Kartik Shah: We see the growth of mega-funds powered by a strong fundraising environment that will continue to allow managers to deploy capital with larger ticket sizes. Managers also increasingly want to hold onto well-performing assets for longer, maximising value out of their existing portfolios, which is giving rise to more continuation funds and single-asset funds offering LPs liquidity and GPs more flexibility.

How are fund structures changing to manage investor requirements?

David Ries: In the US, we are seeing more managers choose to roll investments into continuation funds. Separately, managers that were traditionally hedge fund focused are diversifying into a committed capital business. Likewise, closed-end managers are starting to offer more liquid options to investors, including evergreen structures where there is committed capital with the future option to redeem. That evolution creates operational and personnel challenges as managers’ diversifying strategies surpass existing system and personnel capabilities. Similarly, fund managers are seeking to tap a broader geographic investor base, resulting in increasing compliance requirements and fund complexity.

KS: We are also seeing the rise of the hybrid fund as managers seek to diversify both their investor base and their investment opportunities. Hybrid strategies are opening up liquidity to investors while also mixing up investment strategies to access both public and private opportunities. Some of the biggest operational challenges for private equity managers are around how to match the investor liquidity to the investment liquidity, which is critical.

Also, how do you build the internal expertise to manage a public asset class investment strategy, and manage the complexities of investor redemption terms and lock up period. There is a growing demand for private equity from retail investors, who have historically viewed the asset class as inaccessible due to high minimums, a lack of transparency and the long-term commitments required. There is now more political will to open up private markets to retail investors and fintech firms are providing a digital platform to overcome those operational challenges.

How are managers addressing challenges relating to human capital?

AB: There are two immediate issues. First is the expansion of mid-sized and mega-funds, which puts an incredible amount of operational burden onto those firms to manage that complexity. Private equity managers are moving to multi-strategy, multi-jurisdictional approaches and hybrid structures, raising the question of whether they have the knowhow and technology to support all of that.

There is a growing need for partnerships with service providers to assist, particularly as that burden comes alongside ‘The Great Resignation’ and a quite significant shift in the workforce. How can you achieve greater efficiency when you don’t have the staff and it is difficult to source that talent?

The second issue is that all these new structures and ways of accessing capital mean first-time managers don’t necessarily have the resources or bandwidth to take on the costs of technology adoption required. They need to partner with service providers in order to be competitive operationally.

That’s where the measurement of operational effectiveness is so important, for managers to know the number of hours they are saving and the return on investment they get from partnering with someone that’s investing in technology. There is technology that can offset some of the human capital challenges but knowing how to incorporate that into the value chain is another issue.

Those are the conversations we are currently engaged in with managers: what is your investment in technology and innovation and what is your operating model to ensure you maximise that potential.

DR: Managers are facing recruitment and retention challenges, as are many businesses in this environment. We are seeing a particular demand for outsourced CFOs and controllers, whether temporary or permanent. As managers continue to grow, we are seeing more lift out opportunities to administrators. That helps managers focus on their core operations and reduces the impact of staffing challenges.

KS: We have invested in technologies that will help support managers with better operating models and efficiencies. Digital technology is playing a key role in reducing the manual, paper-based elements of many private equity processes, such as investor onboarding.

We made a strategic investment into a cutting-edge fintech platform, which is looking to tokenise the entire value chain, giving investors easier access to faster transactions, improved liquidity and more transparency, while also supporting secondary market liquidity. Tokenisation offers opportunities for both investors and managers.

What developments have you seen in relation to ESG? How are managers responding to enhanced reporting requirements?

AB: ESG has moved from a relatively amorphous discussion into a tangible and reportable format and framework. Across the value chain of stakeholders in asset management, the demand side has enabled a clear discussion around what can be reported, captured and managed. We launched an ESG Ratings and Advisory solution business, which has been rolled out over the last 18 months with high adoption rates.

There are asset managers that view ESG as a core philosophy underpinning what they are doing and others that are just trying to figure out whether they are compliant with all the requirements from regulators and from an asset-raising perspective. As an asset manager, depending on how large you are, you need to ask whether you are adequately equipped to establish your framework and operationally set up to track ESG metrics in order to implement and execute on your strategy. That is a skillset that is quickly evolving.

The conversation now is around how managers are going to capture this information, analyse it and have clear executable actions on the back of it – throughout the investment life cycle. Exciting progress is likely to come when you start to correlate ESG data to financial metrics like internal rate of return. That’s something we are not too far away from and which will drive an enhanced view of incentive schemes for remuneration and reward.

In certain areas we are seeing first movers, such as in sustainability-linked loans where margins are tied not only to financial metrics for companies but also ESG metrics that incentivise borrowers to perform on certain ESG criteria. That then flows into carry mechanisms and waterfalls and, ultimately, how the manager participates in the upside they have generated.

Every asset manager is also looking at themselves from an ESG perspective and considering what that means for their partners and service providers. We recently offset our lifetime carbon emissions as a Group and we know that’s going to be more of a focus for clients going forward, as well as being a differentiator from a hiring standpoint.

What are the latest themes around the use of data and technology to support managers?

DR: We are seeing managers looking for their general ledger to be in-house, even if a third party is administering it. GPs want that control and direct access, so one solution is a co-sourcing model.

KS: A number of large multi-strategy managers are not just interested in co-sourcing, but also in consolidation. They may be investing in public and private assets and using multiple providers to service those, but they want more control over their data and more access to that data to drive decision making and offer real-time insights. There is an operational challenge around consolidating different systems and data points and whilst some managers are doing that in-house, more are looking to providers to support their data aggregation needs.

Aman Bahel is global head of business development; David Ries is head of private equity solutions, Americas; and Kartik Shah is head of private equity product, Europe at Apex Group