This article is sponsored by Northern Trust.
What trends are you seeing around LP data transparency demands? What are investors most focused on and why?
There are three areas where we currently see an increased demand for LP transparency. First is fees and expenses, where LPs have always wanted to fully understand management fees, fund expenses and costs. However, they now want to know more, such as the timing for distributions and the carry as it relates to performance and returns.
In the past, LPs appreciated that the private markets still operated on a quarterly reporting cycle and they were happy to drill down on a quarterly basis, but now they want to see information much more frequently. Behind the scenes, they are more actively managing their illiquid investments to understand their liquidity needs, so it makes sense for them to want to view the data more often.
The second thing LPs are looking for is increased visibility regarding the exposures to different types of portfolio companies. They know they can’t necessarily have access to the intellectual property of the GP’s investment strategy but they want to understand what is happening in the portfolio companies and what is driving performance.
This has also led to the rise in co-invest vehicles and special purpose vehicles to minimise certain exposures while also continuing to invest with alternative asset managers that have performed. Again, reporting was previously acceptable on a quarterly basis but now LPs want to see that data more frequently so they can standardise the information across their private markets portfolios, often relying on the same data points that GPs are using.
Finally, the pandemic has led to greater demands for transparency around environmental, social and governance considerations, as well as diversity, equity and inclusion. With everyone less connected than previously, LPs want to understand the current and future outcomes for their capital deployment; they accept that performance will have taken a hit in some strategies, such as the hospitality industry or commercial real estate, but they want to understand the full impact and particularly the fallout for the labour markets and overall systems that drive sustainability.
How can GPs respond to these demands, and where should they focus their resources?
There is a lot going on and GPs are being given very little time to figure out how to solve these issues. Unless GPs have top technology or data service teams and technologists in-house, it is recommended that they work with a provider that can aggregate the data, normalise it and serve it up to the LP community in a standardised way with visualisations and any exclusions that may be necessary. Funds need data technologists who understand how to deliver the data investors want, to meet their appetite without revealing trade secrets.
GPs have increased their searches for providers they can partner with, namely firms that do this on a regular basis and are already working with large data sets, so that they can incorporate their data without the need to isolate it.
Investors in private markets are growing their allocations because of the attractive returns, so they want their GPs focused on investment strategy rather than seeking to become
data experts. The digitisation trends require us all to become more data-savvy, but there are service providers that do this well, allowing GPs to focus on what they do
Data is also at the heart of GP efforts to address ESG and DE&I demands. How can GPs begin to track progress and quantify the impact of initiatives in these areas?
European trends for tracking ESG have been miles ahead of North America and Asia-Pacific. APAC is still a fairly new environment for private markets, but North America now seems to be waking up to this, driven in no small part by the pandemic. There is greater awareness that all this information is connected and so there is a need for more than just a tick-the-box exercise or what was common ESG screening practices.
If managers want to restrict their portfolios from tobacco or from certain types of energy production, for example, they now appreciate the need to dig deeper into portfolio companies, their vendors and their suppliers to capture a full picture view. On the data side, that means looking a couple of layers deeper than they did in the past, asking more questions and being much more critical to get to the outcomes they want.
“We have long been in an environment where we were okay with the idea that if you could show diverse representation, that was sufficient. Now, you need to go much further and understand how you are driving outcomes connected to equity and inclusion”
Kim Evans, Northern Trust
The same is true for DE&I. We have long been in an environment where we were okay with the idea that if you could show diverse representation, that was sufficient. Now, you need to go much further and understand how you are driving outcomes connected to equity and inclusion. We have been working with a few firms on this, and what they are looking at now goes much deeper than just representation within portfolio companies, vendors and suppliers – they want to look at outcomes: job creation, affordable housing and the beneficiaries of these outcomes.
That means gathering significantly more data, and this ESG and DE&I data exists in abundance all around us. In this case, what is important is not just gathering data but deciding what your objectives are and what you are benchmarking your outcomes against.
How are GPs looking to move the needle on DE&I? Can you give any examples of new initiatives that are having an impact?
One thing we have realised in this part of the market is that if industry growth continues as predicted over the next five years, it will require much more talent than there is currently in the market. We are participating in programmes of knowledge-building and knowledge-sharing to bring professionals into the space, because while it is great that we can trade for talent between us, we still need to create more.
We could not have a better opportunity than now to focus on DE&I and future outcomes and to create the programmes that will drive diverse candidates into this industry, train them to become experts and supply the demand for talent as the industry grows. There are grassroots and ground-level efforts to work with colleges and high schools to educate people about this industry; I certainly did not know about private markets when I was in college, and maybe not even when I began my career in financial services.
We need to collectively drive talent to this market and then give those individuals the space and capacity to grow. This is a chance to fuel the growth of the industry with diverse talent, and that is one way we can make a difference in the long term.
In the short term, some of the behaviours I see in due diligence are now moving from a focus on representation to a focus on outcomes. I am hearing GPs at conferences and elsewhere talking about this, pledging not just that X percent of their roles will go to women and people of colour, but also that those roles will come with mobility.
In the past, we rewarded the effort of hiring people, but now GPs are saying they are not just going to hire them, they are going to give them a career path and seek to make an impact on diversity at the executive level. Yes, you should start with representation if you do not have it, but then you need to double down on that with a commitment to diversity in the senior ranks, because diversity and inclusion in decision-making roles is what will help GPs move the needle for their portfolios, their fund performance and the industry overall. GPs can also drive DE&I outcomes through the service providers they partner with to execute their fund strategies.
We are excited about the talent that exists to mine, develop and grow, and the positive thing for me is that, as a black woman, I know some of the barriers that exist and I can help people that are struggling to overcome them. The idea of equity is understanding that we do not all start at the same place. Some of us have barriers that need to be removed, but once you remove them, you can get closer to equality even if people do not have an equal starting point.
It is important that we make this effort sustainable. Once alternative asset management firms begin to reap the rewards of outsized performance from a diverse mix of talent, an equitable and inclusive environment, then the story will be undeniable and practices will be repeated.
Previously, as long as you could show some healthy DE&I practices relevant to the portfolio, you were in good shape.
Now, we see LPs saying that managers that are serious about this need to demonstrate that commitment through to the carry. Who in your firm is participating in the benefits of the investments? Who are you hiring? And the other side to the conversation is about access to capital, which has not been easy for women and ethnic minorities in the past.
Before they even embark on due diligence, large institutional LPs in particular want to see managers creating outcomes relative to the portfolio, taking action at the heart of their business to close the economic equity gap. That has created a boom in the hiring of women and ethnic minorities in this industry.
Personally, I am seeing a change take place because of the number of people that want to talk to me as a black woman leading a fund administration business in a global financial services firm. There is industry-wide interest in bringing in more women and more people of colour, creating an opportunity to close some of those gaps. I am excited to see it actually happening, whether it is driven by LPs, GPs, or simply a more widespread understanding that diversity and inclusion creates better outcomes.