Companies offering fund administration technology are promising a private equity world in which cheese-block binders are but a memory, capital accounts are updated automatically, financial data is available in real-time, and portfolio information and statistics can be used to generate analyses to assist both the GP and LP in their investment decisions.
Over the last five years, companies touting fund administration services have been persistently elbowing for the attention of private equity firms. Their message is being heard with greater interest now that the downturn in private equity returns has left investors looking for a little bit of solace while they wait for conditions to improve. If you can't give them returns on investments, these reporting systems providers suggest, you should at least give them superior investor services.
If there's any question about the growing significance of these investor-relations tools, consider last month's acquisition of private equity fund of funds firm Crossroads Group by Lehman Brothers, the investment bank. The official statement released by the two firms specifically states that one of the qualities that attracted Lehman to Crossroads was “its scalable investor and fund services program.”
With so many technology players clamoring for clients, though, some industry participants are finding it difficult to sort through the many systems, not to mention finding a solution that balances the needs of both the GPs and LPs.
“Some software packages out there are either for the GP or the LP,” says Jennifer Morais, a portfolio manager with the Ontario Municipal Employees Retirement System, the Toronto-based pension. “If you try to do both sides, you suffer in that you get away from the core.”
Until recently, what has been good for the goose has often not been good enough for the gander. In other words, general partners may have access to advanced tracking and analysis systems to manage their own investments, but when it comes time to report back to LPs, the old paper trail is considered good enough. Increasingly though, limited partners are asking that, at the very least, they be able to access their account information through web-based systems.
“Our real competition is not other companies, but the old way of doing business,” says Nick Worswick, business development manager at IntraLinks, which provides an online platform for private equity firms to communicate with their investors. “We want to migrate paper-based reporting to Internet delivery.”
General partners who ignore investor requests that they switch from the old way of doing business may not find much enthusiasm for a follow-on fund, warn industry observers.
“Technology doesn't make or break the reputation of the back office, but it contributes,” says Linda Lewis, a portfolio analyst at investment firm Russell Investment
Group, formerly known as Frank Russell. “A private equity firm is fine as long as there is a system in place that provides excellent client service. That definitely impacts whether you invest in a fund or not.”
Though the technology companies would like to see paper-based reporting become an extinct species, that day may be far off. But that does not mean times aren't gradually changing.
“To the extent that we provide accurate information that is transparent, LPs haven't posed the question for electronic reporting,” says Vivina Berla, a managing director at Merrill Lynch Investment Managers Private Equity Partners in London. “If we want to be proactive, however, we need to start anticipating their needs. It's getting increasingly important. Other players are starting to deliver it. We cannot afford not to be in that game.”
Efficiency and cost
An obvious advantage of web-based reporting is that it can save the time and effort consumed by paperwork. With the close of the quarter comes the mad scramble to assemble portfolio company finances, get them in order and present the fund's progress in a neatly bound report -all in the 60 days following a quarter's end. GPs often end up sending reports out at the last minute with overnight couriers and delivery services in order to get them to their investors in time.
The level of transparency to investors varies from partnership to partnership and valuation guidelines across the board are inconsistent
“Whether it's a small or large private equity firm, they're always looking for a way to streamline the accounting and reporting process,” notes Shannon Dolan, a sales manager for Investran, which provides reporting software as well as fund accounting and portfolio management services. “You usually have one or two people on the back-end trying to administer millions of dollars of fund money. They have a significant number of investor reports to get out on a quarterly basis, which can be overwhelming.”
Online reporting systems keep fund administrators from having to rely on delivery services. “With web reporting, all 1,000 people see it instantly, instead of waiting for FedEx,” says Theresa Gore, vice president and treasurer at private equity firm Clayton Dubilier & Rice in New York, which uses DMLT's Investment Café online report management system. “By using web reporting, I can also track which people log onto the system to get information.”
Gore says that although the amount and types of requests for information her firm now receives are same as they were nine years ago – well before web-based reporting came onto the scene – the online system does facilitate easier communication with investors.
“We now answer a lot of requests online – it saves us time and saves the LPs time,” Gore says. “The information is already there. Ninety per cent of the questions that come from the LP can be answered through the reporting system. It's quicker than waiting for a response from us.”
Though many current partnership agreements still require GPs to send hard copies to their investors, Gore says future agreements might make way for strictly web-based LP reporting.
Tell me more
General partners beware: armed with a more efficient delivery system, LPs might start demanding more information than they actually need. With fund data, including portfolio company financials, available on demand over the Web, investors might start scrutinising their portfolios more often than on a quarterly or semi-annual basis.
“The LPs are going to ask more and more questions about the performance of their investments,” says Peter Wooster, a director at London-based AccountingFrameworks, which provides various fund management and accounting services for investment firms. “They haven't had a great deal of straight-through visibility up until this point.”
“LPs need this transparency to see investment practices, which helps them identify the biggest risks,” says Momchil Mitov, director of business development at Netage Solutions, a provider of front-office software solutions. “Why would I invest in a fund manager that I know has horrible practices? Show me everything you do to figure out if a company is worth investing in.”
Web-based reporting systems are 24/7 portals through which GPs may, if they choose, communicate intra-quarter investment details. For example, often when capital calls are made, the most that LPs see is the amount of money deducted from their capital accounts. The details of any transactions involved are limited. With online reporting, there is the possibility of greater detail available instantly should the GP choose to disclose that information.
“There is more interest in having the details of capital accounts closer to real-time, seeing where that money is going,” says Lewis. “The reports I receive from underlying funds that I consider better are those with lots of detail.”
Who benefits – GPs or LPs?
One major challenge for technology companies is negotiating the various methods of reporting that US private equity firms employ.
“Lots of people have tried to implement commonality across reports in the calculations of performance measurement,” says Al Foreman, director of business development at Equitrak, a customisable report and calculations system. “These standards are still optional for the client to accept and reject, and as a result, one of the biggest challenges is meeting these diverse needs.”
As any LP who receives a hundred different reports in a hundred different formats can attest, no reporting standards exist, and no one in the industry is holding their breath for standards to emerge, even though there are currently several industry initiatives underway to develop them. In the meantime, web-based reporting at least provides a means of making investment data from various firms available through one common delivery system. IntraLinks and DMLT's Investment Café applications provide a GP service for LPs to simultaneously track all their fund information on one common platform. In other words, instead of logging into multiple sites to view their reports, the LP can access fund details in one place.
“One username, one login, gives us access to all the funds we're invested in,” says Tom Kerr, a senior associate in the reporting group at private equity investment manager Hamilton Lane Advisors, which uses the IntraLinks service. “It's a more efficient method of delivery, a one-stop shop to get information.”
Rather than waiting for industry-wide standards to be adopted, these reporting systems have acted more as storage and presentation areas. However, according to Ben Mazza, a Product Director at DMLT, web-based reporting is becoming more advanced. The Investment Café product, for example, has multiple layers of capital account details that start at the fund level and itemise all the way down to individual capital calls and even management fees through a series of hyperlinks.
GPs are not convinced we can maintain proper web controls
Many online reports remain static because GPs choose the details they want to post online, and usually do so only on a quarterly basis. In some cases, the only thing an LP can access from a website is a PDF version of the quarterly report. The challenge of translating numbers and statistics into a format useful for tracking investments is still up to the investor.
“Over time, we want a system that will become more flexible and more interactive,” says Merrill Lynch's Berla, whose firm has yet to implement electronic reporting. “Whether the system will benefit the LP or GP more is a matter of debate. The portfolio managers will tell you LPs request information beyond what is useful. If you talk to sales people, they always try to accommodate clients' wishes and needs.”
Because the internet was born a creature of the public domain, it is only natural that private equity firms approach the topic with extra caution. Private equity firms thrive on keeping their data, well, private. Having their financials posted online naturally makes GPs nervous that the information will fall into the hands of the wrong people. At the very worst, disclosure raises the spectre of a hacker breaking into a firm's financials.
“Clients are always concerned about security,” says Investran's Dolan. “We provide flexible security with our product that gives different levels of access to different types of data.”
Technology companies put security at the top of their priority lists. But web-based reporting makes it more difficult for GPs to monitor who receives sensitive fund information. When a report is in paper-format, it's much harder to intercept, let alone duplicate and distribute. With paper reports, “breaking and entering” literally means deadbolt and door, not username and password.
Some products provide special features such as the option for the GP to lock sensitive documents and prohibit copying, printing and forwarding. Other technology providers find alternate safeguards to prevent sensitive data from falling into undesirable hands. Gore says her firm's reporting system has a feature that removes any reference to Clayton Dubilier & Rice when information is downloaded to a spreadsheet.
Online portfolio analysis
In the last few years, LPs have begun to look for more sophisticated ways of viewing their current investments. Despite all the information online, any kind of comprehensive analysis must be preceded by a great deal of data entry.
A number of expensive software applications currently exist to help investors better understand their data. Ted Clark, a managing director at Boston-based fund of funds managers HarbourVest Partners, says that even this option requires someone to track, input and update financial data. He says the amount of time and resources required by the LP to maintain such an application is significant.
An alternative solution is to have the GP provide investors with the capability and tools to analyse their portfolios themselves. In an ideal world, Web-based reporting linked to a firm's own financial statistics and data would facilitate that, providing instant online analysis of a portfolio at the request of the LP, rather than having an intermediary input the data manually.
“Being able to do analytics, cross-examining IRRs, statistics – anyone with a bit of curiosity would be keen on that,” says Russell's Lewis. “However, though there is a trend to make reports available on the web, I don't necessarily see a trend yet to do analytics on the web.”
Technology provider Relevant Equity Systems is betting that the next frontier is this interactive type of portfolio analysis. CEO Ray Haarstick says the emphasis for his clients has changed from active investing to active portfolio analysis. He says more clients want to figure out how to best spend their time and resources and allocate their capital efficiently.
LPs haven't had a great deal of straight-through visibility up until this point
Netage has a similar outlook on the future of private equity reporting systems. For Mitov, the true power of administration systems lies in their potential to organise a company's infrastructure, data flow and accounting, while simultaneously helping clients make investment decisions based on the information they've been gathering.
“In the future something like this would be much more beneficial to track company revenues and other information in the pipeline,” Mitov says. “You get tech charts, analyses – you see what is most profitable. The tracking would help you do decision support on the micro level.”
However, online portfolio analysis is a neat idea, but not a strong trend at the moment.
“The challenge is the vast scope of reporting,” says Hamilton Lane's Kerr. “Methods differ greatly from one partnership to the next. One may have details down to the lowest level, the next may not. The level of transparency to investors varies from partnership to partnership and valuation guidelines across the board are inconsistent.”
Variations of the dream systems Haarstick and Mitov describe already exist within the internal networks of private equity firms, but it will be a while before LPs will be able to share in on this technology without having to make a separate purchases of their own management and analysis applications.
“Most GPs will not bend over backwards to satisfy the requests of all the LPs,” says Merrill Lynch's Berla. “What are the chances that any single system will integrate all functions and upload the information from a variety of GPs, consolidate that data, and then spit it out in a way that is consistent with the needs of LPs?”
The general consensus among technology companies and private equity firms, however, seems to be that once Web-based reporting catches on, there will be no turning back. Furthermore, once online reporting becomes the norm, it will only be a matter of time before the whole private equity process, from capital calls to portfolio company financials to quarterly reports, is streamlined to produce an active portfolio management, analysis and reporting system that will serve both the GP and LP. There is no doubt that a number of technology systems are trying to position themselves to benefit from this possibility.
Now if only someone could invent a system that guaranteed positive returns.