July 28, 2017
Interviewed by: Privcap
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Michael Halloran: How to Make Fund Admin a Competitive Advantage

It’s becoming ever more complex to run a private equity fund back office. How do you take fund administration from paper pushing to a strategic asset? Michael Halloran, chairman and chief executive of NES Financial, explains.

It’s becoming ever more complex to run a private equity fund back office. How do you take fund administration from paper pushing to a strategic asset? Michael Halloran, chairman and chief executive of NES Financial, explains.

How to Make Fund Admin a Competitive Advantage

Privcap: What are the distinct set of challenges facing fund managers today?

Michael Halloran, NESF:

Today, in the GP world, we’re going through a sea change. The demands on GPs from limited partners—be it from an individual all the way up through a big institutional limited—are changing. They’re requiring more and more in the way of transparency reporting, actionable intelligence out of the fund itself. At the same time, while those limited partners are seeking those things, you’ve got greater compliance requirements being pushed down onto the general partners in the funds.

There is a range of challenges and they’re all related. You can break down the needs of the funds into multiple categories. The first one is really about accessing and retaining capital. The second one is all of your operational infrastructure, all of your fund accounting, your administration, your reporting, your SEC compliance. Then, the last one is really your risk mitigation.

In practical terms, how do those challenges impact the fund?

Halloran: It is generally accepted within the private equity world, particularly alternative assets, that the administrative costs or actual operating costs of the fund are too high, and that there’s a lot of downward pricing pressure that needs to be implemented. Again, you go back to the structure within the sector, and that’s a hard thing to do, because what you have is a significant amount of domain expertise that sits with all of these different individuals who then have to somehow pull together, out of disparate systems, all of the necessary components that are deliverable for the fund. That’s hard to get efficiency out of and the reality is that accountants are expensive and customer service reps cost so much money. Until you can create an integrated environment and really leverage technology and create business processes and operational efficiencies, it’s really difficult to cut costs out. But, if you can’t cut the costs out, then you severely limit the fund and where it can ultimately go.

Given the complexity and cost pressure, how can fund administration be transformed into a strategic asset?

Halloran: When you look at private equity and particularly alternative assets today, you have a whole ecosystem of providers out in the marketplace. These are your traditional fund administrators—back, middle and some front-office services. But, in reality, they’re kind of plumbing, right? And fund administration needs to become much more strategic.

You have to get yourself out of the box of traditional fund administration for a moment and, say, the fund administrator sees certain data inside the fund. They can look at that underlying asset data. But the reality is, the fund goes out and tries to find external data and they hire brilliant analysts who sit down and spend a tremendous amount of time analyzing that data and then marrying it up with the internal performance data to create some intelligence about what they’re going to do with their investment strategies when they’re exiting, how they’re servicing their customers, etc. So, imagine if you had that environment fully integrated, where you could take data from internal performance data on the fund to external data within the sector, maybe within a particular region, and be able to analyze all of that data in real time? The best funds out there are going to be better, faster and smarter than the other guy because they’re able to take data from disparate sources, pull it together, and turn it into actionable intelligence. The delivery mechanism for that is going to be the fund administrator.

What about cybersecurity and regulatory pressures?

Halloran: From a security perspective, the first thing you need is one holistic environment that you can control and that you can wrap with cybersecurity capabilities and defenses. The reality is, that’s more a Silicon Valley technology thing and that’s less something that comes from an accounting background.

Unfortunately for this sector, the hackers are becoming more and more sophisticated and they have the distinct advantage over a sector that doesn’t have that expertise.

When the SEC went out and started really looking at private equity funds, they went through a process of surveying I think it was 150 funds. When they were done with that survey, the report they put out was that rampant law-breaking and cheating, or rule-breaking, in every fund that they looked at. It put the spotlight on private equity. It’s become a priority exam area. We’ve had funds where the SEC came in and they started examining the fund. They examined that fund for nine months. In the first 30 days, one of the funds that we had dealt with had to produce 150,000 pages of documents. They didn’t need to just show the waterfall reports, they needed to show the underlying algorithms to those waterfalls. You get to this question of how much of a disruption as a fund can you actually deal with and take? And that’s where, when you talk about risk mitigation, it’s not just about having bullet-proof cybersecurity. It’s having an agility and an ability to respond without disrupting the fund or creating huge cost-burdens on the fund. Again, you can’t get there unless you do it in a different way than the way it’s been done up until today.

PE funds are actively seeking ways to tap retail investors. How does this change the calculus for fund admin?

Halloran: If you look at private equity funds today, they’ve got the institutional limited on the high end that’s demanding an all-new level of reporting and transparency. Now, at the same time, they want to democratize alternative assets and alternative investments. And, to do that, that means you’re driving all the way down from the extreme of the institutional limit to the individual retail investor. That’s a challenging number of degrees of separation between all of them and they have a totally different set of requirements. I think that, from the fund’s perspective, they have to have the capability ultimately to access that lowest common denominator, which is the individual investor.

Here’s a good example of how a very large fund has gone out and accessed markets that heretofore had been inaccessible because of the cost of servicing: this particular fund is a private equity real estate fund. They have raised multiple billions of dollars. They did it in three large phases. Then, they broke each one of those phases down into $50million tranches. Every $50-million tranche has its own PPM and it had different terms. Now, I have to pay out on a monthly basis—deliver statements, my interest, my interest allocations to the individual investor. I also have to pay these broker dealers. The waterfall complexity in this is insane. You simply cannot get there manually. The complexity is far too high.

It’ll be a combination of technology, domain expertise and business process. When you bring those right components together, you can do some amazing stuff.

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