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Three questions every LP should ask about their PE monitoring

Monitoring_screenInstitutional investors have long sought the diversification benefits of private equity (PE) and other alternative assets to boost the return potential of their portfolios. But while their strategies and operations have grown increasingly complex, the reporting and monitoring systems needed to track the management of those assets have not managed to keep pace.

As the appetite for PE has increased, deal competition has also intensified, as has the number of investors pursuing those deals. Family offices, pension funds, insurance firms, foundations and endowments hunting for yield have fueled significant growth in the space in recent decades.

With those dynamics has come increasing pressure on Limited Partners (LPs) to work more efficiently to deploy capital and seek a more diverse range of strategies and investment structures.

Monitoring PE funds is far more complex than tracking market exposure and liquidity for retail funds. And the space continues to evolve as the demand for diverse strategies increases, posing challenges for investors attempting to process more advanced data points on committed capital and liquidity horizons.

The ever-changing landscape, increasing investor demands and evolving use of technology are driving the PE industry to increasingly turn to specialist providers to deliver the necessary technological platforms and outsourced service solutions. With the need for fast, economical and accurate due diligence being ever so important, outsourcing of fund administration has evolved into a more complex and tailored delegation of operational expertise. Fund administrators are meeting rising demands through the application of innovative technologies and a flexible client-centric approach based in experience and expertise. At IQ-EQ, we have created a bespoke technology platform providing LPs with real-time data reporting and data analysis on their investment portfolio.

Here are three questions to ask to determine whether an LP’s monitoring system is primed to boost productivity and reduce operational risk:

   1. Do you rely on a spreadsheet to monitor portfolio performance?
To ensure long-term strategies aren’t disrupted due to a lack of planning, LPs need the ability to quickly identify the status and location of their assets. That requires a system that can extract data from multiple locations and screen it for accuracy—then aggregate it by asset class, fund, equity position, geography, or sector exposure.

With a customizable dashboard, LPs can identify, for example, every place they might be holding a poor performing stock, whether with a broker, custodian, or hedge fund. It’s instant perspective on the availability, location, and level of assets, amounting to a total portfolio view into all investments.

That’s far more transparency than a spreadsheet can provide, especially one that requires manual entry of data with many complex macros. That increases the chance for risk to be highly concentrated among one or two key people entering data.

   2.  Are you able to instantly locate available cash in the event of a capital call?
The ability to instantly peer into a portfolio for a customized view is particularly important when LPs need to immediately locate available cash for a capital call, generally issued when a deal is about to close with a typical notice period of 10 days. Once initiated, the process needs to run smoothly on both sides to maintain the fund’s growth trajectory.

General Partners (GPs) seek capital commitments to sustain deal momentum and maintain operations by securing investments in companies. But the short window allowed for the process means an increased potential for error and additional risk for LPs providing the capital.

PE firms trying to avoid a default can withhold distributions or sanction LPs who aren’t able to provide capital. A default can damage the reputation of LPs and limit their access to future investments. Investor services that can not only quickly locate available cash, but manage the capital call process and the accompanying back office functions, can help minimize this risk.

   3.  Does your monitoring system have human oversight that works in tandem with accounting technology?
Monitoring systems require advanced accounting technology designed specifically to handle PE inputs, but the modern fund services provider needs to be more than just an accountant.

Accounting technology needs to work in tandem with human oversight, employing both quantitative and qualitative measures to ensure quality services. Technology is nothing without human intervention, you will get a good output only if the data that has been added is correct.

LPs need experts who understand the variables of PE fund operations as well as the nuances of portfolio composition as it relates to the unique needs of each firm. Technology must be able to adapt as the space evolves, and the monitoring system must be able to accommodate the various structural differences of investors.

Providers should have expertise in alternative assets across the full investment cycle, and understand how they are impacted by regulatory and economic changes. The ideal provider understands the space from the perspective of the GP, consumed with fund formation and deal flow, and the LP, charged with monitoring a portfolio diversified with alternative funds.

Some PE funds use complex structures to minimize taxes, which may require modifications that complicate reporting as laws change and risks evolve over the long-term. In-house programmers can make any necessary changes, updates, or tweaks to the system.

Firms should assess their monitoring system as part of an analysis of current and future investment strategies. Timing is critical during the PE investment phase. But it’s also critical to continue monitoring throughout the life cycle of the investment, as strategies are consistently executed over an extended period of illiquidity when value is not clearly defined.

Portfolios require real-time data reporting and data analysis. Investors need the ability to set risk and investment parameters, forecast cashflows, and calculate commitments and distributions. Strategies and operations are often too complicated for the tools investors use. A quality monitoring system should work to boost productivity and minimize the potential for error, while meet reporting requirements across a range of asset classes over the long-term.

Hugh Stacey, Executive Director - Investor Solutions at IQ-EQ, a leading investor services group supporting fund managers, global companies, family offices and private clients operating worldwide, including top private equity firms.

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