Private equity investors saw a 20 percent better return compared to their colleagues who stayed with conventional stocks. And, since private equity investments are illiquid and focused on the long-term, they are less volatile, thereby providing both a hedge against riskier investments and the diversification necessary for a well-balanced portfolio.
That’s meant more and more investors are feeling the love for private equity. Some 80 percent view private equity positively, according to Preqin, an alternative data research firm. And twice as many investors plan to put their money into private equity compared to hedge funds. As a result, private equity firms’ assets under management ballooned from $580 billion in 2000 to nearly $2.5 trillion as of June 2016.
Challenges Ahead
Private equity firms and their investors should enjoy the party while they can. Popularity doesn’t last forever, as the waning interest in hedge funds proves. Although the Trump administration’s still-to-be-finalized policies regarding the corporate tax rate and handling of the carried interest tax deduction could provide a huge boon to private equity, firms still face ongoing challenges that could impact overall returns.
Regulatory reporting obligations continue to increase. Fund managers are dedicating more time than ever to meet the reporting requirements under the European Union’s Alternative Investment Fund Managers Directive (AIFMD), and the Foreign Account Tax Compliance Act (FATCA) and Dodd-Frank in the U.S.
In addition to regulatory compliance, private equity fund managers must also contend with the intricacies of tax reporting. K-1s and foreign bank and financial accounts (FBAR) reports, for example, include detailed disclosure requirements that seem to change regularly. Keeping up with reporting requirements is even more onerous for global deals that cross multiple jurisdictions. Enhanced scrutiny of investments by regulators, more frequent audits, and pressure from investors and other stakeholders for increased transparency add to private equity’s ongoing challenges.
Addressing these issues requires time, expertise and resources. Finding and hiring additional staff is not as straightforward as it would seem. The complexity of private equity structures combined with fierce competition among firms for what is a limited pool of qualified professionals makes for a difficult hiring environment.
Plus, adding more staff to keep up with administration and compliance increases expenses and ultimately reduces returns. That puts private equity firms in a bind. How do you meet regulatory and reporting obligations while keeping costs down and giving regulators, investors and partners the information and transparency they expect?
Bridging the Gap
Third-party administrators would seem to offer the perfect solution. They provide transparency, scalability, expertise and operational efficiencies that can reduce costs.
Historically, private equity firms had shied away from administrators because fund managers were skeptical such services could handle private equity’s complex valuations, waterfall, IRR and other calculations. Smaller boutique firms were concerned that many fund administration services were overkill for their needs and too expensive for their limited budgets.
Much has changed in the last few years. Not only are there more choices of providers but prices have come down on third-party administration services. Given the large size of many funds and continued anticipated growth, administrators can provide the sophisticated infrastructure private equity firms need to meet investor and regulatory demands for transparency, independent oversight and best practices. More importantly, they can typically do it more efficiently and cost-effectively than the private equity firm.
That’s good news for private equity. It’s one reason why close to 50% of private equity firms now outsource some portion of their back-office operations to third-party administrators.
Firms that choose to keep back-office operations in house rather than outsource to an administrator must still answer to investors and regulators. Using an accounting, investment analysis and reporting platform like FundCount can deliver the operational efficiency and transparency to put your firm on solid footing. With less time spent on managing spreadsheets, there’s more time for managers to focus on raising capital. That means private equity firms have a better chance of turning a budding romance with their investors into a lasting relationship.
