“How investors monitor their portfolio is perhaps one of the areas of private equity that has changed the most over the past 10 years,” said Kevin Gruber, Managing Director at AssetMetrix, in Preqin’s 2019 Private Equity & Venture Capital Global Report.
We can’t agree more.
It’s against this landscape – one that is shaped both the pull from investors and the push from macroeconomic forces – that we provide our views on the technological changes we’re seeing in the industry.
We know the private capital landscape is getting more competitive, with private equity fundraising down in 2018 by 24% compared with 2017. Across all sectors of alternatives we track, we’ve seen an unprecedented level of capital concentration among the largest and most established players, and this trend has been consistent year over year. In an environment where many are concerned about a change in cycle, we predict this concentration to only continue, as investors seek out those managers with a track record or reputation that offers them confidence.
What’s the end result? It’s becoming tougher for fund managers that lack operational capabilities to meet investors’ requirements to raise capital and differentiate in a crowded market.
These shifts in the industry lead to just one conclusion: fund managers considering scaling their operational capabilities around data collection, portfolio monitoring and reporting should not delay.
In an uncertain market, technology provides a competitive advantage
The largest GPs typically have technology systems in place that help them save costs by collecting and analyzing information from across their portfolio companies and help support their decision-making around new deals. Apollo, for example, has invested in data warehouses and data scientists to allow its teams to collect and analyze information across its portfolio companies and assist in decision-making on new deals.
In 2018, we surveyed the industry to ask about their adoption rates for new technology and we found that, unlike the largest GPs, many small and mid-sized fund managers are still managing their portfolios via Excel. This approach is limiting – it takes more time to provide collated reports to investors, funds are unable to conduct sophisticated scenario tests, and data collection and management often lacks a thorough audit and validation process.
For many fund managers and particularly finance teams that we speak with, the operational arguments for adopting a technology platform to support their portfolio management process are often clear. However, many often feel that this alone does not create sufficient incentive to invest in researching, validating and implementing a new system.
Risk management is top of mind in 2019
However, what does make a difference to our clients is the benefits that such a system provides to their risk management process and the clear advantages it gives to them to provide confidence to investors when they are fundraising.
Our research indicates that most market players are anticipating a change in cycle; therefore, they are looking for evidence of solid risk management and internal governance during their due diligences process. We know that because capital in the industry is often flowing to the largest players, many LPs in small and mid-sized funds are also working with the largest funds. This means that for small and mid-sized funds to stay competitive in this environment, they, too, need to demonstrate similar capabilities. Funds still using Excel can’t provide evidence of a sophisticated framework for scenario analyses: the ability to immediately notice when fund metrics are at risk of missing targets or managing data inconsistencies. We’ve heard from LPs that this raises red flags.
ESG is table stakes
Furthermore, GPs that can’t provide ESG metrics often miss out on being part of an LP’s consideration set. When we asked LPs in the past, over 86% indicated they consider ESG factors when making new fund allocations.
Today, there are technological systems that can address this added requirement without providing an increased operational burden. O
Our Outlook for 2020
At Preqin, we track the ebbs and flows on the private capital markets. From our vantage point, it’s becoming clear that investors are increasingly focused on managing risk and are investing more time in screening funds to ensure that these fund managers have the capabilities in place to manage and monitor their portfolios in a volatile market and provide the capabilities, such as those around ESG reporting, they expect. Furthermore, we know there is generally an increasingly gap in fundraising ease and technological sophistication between the largest fund managers and everyone else. We expect more small and mid-sized fund managers to prioritize digitizing their operations in 2019 to remain competitive.
For those who do not, we wouldn’t be surprised if they have a difficult fundraising cycle ahead.
Preqin Special Report: Digitization of Private Capital Operations
Drawing from the results of our survey of 300 private capital fund managers and the insights from industry experts, this report looks at how technology is disrupting the operational landscape in the private capital industry. It examines how private capital firms are using technological solutions and the factors that are driving spend in technology, as well as how satisfied firms are with their current solutions.