Illiquid Alternative Assets Face Brave New World with TPFAs
by Anne Anquillare, PEF Services LLC

Anne-webAs I am sure you are aware, the illiquid alternative asset market (mainly buyout, venture, private real estate and debt funds) is facing mounting pressures on its back office operations. This market has been transformed by regulatory pressures, investor concerns and technology needs. Operational and financial executives at these firms have to scale their resources to meet these pressures and have taken a strategy from the liquid alternative asset side in the use of third-party fund administrators (TPFAs).

That is not to say TPFAs are for everyone. How do you know if they are for your firm? Below are some questions you need to address internally to find the right fit for your firm.

How organized and disciplined is your firm? If all your capital calls go out at 5 p.m. on Friday, and no one knew about the call at 10 a.m. on Friday—TPFAs are not for you.

Is price the only selection factor? Price is a factor, but it should not be the only factor. Investors (and regulators) expect timely, accurate information—and lots of it. You want to make sure you have a vendor/partner that adds value to your back office—and more times than not—you get what you pay for in the long run (and funds last a long time). If your firm cannot look beyond just price—TPFAs are not for you.

What are your current and target investors expecting of your back office? European investors are increasingly focused on ESG reporting (for us Americans that is Environmental, Social and Governance). While the S and G are not so hard to collect if you have the proper system, E is a doozie. Do you know your portfolio company/property’s carbon footprint? Meanwhile, U.S. institutional investors are all over detailed reporting on fees and expenses. They also like the involvement of an independent party in the process of keeping the fund’s books and records. The rest of the world’s investors might still be focused mostly on performance, but they are catching up.

How important is operating leverage to your firm’s future; are you going to be adding more funds, co- invest vehicles, SPVs, etc.? This is a buy vs. build decision. You need to focus on building the internal skills and expertise for your firm’s specific competitive advantages and finding what you can successfully outsource to benefit from a third party’s expertise and technology. If you think bookkeeping is a competitive advantage for your fund’s investment performance—TPFAs are not for you.

So if you are considering selecting a TPFA or making sure you have selected the right one, below are some helpful hints. And, like any successful third-party relationship, vendor selection and management is key. Remember, TPFAs are service businesses, and that means people are not a commodity. In addition to the people, a TPFA’s service also depends on its technology platform, especially to achieve scale and efficiencies without sacrificing quality.

The best place to start is to know:

  • What you need
  • Your firm’s service requirements
  • If it is more or less than what is typically provided. Typically, TPFAs’ services include books and records, allocations, data for compliance, capital calls/distributions, technology (investor portal, database for portfolio and investment information and performance reporting, etc.).

Use your network. Do firms similar to yours use a TPFA, and are they happy with the service? But, do not just stop with one name. Make all the reference calls—and not just those provided but also those found through your network. This is a big decision, and you need to do thorough due diligence. You should carefully investigate at least three vendors that meet your search criteria, but that means you need to start with 10.

When you sign on with a TPFA, the technology platform it uses comes along with the service. What is the TPFA using as its technology platform(s)? Is it proprietary, third party or both? Has it integrated its technology tools? Is it making investments in its technology team and applications to support future growth?

Just like technology, when you sign up with a TPFA, you get its people. How does it staff your account? What is its turnover and at what levels (e.g. staff vs. manager)? Make sure you do a site visit to the office that will be handling your account. Does it have a documented SLU (Service Level Understanding), which are like SLAs but mutual so expectations are clear on both sides.

You also get their processes. Does the TPFA have a SOC 1 (type 2) audit report covering the services that it will be providing to your firm? This is an audited report on “Controls at a Service Organization Relevant to User Entities’ Internal Control over Financial Reporting,” and it is a huge “check the box” for institutional investors and consultants during due diligence.

This is a big decision, ask the hard questions. If it does not work out, how easy is it to exit the relationship? Will my account be significant, meaning you will care if I am not happy because that can influence your referrals and reference sources?

Hopefully this gave you food for thought on 1) if the use of TPFA is a good option for your firm, and 2) if so, how you go about evaluating your options. Our industry is maturing and becoming more complex. Vendor selection is an important process for illiquid alternative asset firms, and not just for TPFAs, but for all vendors critical for the firm’s success.

You are only as strong as your weakest link.