While few firms outside of the hedge fund market would have considered outsourcing fund administration twenty years ago, market requirements have since undergone a dramatic change. As the private capital market shifted from its heady, pre-bubble days to a time of market turbulence, regulatory oversight, and fierce competition for investors, outsourcing fund administration became a very viable option.
Fund administration has evolved from a simple task to an intensive and complex activity requiring higher headcount, greater expertise, and sophisticated technological resources.
As the private capital industry continues to see rapid changes, more General Partners (GPs) are shifting gears to reexamine the question of whether to outsource their fund administration or keep it in house.
In this more competitive and highly-regulated space, investment firms must not only deliver strong returns to attract new investments, but they must also demonstrate an ability to navigate fast-changing regulatory requirements and deliver exceptional levels of service and transparency to their investors.
Let’s examine the trends driving change from in-house to outsourcing fund administration.
Industry changes have motivated a new generation of GPs and their CFOs to re-examine the back-office function and find ways to strengthen, streamline, and redeploy it more effectively.As fund administration has become more resource intensive and specialized, outsourced fund administration has evolved from a small, niche industry to a business with $6.7 trillion in assets under administration in less than two decades.1 It has become a mainstream service category, not just for hedge funds, but for funds of every size and type, including venture, buyout, debt, real estate, SPVs, fund of funds, and more.
Growth may be the single biggest factor in the decision to outsource, yet many firms fail to recognize the point at which their growth trajectory exceeds the ability of their back office to keep pace. To achieve growth, every function, including the back office, needs to focus on activities that add value.
Virtually every firm will experience a pivotal point beyond which the firm’s existing staff can no longer stretch to accommodate growth. An in-house team that has successfully supported Funds I and II may suddenly find themselves struggling to prepare for subsequent fund launches and support the ongoing administrative and reporting requirements.
Increasing the headcount can ease the pressure during the early years of a firm’s growth, but as the firm continues to add to its portfolio, this option may no longer be financially viable. In 2016, a full 30 percent of all assets under management were administered by a third party. By 2018, it is expected to rise to 45 percent.2
EFFICIENCY & EFFECTIVENESS
There is a break-even point beyond which the cost of adding staff will exceed the cost of a third-party solution, especially when the expense of a private capital accounting platform (including staff training, IT support, infrastructure, and integration) is factored into the equation. As the portfolio broadens, the in-house back-office team may also find themselves challenged to deliver specialized fund expertise across the full range of strategies, which is another area where a fund administrator can provide support.
One in four private equity and real estate managers who currently insource are planning to outsource at least one back-office function in the next 12 to 24 months.3 For CFOs faced with the need to simultaneously manage costs, meet investor demands, and assume a more strategic role in the firm’s operations, outsourcing fund administration is an option that can’t be overlooked.
For mid-tier and large investment firms alike, investor expectations around the flexibility, transparency, accuracy, and speed of reporting is placing a growing strain on back-office resources. Firms of all sizes are struggling to keep pace as investors demand greater access to investment data than ever before.
ILPA raised the bar considerably when it comes to the levels of communication and transparency required, the array of financial data expected, and the frequency with which it is expected, and those standards have transformed investor expectations and back-office workloads.
At the same time, the firm’s ability to meet complex investor reporting requirements has become integral to the firm’s ability to attract future investments. According to EY, between 2014 and 2015, there was a 400% increase in investors who ranked a firm’s ability to handle reporting requirements as the most important selection criteria.4
Beyond alleviating back-office pressure, outsourcing fund administration enables the firm to put its in-house talents to more effective and profitable use. To achieve growth, every function, including the back office, needs to focus on activities that add value.
When the CFO and their team can leave the day-to-day details in the hands of an administration partner, they can focus on supporting key growth levers, including sourcing deals, fundraising, and building strong client relationships.
Outsourcing can also fuel growth by saving costs and freeing up resources, especially for firms in major metropolitan areas where business costs—including office space and staffing—are particularly high. The costs of compliance doubled between 2012 and 2015.5
Many firms explore outsourced solutions only when the issue begins to impact the firm negatively, an approach that can result in a decision made under pressure. Taking a proactive approach, and shifting gears to recognize emerging issues before they become critical, gives GPs time to evaluate their options thoroughly and make a more informed decision.
For a guide to evaluating the options and making the right decision, read this white paper: Fund Administration Outsourcing.
1 eVESTMENT, Alternative Fund Administrator Survey, 2016.
2 2016 Preqin Global Private Equity & Venture Capital Report.
3 PwC, Alternative Administration Survey, 2014.
4 EY and Private Equity International, 2016 Global Private Equity Fund and Investor Survey.
5 The Post Dodd-Frank Act Evolution of the Private Fund Industry: Comparative Evidence from 2012 and 2015.