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Hedge funds can show private capital funds the way to transparency

1 March 2021

Ian Lynch

Chief Commercial Officer

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Ian Lynch

Chief Commercial Officer

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The increasing demands for transparency we’re currently seeing from investors in the private capital sector has a precedent; hedge funds went through the same experience some years ago.

This is hardly surprising, given that the investors have been the same in both sectors: originally high-net-worth investors who were later joined by more mainstream institutional investors chasing the higher returns that were on offer.

Investor base changed with market growth

As much as private capital funds are seen as having low transparency today, there was a time when hedge funds were noted for this. Of course, it’s fair to say that expectations for transparency have risen in line with technological progress; as technology has allowed for more efficient communication, investors have naturally wanted more frequent reporting.

For example, in the late 1990s, many hedge funds would have posted to their investors a monthly report giving one-line ‘per share’ valuations. In time, this document might have been delivered via fax, then email and now digitally.

Between 1999 and 2008 there was massive growth in the market as the investor base expanded from high-net-worth individuals to more mainstream institutions. Hedge funds’ operating models changed from being somewhat disparate to becoming well-resourced in-house operations.

GFC prompted focus on costs

After the Global Financial Crisis of 2008, however, hedge funds had fewer assets and their business costs were brought more sharply into focus. When costs and efficiencies became issues, they turned to outsourcing.

They recognised they were paid to manage money and not operations. But the operations themselves had matured and become more sophisticated, making the task of managing it more complicated.

The demands of investors had matured too. They had become more powerful and quite rightly demanded more transparency, in more depth and more frequently.

Hedge funds were happy to downsize

Private capital firms, especially mid-sized and smaller ones, are now in the same position that hedge funds were in 10 years ago. They want to minimise costs and maximise profitability as far as possible but are being faced with the same demands from the same investors who now want the transparency and data updates that they receive in public funds. And private capital funds will have to provide it.

Ultimately, hedge funds were happy to downsize their operations. They recognised that having 100 people managing operations in an office did not make a lot of sense. They outsourced quite rapidly and ended up with what they wanted, which was a variable cost base versus their assets.

Rising demand for live/daily updates

New research* commissioned by Intertrust Group in association with Global Custodian casts some light on the extent to which chief financial officers (CFOs) at private capital funds anticipate increasing demands for transparency from investors.

Our findings, outlined in a new report entitled The future private capital CFO: Evolving in a digital age, show that over the next decade, CFOs expect their limited partners (LPs) to require data updates with increasing frequency. Almost two thirds (64%) expect their investors to be looking for access to live or daily updates on portfolio performance, followed by cybersecurity (57%), environmental, social and corporate governance (51%) and operational service level agreements (50%).

Hedge funds do have a major advantage over the private capital sector regarding portfolio valuations. They deal in listed securities, so their prime brokers can provide asset prices easily in real-time to give investors the look-through they want.

In private capital, valuations are quarterly and there is a lot more manual paperwork involved that must be digitised. But LPs want more than just portfolio valuations. They want to understand the risk exposures of the underlying investments, which increasingly is ESG as well as market-related. They want more look-through reporting on the underlying special purpose vehicles (SPVs) and this means a paradigm shift in private capital administration.

Why Intertrust Group?

Intertrust Group offers a unique combination of being a large, listed company with substantial resources but with the flexibility to work as a boutique and offer clients bespoke solutions. We can service LPs and GPs and we are the largest provider of SPVs to the private equity market, administering 18,000 of them in all the main fund centres across the world. We have breadth, end-to-end ability and give LPs and GPs a unique look-through into their funds.

By outsourcing to us, our clients are saved the expense of buying and maintaining a state of the art systems. We buy technology on behalf of 200 fund administration clients, so there is a clear economy of scale.

But while a standard operating model will serve common transparency standards, no two fund managers, or the jurisdictions in which they operate, are the same. Bespoke and local knowledge and flexibility are key in the alternatives space.

Download the report

*Source: Global Custodian in partnership with Intertrust Group; a global sample of 300+ chief financial officers at private capital funds were surveyed between 20 November 2020 and 26 January 2021, including 88 in the US