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eFront’s Tarek Chouman explains how data and information exchange powered by technology will open the door to increased allocations to private markets.
When challenged for detail on metrics like portfolio valuation or processes such as asset selection, to excuse the lack of information available, it is not unusual to hear managers give the time-worn response: “Well, private markets are private.” eFront chief executive officer Tarek Chouman does not agree. He explains how a lack of transparency is hindering data availability, inhibiting information exchange, and ultimately squashing the potential for private markets to grow.
Private markets today are, without exaggeration, around 20 years behind public markets in terms of sophistication and transparency. The industry is inefficient and unstreamlined. It needs to change the way it does business, particularly in the adoption of technology to improve reporting, boost communication between LPs and GPs, enhance the availability of data, and generate analytics. The difference between private and public markets is like the difference between haute couture and prêt-à-porter, but even haute couture has begun to embrace innovations from ready-to-wear fashion.
If managers want to capture a bigger chunk of the available LP capital, they need to address the sophistication gap. Private markets are definitely growing. That’s obvious when you look at the money flowing into them and the number of fundraisings and new entrants. It’s in full thrust. However, private funds still account for less than 10 percent of global AUM. LPs are not reaching their allocation targets. There’s huge untapped potential and opportunity to expand. But, lack of data tools and risk management mechanisms are enormous hurdles. When you don’t know where you are putting your money, you will always be somewhat reluctant to invest more. If LPs want to increase a 5 or 10 percent allocation to 20, 25 or 30 percent, they can’t make a mistake. They need a clear view of the risks and rewards, and to be able to weigh them against each other.
First, the way GPs and LPs communicate. Most GPs still email a PDF report to their LPs every quarter. The most sophisticated may upload the same report to a portal for LPs to download. This means LPs only receive news about their holdings every quarter – and even then there is a possible time lag of around two to four weeks necessary for the GP to collect and process the information. Compare that with public markets where investors receive information in nanoseconds via digital formats. The second obstacle is access to data. An LP invested in a fund or series of funds has to really dig to obtain specific data on its private markets portfolio, let alone apply analytics to it.
It can help the industry achieve more transparency, better risk management, increased automation of information exchange between LPs and GPs, and in general, enhance the ability of LPs and GPs to be more creative and sophisticated. Importantly, data is delivered on time and is therefore relevant.
At the basic level, whether an LP is investing through funds, directly or co-investing, software can facilitate the collection of diverse types of data that describe not just a portfolio company’s financials, but its potential and its constraints. An LP can better monitor and compare its funds including fees and carry, GP performance, and manager benchmarks both within a GP and across multiple funds.
Mainly from LPs. Using the latest technology is critical for good portfolio management and obtaining enhanced returns based on smart analytics, as well as for meeting reporting obligations. GPs are also under pressure to change their practices as they seek to raise ever-bigger funds. Additionally, there is regulatory pressure from the SEC and industry bodies like the Institutional Limited Partners Association to up the volume, rigour and detail of reporting to LPs.
We observe and enable the growing level of complexity of private markets in our solutions. Take our eFront Invest platform for example, which supports LPs, GPs and asset servicers to manage fund operations and reporting. The typical number of LPs committing to a decent-sized, reputable fund used to be around 50.
Today, when we look at the new breed of funds supported by our platform, the average number of investors is closer to 300 LPs per fund. To send 300 LPs a simple call notice, the GP needs an automated process. A manager can’t do it over a weekend using Excel. Completing such a task manually creates 300 chances to make a mistake, like sending the wrong document to the wrong LP. Similar hurdles exist on the LP side. Such a state of affairs is not sustainable.
Depending on their maturity, many GPs are hiring a CTO or CIO. It’s becoming a no-brainer for them to employ someone with a perspective on the right technology and processes that serve the business’ needs. The bigger GPs are also investing in a separate position of chief information security officer to support the CIO. Together they ensure that the IT infrastructure is shielded from external threats and that the technology is up to date, reactive, scalable and fast. Those roles are privileged interlocutors for a service provider like eFront, and they appreciate the level of service and functionality we can provide.
Industry participants are already surrounded by new technology, starting from their mobile phone to their TV. They are moving at a fast pace. Failing to adopt technology is likely going to exclude those GPs, LPs and asset servicers who lag behind.
The ramp-up will be faster than with public markets, simply because private markets can measure themselves against those existing benchmarks. If today we are 20 years behind, in five years we should only be 10 years behind. But remember, private markets will be growing against a moving target. eFront together with BlackRock’s Aladdin technology is best positioned to drive this convergence between public and private technologies.
In the future, we believe, GP back-office staff will shift focus and work increasingly on the analytical side of the business and less on producing reports, sending emails, or generating financial statements. Employees will be more client-facing and involved in decision-making tasks.
The challenge is to move to a new world where managers and investors are open and connected while retaining the market’s uniqueness and level of returns. Some GPs are afraid of revealing their “secret sauce”. We believe transparency and openness demonstrate strength, not weakness. On balance, the value of using more sophisticated technology and automation far outweighs the costs – as we have seen with our eFront Invest and eFront Insight platforms. Technology adoption in order to enable easier information flows between investors and managers is a win-win for all, and a requirement to make alternatives less alternatives, which is eFront’s mission.