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The rapid growth of the private markets industry during the last 15 years has supported growing demand from alternative assets managers for middle and back-office support and expertise to support their expanding franchises.

The fund administration sector has been a crucial service provider to managers seeking middle and back-office assistance, but what exactly is fund administration and what services do fund administrators provide?

What is fund administration?

Fund administration involves the third-party provision of middle and back-office services to private equity, private debt, real assets, venture capital and hedge funds.

Managers of these alternative asset funds will rely on fund administration service providers to manage their middle and back-office services requirements so that they can focus on their core, front-office functions of sourcing and executing deals, managing portfolios, securing exits and delivering returns for investors.

Tasks that fund administrators will manage for alternative asset managers include:

Fund accounting
Financial and investor reporting
NAV (Net Asset Value) calculations
Managing capital calls and distributions
Fund compliance
Regulatory assistance
Audit and tax support
Anti-money laundering (AML)
Investor services
Technology and advisory services

What are the benefits of fund administration?

Outsourcing back-office functions to a third-party fund administrator has become more important for alternative assets managers as the industry has grown, and regulatory, compliance and investor demands have increased.

The private markets industry started out as a small, niche asset class, led by entrepreneurial teams of dealmakers who ran their firms with small back-office teams and simple IT infrastructure.

As private markets assets under management have significantly increased, similarly the demands on the operational infrastructure of managers and firms have intensified. Managers require much larger back-office teams and more robust technology platforms to service a larger, more global and sophisticated investor base.

Working with an established fund administrator means that managers can address these rising demands without having to invest large sums of upfront capital expenditure in back-office infrastructure, and take advantage of the global reach, economies of scale and technology infrastructure of specialist fund administration providers.

What are the primary functions of a fund administrator?

The role of the fund administrator is to assist clients by managing the tasks related to fund accounting, investor onboarding and reporting, compliance, and regulatory obligations, while ensuring that all requirements are met on behalf of the firm.

When working with a trusted fund administrator a private fund manager can rest assured that all fund accounting is timely and accurate, that the issuance of capital calls and distributions to investors are prepared, coordinated and delivered, that investor reporting and portal requirements are fulfilled and and that their fund is in compliance with regulatory, know-your-client (KYC), know-your-transaction (KYT), and anti-money laundering (AML) obligations.

A fund administrator’s primary responsibilities will include:

Fund accounting
Investor, regulatory and tax reporting
NAV calculation
Capital call and distribution management
Cash management
Financial statement preparation

In addition to performing core back-office functions and assisting the manager in meeting the obligations outlined in fund documents, a fund administrator can leverage its experience and scale to offer additional, related services that add further value.

Other services fund administrators will provide include:

Transfer agency
Performance measurement
Risk management
Fund formation / set-up assistance services
Custody services
AIFM services

Corporate governance
Software and technology solutions
Compliance services
Investor services and communications
Audit and tax support

These services can free up additional in-house resources, help managers to provide additional financial information to investors outside of set reporting periods and give investors comfort that a manager has strong, comprehensive operational infrastructure in place to support their firm.

Technology and software services are one particular area where there has been a transformation in additional value a fund administrator can offer.

Technology has become a crucial enabler for faster, more comprehensive reporting that investors and regulators require.

Fund administrators, who work with multiple clients across a wide range of asset classes and jurisdictions have built up invaluable experience and knowledge of how to implement configure best-in-breed industry software and help managers to select the best software and technology to meet their bespoke requirements.

This is one example of how the value and services a fund administrator can provide expanded value beyond the foundational disciplines of fund accounting and investor reporting.

What teams are involved in fund administration?

In order to deliver the various services, fund administrators draw on the expertise and skills of a wide range of professionals.

The teams of professionals comprising fund administrations teams will include:

Accountants
Compliance officers
Investors relations specialists
Tax advisers
Cash managers

Corporate services teams
Regulatory experts
AIFM managers
Depositary services teams

The depth and breadth of skills required to manage fund administration is difficult for managers to replicate in-house. Outsourcing to a third-party provider that has economies of scale and can offer professionals with career development opportunities can be a much more efficient way for a manager to access these skills and knowledge.

What are the different requirement for different managers?

Some managers will be raising their first funds or only be managing one or two funds, while other managers will be managing multiple funds across a range of private markets strategies. Fund structures can also vary in complexity and size.

Different investors will also have different requirements. Some investors will demand frequent reporting and portfolio analysis, while for others quarterly reporting will suffice.

Fund administration services can be tailored to the specific requirements of individual managers and their investors.

Fund administration models will also vary by asset class, and each asset class will have its own specific fund administration requirements:

Private equity, real estate & infrastructure and private debt are the main asset-class specific fund administration models.

There requirements are as follows:

Private Equity:

Capital call management
Distribution processing
Waterfall calculations
Deal structuring
Aggregate valuations

Real Estate & Infrastructure:

Property valuation services
Real estate asset management
Lease administration
Property acquisitions services
Real estate financial reporting
Asset management
Infrastructure valuation services

Private Debt:

Loan servicing and administration
Debt fund compliance reporting
Private debt portfolio management
Covenant monitoring services
Credit risk assessment

A stamp of assurance for investors

For private markets LPs the knowledge that a manager has an experienced fund administrator in place provides confidence.

LPs will be familiar with the leading fund administration providers and can ease due diligence requirements knowing their operational knowledge, processes, technology and cybersecurity.

A credible fund administration provider can give a manager’s LPs, who are investing for the long-term, the comfort that a manager has a robust and scalable operational model in place that has been tried and tested.

LPs can leverage third-party administrators to support them in navigating the everchanging regulatory landscape and help them provide transparent and accurate reporting efficiently. Managers working with fund administrators can also benchmark their fund administration costs against market rates, further strengthening investor confidence that back-office functions are not only robust, but also economic.

Fund administration: a key partner in a mature industry

The private markets industry has grown and matured over the last decade, and the expectations of managers when it comes to fund accounting, investor reporting, and regulatory compliance have intensified.

Managers do have the option of keeping these functions in-house and investing significantly in back-office teams and operational infrastructure to keep pace with increasing back-office expectations. For managers that want to focus on the core business of investment management, however, third-party fund administration has become an essential service that frees up managers to focus on creating value for its LPs by doing deals and growing their franchises, all by knowing an administrator provides knowledge that their operations are secure and that they count on the support of the administrator’s reporting and regulatory teams to navigate the various regulations in the jurisdictions a manager is operating in.

If you are a manager seeking back office, technology and operational support, Alter Domus’ Fund Services team is available to discuss how you can future proof your operational model, simplify your back-office infrastructure and harness technology and best-in-breed industry software to its fullest potential.

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Interview

Q Given the rapid growth of private credit, what do managers need to consider when shaping their operating models to take advantage of new opportunities?

There are a number of considerations – not only the outsource versus insource question, and which systems and technologies to engage, but also the allocation of costs. Typically, overheads and internal staff are paid for by the management team whereas fund expenses or middle office administrative costs are borne by the funds themselves. Attempting to reach that balance with the right oversight and the correct cost allocations is a challenge, as is how much control you want over the entire system. Oversight and control can take many forms, managers need to ask themselves whether it is enough to have a small staff overseeing a provider, or whether building an entire oversight operation that oversees everything done by a provider would serve their interests better. Similarly, private credit has far more moving parts than exists in bonds or equities. Obviously, the oversight and investment management is similar, but loans are more complex with multiple tranches, different rates and payments of principal and various sources of income that need to be tracked. Added to that, the information ecosystem that exists for broadly syndicated loans isn’t there for private credit, so you may be in a small group of lenders where the data is not easily recovered, creating its own problems.

The choice of operating model also depends on the size of the manager and their level of experience. The infrastructure required for private credit operations and accounting is very different to private equity. In credit, you need the ability to track portfolios that are very dynamic – an entirely different skillset for accounting and operations staff . Investors now typically require a fund administrator, so the question really is what level of infrastructure is needed to engage and oversee your chosen administrator. At Alter Domus, we use a number of systems. We own innovative technology such as Solvas, which offers integrated accounting, modelling and credit risk solutions, alongside a licensed loan administration platform called Sentry. This means we can support from inside a client’s own portfolio management system – integrating data and sometimes even operating from within the client’s systems. All these options feed into our fund accounting systems, which provide managers and investors with regular reports – either on a monthly or quarterly basis. Clients receive data feeds so they can update their own internal accounting systems. Some clients are very light touch and comfortable with an outsourcing model; others run a full internal operations team that tracks what we are doing daily. There is a cost implication to the latter, but we work to what our clients need.

Q What should managers look at when considering outsourcing versus insourcing options?

Not all fund administrators offer portfolio accounting in their loan administration system, but at Alter Domus, we find that it is key to the core team having enough understanding to be able to check daily. Whether you opt to outsource or run your own team, experience is key, something which we have found is getting harder to find amid the talent squeeze that exists within running private credit operations. Finally, I’d highlight the value in an organization’s ability to manage and track data internally and whether they have the requisite software and IT systems that can support substantial data.

Q How can managers maximize opportunities around technology to support their operations?

We have found that a lot more managers opt for co-sourcing arrangements today, meaning we do the work on their systems. They can trust that they have full transparency and access to everything we do, as well as the ability to seamlessly access the underlying data that we work with. This is becoming the preferred model and more commonplace, as managers can achieve greater efficiencies when they don’t have to manage or hire staff – they are making the investment in the technology but not the headcount.

We have completed several successful lift-outs over the past few years when we took on the staff and cost from a client and updated their systems. In doing this, we construct a revenue model that makes sense for the manager, while giving their people a career path that they might not have access to if they stayed at the fund manager. It is much more important to investor today that they have access, through their manager, to all their underlying portfolio data, so it often makes sense for managers to own that IT infrastructure.

Q What should GPs prioritize for data integration?

Within each GP, there is often a struggle between constituencies. Investor relations teams want a whole set of data around performance and what they can put together for investors; operations teams need enough access and availability to analyze data and satisfy investment professionals; the front office wants feedback on performance of the portfolio assets, and the accounting team need to make sure the fund books and internal books of the manager are up to date. There is no single system that does all those things and satisfying all of those constituencies is huge task. Many of our clients will focus on one aspect first before moving forward with others, depending on their own priorities.

Q How are both LP and regulatory demands likely to evolve going forward, and what can managers do to future-proof their approaches?

It is always risky to speculate on this, particularly in the US, given the political backdrop of a presidential election year. What is clear is that there will be an even greater increase in regulation and oversight down the line, as legacy private credit was historically handled by regulated banks and institutions. Despite the overruling of the SEC regulations, we expect an increase in adoption of the practices and disclosures recommended in them, as well as a heightened focus on how private credit operates with investor money being lent to private companies. Understandably, LPs want more and more. The operational data that we help clients prepare for the more sophisticated LPs is increasingly time-consuming, with requirements for everything from information safeguards through to physical office security. The detail required in these requests is also getting more and more granular. Managers need to have a highly robust framework in place to ensure their internal infrastructure can meet those demands. That means thorough change management investment underwriting and oversight processes, and partnering with service providers that have corresponding policies and procedures. Even more investment is going to be needed into compliance infrastructure, or in partnering with others that have made that investment in a way that can be relied upon.

Private Equity in H2 2024: a waiting game

Tim Toska
Global Sector Head, Private Equity

What to watch out for H2 2024:

Slower than expected rate cuts have kept the PE industry in a holding pattern for the first half of 2024
Secondaries markets and continuation fund deals will remain a crucial source of liquidity through the rest of the year as deal markets adapt to a “higher for longer” rate environment
The reopening of the IPO window and a cluster of high-profile sales to strategic buyers raise hopes that exit market are showing green shoots
A two-tier fundraising market is emerging as investors waiting on distributions focus new fund allocations on a select band of managers

The rebound in private equity M&A and fundraising anticipated at the beginning of 2024 has yet to materialize, but dealmakers remain hopeful that momentum will build in the months ahead.

The PE industry entered 2024 on the back of a challenging 24 months where buyout and exit deal value declined for two consecutive years as inflation and rising interest rates drove up deal financing costs, decreased appetite for risk and spark dislocation in pricing expectations between buyers and sellers.

At the end of 2023 hopes built that cooling inflation would lead to a series of interest rate cuts in 2024, the first coming as early as May 2024, but hawkish central banks have been reluctant to cut rates early, with the US Federal Reserve signaling that there may only be one interest rate cut this year.

Deal activity green shoots

Slower than anticipated rate cuts have put the expected rally in PE deal activity on hold, but even though many dealmakers have opted to sit tight through the first six months of the year, buyout and exit activity has shown some early green shoots, putting the market in a better position than it was 12 months ago.

According to White & Case figures, global buyout deal value for Q1 2024 came in at US$165.73 billion, ahead of the US$144.65 billion posted in Q1 2023. Exit value also improved year-on-year, but only marginally, up from US$57.48 billion in Q1 2023 to US$59.17 billion over the first three months of this year.

A rally in equity markets and the reopening of the IPO market have helped to kickstart PE exits back into life, according to Bain & Co, with jumbo IPOs such as EQT’s US$2.6 billion listing of Galderma Group delivering large exits for managers.

There can be no arguing, however, that exit markets will have to build more momentum in coming months to clear backlogs of unsold companies and improve distributions to LPs.

Bain & Co analysis of funds at 25 of the world’s largest buyout firms shows that the number of portfolio companies held by managers has doubled during the last decade. Managers will be hoping that deal markets fully reopen sooner rather than later so that portfolio companies can be exited and distributions to LPs improved.

Flat fundraising

A rise in exit activity and distributions to LPs will be a catalyst for improving fundraising conditions. According to PEI’s Q1 2024 private equity fundraising report, fundraising over the first quarter of 2024 slipped to US$176.7 billion, down from US$195.5 billion in Q1 2023 and the third-lowest quarterly total since 2019.

LPs haven’t turned off the taps completely. EQT, for example, hit the €22 billion hard cap for its latest flagship fund (and largest ever) early 2024, with other blue-chip names including Cinven, BDT Capital Partners and Apax Partners also closing new flagship funds in the first half of 2024.

With a cohort of big names scheduled to wrap up funds that are currently on the road in the coming months, PEI anticipates that fundraising numbers will improve through the course of the year. This, however, does not mean that fundraising is getting any easier, with a two-tier market emerging as investors focus on making allocations to select managers, while other firms have had to spend longer on the road to coral sufficient support.

Alternative liquidity routes provide breathing room

The slower than hoped for reopening of traditional exit markets has been mitigated by steady activity in the secondaries space, which has continued to provided managers and LPs with opportunities to take liquidity and keep the PE ecosystem ticking over.

According to PJT Partners, secondaries deal volume was robust in Q1 2024, climbing by around 20 percent year-on-year as LPs continued to turn to secondaries markets to realize portfolio assets in a low distribution environment.

A surge in exits via continuation fund structures have also provided a welcome source of liquidity, as managers take up opportunities in a flat exit market to put prized portfolio companies into continuation funds that provide investors with the option to take cash proceeds or retain exposure. According to Pitchbook, 27 continuation fund deal progressed in Q1 2024, more than double the 13 continuation funds deals posted in Q1 2023. Some managers also continue to explore other novel options to unlock liquidity for investors, with NAV finance (where managers take out loans against fund assets) one pathway that has been used to fund distributions.

Patience required

Alternative routes to liquidity are expected to remain a busy area of the market through the second half of 2024, but managers who have had assets lined up for sales through traditional exit routes will be hoping that deal markets do finally reopen.

Big exits such as the US$18.25 billion sale of roofing supplier SRS Distribution to The Home Depot by Leonard Green & Partners and Berkshire Partners do point to signs of strategic sales defrosting. With buyout managers sitting on US$1.1 trillion of dry powder, secondary buyout activity will also have to increase eventually.

Deal markets may be a long way off matching the red-hot activity levels and valuations of 2021, but managers will only be able to hold off on new investments and exits for so long.

As stakeholders accept that interest rates will be higher for longer, and recalibrate pricing expectations and risk appetite accordingly, deal markets should fall back into balance and get the PE industry moving in earnest again.

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Private Debt in H2 2024: back to basics

Greg Myers
Global Sector Head, Debt Capital Markets

What to watch out for in H2 2024:

Private debt managers will see steady deal flow and opportunities to underwrite deals at attractive yields – but competition is intensifying
Loan margins will compress as banks return to market and syndicated loan markets reopen
Defaults in private credit will start to climb, putting more pressure on lender portfolios
Market consolidation is anticipated as scale becomes increasingly important for deal origination and managing stressed and distressed credits

Private debt has been one of the few beneficiaries of climbing interest rates, but while attractive risk-adjusted returns remain on offer, deploying capital will be more challenging the months ahead.

Through the course of 2023 banks and syndicated loan investors pulled back from underwriting in the face of economic uncertainty and rising interest rates, leaving the way open for private debt funds to gain market share and finance larger tickets. According to Barclays, private debt managers financed 84 percent of US middle market leveraged buyouts in 2023, the highest market share in decade.

Private debt managers have not only gained market share, but have also been able to secure highly attractive risk-adjusted returns. With base rates climbing to above five percent, the typical floating rate structures used in private debt loans have produced yields of around 12 percent, according to analysis from FS Investments, putting the class in a position to produce equity-like turns with lower risk.

Margins compress as competition intensifies

Looking ahead to the rest of 2024 and into 2025, slower than anticipated rate cuts will see private debt managers continue to source deals with attractive yields, but the strong tailwinds that carried the asset class in 2023 will begin to ease.

Peak interest rates coupled with soft landings for the US, and European economies have seen momentum return to syndicated loan markets, with banks and investors moving to regain market share ceded to private debt players during the last 12 to 18 months. US leveraged loan issuance was up 63 per cent year-on-year in Q1 2024, while European leveraged loan markets showed gains of 50 per cent year-on-year for the first quarter, according to White & Case figures.

As syndicated loan markets have reopened, borrowing costs have edged lower, with White & Case reporting tighter margins in both US and European leveraged loan market.

Margin compression has filtered into private debt as managers have encountered more competition. Bloomberg reports that average margins for private debt loans issued during the last 12 months have come down by 0.5 percent when compared to margins on loans issued between one and two years ago.

This is by no means a disaster for private debt (direct lending activity remains robust, and issuance has continued to grow through the course of 2024, but tightening margins do point to narrower yields in a more competitive market where private debt managers don’t have it all their own way.

As competition intensifies, private debt managers are expected to sharpen focus on their core middle-market lending franchises. As the large cap end of the market sees more competition, managers will see more flow in the less liquid middle-market, which more insulated from the resurgence in syndicated loan issuance.

Lending to borrowers with Ebitda of less than US$100 million will be an active and attractive part of the market for private debt managers, as there is less competition from syndicated loans for these smaller credits, giving managers more scope to protect margins.

Dealing with defaults

In addition to navigating more competition and tighter margins, the next 6-12 months are also expected to see private debt funds encounter more stress and default risk in current portfolios.

S&P Global Ratings notes that while deal flow remains abundant for private debt managers, defaults and negative ratings are forecast to climb to multi-year highs in 2024, testing portfolios and returns.

An uptick in private debt default rates would place a natural check on the rapid growth of the private debt industry over the last five to 10 years. Investors allocated more than US$200 billion to private debt from the start of 2021 to the beginning of 2024, according to S&P, growing the industry into a US$1.7 trillion asset class.

This has seen the number of private debt managers proliferate, with Preqin tracking more than 1,300 private debt managers in North America alone. Bank retrenchment, low defaults and high yields have created a ‘goldilocks’ environment for new entrants, but as these favorable drivers moderate, a winnowing of the market is set to follow.

Value of scale to drive consolidation

Established managers with proven track records, who have built platforms of scale, will be well positioned to navigate this shift in market conditions.

Smaller players, however, who do not have the scale and fee income to invest in deal origination and distressed credit workout infrastructure will find it more difficult to source transaction flow and protect portfolio value in a more “normal market”.

Big platforms also benefit for the ability to run multiple strategies, such a distressed debt and specialty lending, alongside direct lending, which is the largest strategy in private credit, but is also the most competitive. Firms with more than one strategy are more diversified and have a wider range of options when it comes to raising and deploying capital across economic cycles.

The emerging bifurcation between large private debt platforms and smaller firms is set to lead to a period of consolidation in the asset class, as smaller managers move to team up with larger private markets peers, and big platforms leverage acquisitions to grow assets under management (AUM) and broaden out into new geographies and investment strategies.

Private debt continues to offer attractive yields and protection against downside risk, but scale and track record will become increasingly important as predictors of manager longevity and performance in the months and years ahead.

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Real Assets in H2 2024: holding Steady

Anita Lyse
Global Sector Head, Real Assets

What to watch out for in H2 2024:

Real estate and infrastructure portfolios hold steady in high-rate environment
Deal activity and fundraising tepid as anticipated rate cuts decline
Fast-approaching debt maturities will absorb GP bandwidth
The long-term megatrends of ESG and decarbonisation will drive sustained growth and investment opportunities

Slower than anticipated interest rate cuts have tempered hopes for a revival in real assets investment activity and fundraising in the first half of 2024.

Global infrastructure and energy asset M&A registered a 24.3 percent year-on-year decline in the first quarter of 2024 according to IJGlobal; while JLL recorded a 6 percent year-on-year decline in global real estate direct investment in Q1 2024, and a 34 percent decline on a trailing 12-month period.

Fundraising has been equally challenging, with real estate funds only raising US$19.8 billion in Q1 2024, the lowest quarterly takings since 2011, according to PERE. Infrastructure fundraising performed better, climbing from US$8 billion in Q1 2023 to US$27 billion in Q1 2024, according to Infrastructure Investor. The strong rally in Q1 2024, however, masks what was still the second-worst first quarter for infrastructure fundraising in five years, and the fact that many of the managers that closed funds in Q1 only did so after lengthy periods on the road.

Steady performance and a brightening outlook

Real assets portfolios, however, have sustained steady performance despite the impact of rising interest rates on investment activity and fundraising.

Infrastructure returns have dropped into single digits, according to the CBRE, but have weathered rising interest rates and continued to deliver predictable, low-risk cash flows for investors. Schroders, meanwhile, sees property total returns registering 4% to 5% in 2024, and rising to between 7% and 9% from 2025 to 2029.

Resilient portfolio performance positions real assets managers well to take advantage of opportunities that will arise when M&A markets eventually do reopen.

Even though sticky inflation has meant that interest rates have not come down as quickly, or by as much, as anticipated at the beginning of 2024, there is confidence that rates have now peaked, with rate cuts on the way. The European Central Bank (ECB) has already trimmed rates in 2024, with the Bank of England and US Federal Reserve expected to follow suit in H2 2024.

As rate cuts begin to come through, real estate and infrastructure dealmaking should finally revive, making it easier for managers to sell assets and return proceeds to investors. Increases in distributions will have a positive impact on fundraising, as LPs get back to reinvesting proceeds in the next vintage of funds.

Through this period of low transaction volumes and low fundraising in real assets, managers have also adapted and kept busy by developing real estate and infrastructure debt strategies, forming joint venture partnerships, and executing deals through separate accounts and deal-by-deal arrangements.

Maturity wall looms

Even if real assets M&A markets are set to rally, one looming cloud on the horizon for managers will be refinancing current borrowings as debt maturities come into view.

According to MSCI figures reviewed by asset manager LGIM, around £130 billion of UK commercial mortgages will mature between 2024 and 2026, with the equivalent figure for the US is sitting in the US$1.4 trillion region.

For many issuers, these maturing debt tranches will have been issued at the peak of the credit cycle, when borrowers could take on relatively high levels of leverage at low financing costs. Borrowers that have to refinance will find that borrowing costs are significantly higher, and that the amount of leverage available is down. It will be difficult, then, for investment managers to maintain existing capital structures for their portfolio on the same terms.

This will not necessarily lead to defaults but is likely to see higher financing costs and an uptick in amend-and-extend deals, equity cures, and repricings, which will put strain on cashflows and stretch manager resources.

Going Green

There are certain subsectors within real assets, however, that are expected to ease through near-term refinancing pressures and navigate the transitional period out of the cycle of interest rate hikes.

Infrastructure investments facilitating decarbonization and energy transition have sustained ongoing investor interest through recent periods of market dislocation and are expected to continue enjoying strong investor and lender support through the rest of 2024 and into 2025.

According to LGIM, countries representing 90% of the world’s population have committed to net-zero targets, and in the US and Europe substantial subsidies have been made available by governments to accelerate the shift.

The long-term, strategic priority placed on net zero by policymakers has seen energy transition emerge as one of the most resilient areas for investment during the last two years.

CBRE notes that the five largest project finance deals in 2023 were all linked to energy transition, while an Infrastructure Investor survey found that renewables ranked as the most popular segment for LP infrastructure allocations.

In real estate, meanwhile, ESG is becoming an increasingly important differentiator, with research from JLL indicating that office buildings with sound green and energy efficiency credentials are able secure higher capital values and rents. Similar trends have been observed in logistics assets, where Savills has found that 90 percent of tenants in logistics real estate are prepared to pay a premium for sustainable buildings.

In a real assets market that is still finding its feet after a period of climbing interest rates, ESG and energy transition will remain the core drivers of fundraising and deal activity, even as other parts of the market spring back to life.

The Real State of Real Estate

The real estate market has offered many challenges in recent years. Here we assess the opportunities beginning to arise and the role of advanced services and technology on your operations.

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After a challenging two years punctuated by rising interest rates and post-lockdown dislocation, there is cautious optimism among real estate investors and operators that markets are stabilizing.

As green shoots start to emerge, Alter Domus assesses and compares the key drivers of growth and investment opportunities across the US, European and Asia Pacific markets.

United States

Even though interest rates in the US have not come down at the pace anticipated at the end of 2023, US real estate markets have enjoyed a sense of renewed confidence in 2024 as investors have built comfort on asset pricing and sought to resume capital deployment after stepping back from new deals in 2022 and 2023.

Office

Despite an improvement in overall sentiment across US real estate, the office sub-sector has remained challenging, with investors and operators not only having to adjust to a higher interest rate environment, but also the secular shift in office space demand following pandemic era lockdowns.

According to CBRE, tepid economic growth and the entrenchment of hybrid and homeworking have put the brakes on demand for office space and driven up vacancy rates. CBRE forecasts show vacancy rates climbing to almost 20% in 2024, with a survey of US office occupiers highlighting plans to reduce office space through the course of 2024.

Slowing demand has already filtered into new build activity, with Cushman and Wakefield figures showing that construction pipelines have fallen below 50 million square feet (MSF) – the lowest levels since 2013.

The US office real estate slowdown, however, is not universal, with certain locations and categories proving resilient and continuing to grow.

CBRE, for example, has observed steady growth in the Las Vegas market, where a business-friendly tax regime has attracted new companies and driven up office-using employment. Miami is another hot market, with asking rents showing year-on-year growth of around 6%, with the Nashville market also enjoying steady demand for office space.

Logistics

Demand for US logistics real estate has trended lower during the last 12 months, with Prologis analysis estimating demand at 195 million square feet at the end of 2023 – below the 490 million square feet of new space that became available as projects launched in 2022 reached completion.

Vacancy rates have also edged higher, but there is an expectation that vacancies will peak below long-term averages this year.

The continuing growth of global e-commerce sales, and ongoing efforts to “near-shore” supply chains in the face of rising geopolitical tensions, will support long-term rent growth, which although down from the levels observed at the peak of the market in 2022, has settled above pre-pandemic levels in North America, according to JLL.

Ongoing demand for sites that meet best practice ESG standards, and can support increasingly specialized warehouse picking and packing technology, are also set to spur ongoing investment.

Retail

The long-term secular shift to online shopping has continued to weigh on US retail space, with Colliers recording an increase of 10 basis points in US retail real estate vacancy rates in Q1 2024.

There is a growing sense, however, that the retail real estate space may have bottomed out, with supply-demand dynamics shifting back in favor of landlords, particularly for space in prime locations and high-end shopping malls.

According to JLL leasing rates have reached 35.1% in 2024, an improvement on rates for the prior 12 months. Demand for small spaces of less than 2,500 square feet has proven particularly robust, with casual dining and fast-food chains snapping up these smaller spaces.

Regionally, JLL has also noted strong growth in markets across the Sun Belt, where rising populations and strengthening buying power have supported steady demand for retail space.

Residential

US house prices have proven remarkably resilient through the rising interest rate cycle, and even though mortgage costs have increased, the National Association of Realtors anticipates that house prices will still edge higher by around 2.6% in 2024.

Apartment occupancy rates are also expected to remain robust and well-above the 90% threshold according to the CBRE.

Investors and developers, however, are taking the time to ensure that investment in additional residential real estate construction is targeted in the right areas, with demand bifurcating between different regions.

CBRE, for example, notes that rental growth and occupancy rates for multifamily real estate is expected to be strong in the Midwest, Northeast and urban centers of New York, Washington D.C. and Chicago, whereas the Mountain and Sun Belt regions, where supply-demand imbalances are less acute, will see softer demand and rent growth.

Europe

After a year of inflationary and interest rate headwinds, as well as weak economic growth, European real estate markets have stabilized in 2024. Even though the European Central Bank (ECB) did cut rates for the first time in almost five years in June, macroeconomic uncertainty continues to linger and drive a delta between buyer and seller valuation expectations, according to asset manager abrdn. But with the value of real estate assets relative to government bonds improving, a pathway back into the market is opening up for investors.

Office

As has been the case in other regions the combination of a higher rate environment and increased homeworking post-COVID have proven challenging for office real estate in Europe.

According to abrdn, take up of European office space was down by almost 20% year-on-year in 2023, and some 16% off the long-term average.

The downswing in European real estate office space has not been universal, however, with demand for prime office in key locations continuing to show growth.

Prime office yields have rallied strongly from the lows of 3.2% seen at the trough of the market in the middle of June 2022, improving to 4.6% by the end of Q1 2024, according to BNP Paribas figures.

Logistics

The last 12 months have been a period of reset and recalibration for the European logistics sector after a red-hot period of activity immediately following the pandemic.

Weak economies across the region coupled with the topping out of online shopping growth have resulted in lower new build supply coming to market, as developers readjust to softer demand.

Rents, however, are still growing and according to CBRE are set to expand by 4% in 2024, which is well below the double-digit rent growth observed at the top of the market, but more in line normal run rates. Regional trends are also emerging, with CBRE anticipating that Italy, Germany and Spain will see the biggest jumps in rental growth in 2024.

Certain segments on the market are also performing better than others, with modern units that meet high ESG standards attracting more attractive rents than older sites in need of refurbishment. CBRE anticipates that widening gaps in rents will lead to a two-tier market.

Retail

The long-term secular headwinds challenging European retail real estate have shown little sign of abating, with abrdn recording an increase in shopping center vacancy rates to 12.7% by the end of 2023.

With the market at a low ebb, however, there are opportunities emerging to invest at attractive entry valuations. Retail real estate attracted just under a fifth of total real estate investment in Europe in 2023 – a meaningful increase that points to the potential value still on offer in the segment for investors.

Indeed, JLL notes that prime shopping center and retail park sites in Europe have continued to deliver attractive yields through the investment cycle, and outperformed other categories such as office and industrial assets. With corrections in rental rates having already worked through the market, there is also room for rental growth in the coming months and years.

Residential

Population growth in urban centers has provided a solid foundation for residential real estate in Europe’s capitals, with the CBRE forecasting a 3% rise the number of households in major European cities during the next five years.

These solid underlying fundamentals have made residential real estate one of the most resilient industry segments through the rising interest rate cycle, and while new rent regulations do pose risks for investors, vacancy rates in Europe’s top thirty cities have been low, and some cities have seen double-digit rent growth, according to abrdn. Limited new supply across Europe has supported rental growth and industry cashflows.

As has been the case on logistics, however, sustainability is a looming challenging for residential landlords and investors, who may have to make significant investments to upgrade existing housing stocks to meet higher emissions and environmental standards.

According to CBRE, the European Commission’s Energy Performance Buildings Directive (EPBD) demands that all homes across the EU will have to meet energy performance certificate ratings (EPC) of class E by 2030 and class D by 2033. At present, a quarter of European housing stock is below class E, with a further 49% below class D.

In addition to absorbing extra cots to upgrade properties, investors will also have to be alert to the risk of assets that are lagging on ESG being cast adrift as demand for ESG compliant properties grows.

Asia-Pacific

Asia-Pacific’s (APAC) real estate industry has felt the chill of rising interest rates in the US and Europe, and has also had to manage the fallout from a liquidity crisis in the core Chinese real estate sector, which has seen once blue-chip developers fall into default and liquidation, with severe knock affects for investors and the wider economy.

Office
Macro-economic headwinds have taken a heavy toll on APAC’s office market, with average prime rates falling to 3.2% year-on-year in Q1 2024. According to Knight & Frank this represents the seventh consecutive quarter of declining rates. China’s tier-1 cities have been in the frontline of for the downswing, but few APAC jurisdictions have been insulated, with Singapore, Melbourne, Sydney and Tokyo all suffering rental rate declines, according to abrdn.

Prime office sites in Seoul have bucked the trend, with sustained demand keeping a lid on vacancy rates, while in Australia investors are still deploying capital in selected prime office assets. Overall, however, the market is set to remain challenging, with Knight & Frank forecasting that vacancies will continue to edge higher as new supply continues to flood the market.

Logistics

Logistics real estate has been an indirect beneficiary of the tough conditions facing the office segment, with international investors shifting allocations away from office and into logistics.

According to CBRE, logistics leasing in China has held up well, with international e-commerce businesses, third-party logistics (3PL) providers and manufacturers all supporting demand. 3PLs and e-commerce companies have also sustained demand in Korean market, although an oversupply of space has kept vacancy rates elevated. Occupiers are, however, pivoting towards shorter leases in the face of macro-economic risk.

The broadly stable backdrop has supported healthy demand for logistics space across APAC overall, with Savills reporting year-on-year increases of more than 20% in logistics and industrial real estate absorption rates (the amount of space leased less the amount of space vacated).

Retail

Retail has been another bright spot in APAC real estate markets, with abrdn reporting year-on-year rental growth of close to 6% at the back end of 2023.

Momentum from the lifting of lockdowns and the reopening of tourism has supported the retail segment, and the outlook for leasing pipelines is positive, with a CBRE industry survey showing that two-thirds of retail brokers are reporting increases in leasing enquiries and site viewings.

The market is, however, splitting into two tiers. In Hong Kong, for example, demand for prime locations and tier 1 high streets has been strong, according to CBRE, whereas sites that fall outside these locations are encountering high vacancy rates.

Residential

Growth in urban populations is set to carry APAC residential markets through near-term headwinds, with long-term housing demand in cities boosted by forecasts that 19 cities in APAC will have populations of 10 million or more by 2030, according to Knight Frank analysis.

The favorable long-term demographics buoying residential real estate have shielded valuations from wider market dislocation, with Knight Frank reporting dips in pricing of less than 1%.

These solid fundamentals present an attractive mix of investment opportunities for, according to abrdn, ranging from hotel-to-rental apartment conversions in China to multifamily opportunities in Japan’s largest cities.

Now that we’ve set the scene for the current deal environment and fundraising conditions that real estate asset managers are encountering, we turn our attention to another real estate trend shaping these fund managers’ challenges and opportunities: the specter of refinancing

With the outlook for real estate deal activity and fundraising improving, the biggest financial challenge facing real estate investors in the coming quarters will be refinancing.

Billions of dollars of real estate debt – issued at bargain-basement rates at the peak of the credit cycle in 2021 – will mature in the next 12–36 months and must be refinanced at much higher costs.

According to Morgan Stanley analysts more than US$1.5 trillion of commercial real estate debt falls due for repayment before 2025. The delta between office and retail property valuations at the top and bottom of the market could be as wide at 40 percent, according to Morgan Stanley, resulting in heightened risk of default across the sector.

In this article, we explore the challenges real estate asset managers face as a result and the resources they can seek out to help mitigate the impacts.

The road from low rates to daunting refinancing

As interest rates hit new lows in 2021 in reaction to a Covid-rattled economy, real estate managers saw their investment target options open up.

Alongside the boon for real estate, private debt strategies experienced a rush from managers and investors eager to take part in the attractive terms. Real estate debt wasn’t left out of that equation. Managers with pure real estate strategies hurried to stand up debt strategy arms to meet soaring investor demand while those already raising real estate debt funds basked in the rush on their fundraising efforts.

Now, three years down the line, real estate managers and real estate debt managers alike are staring down the maturities of their loans.

Banks and capital markets are not completely shut, and there will be liquidity available to refinancing these debt maturities, but with interest rates settling at elevated levels relative to the last five years, interest rate coverage ratios could be a factor in determining whether senior loan and bond lenders will be able to fully refinance maturing debt facilities.

This could open up opportunities for junior capital providers to gain traction in capital structures, with mezzanine and preferred equity as some of the solutions that real estate companies could turn to when topping up capital structures.

As in the fundraising space, the upcoming refinancing wall could also lead to a split in the market between haves and have nots. Real estate borrowers in resilient sub-sectors that exercised restraint at the peak of the credit cycle should find refinancing relatively straightforward.

As one example of a resilient subsector, also mentioned in our previous article, the data center real estate market continues to perform, especially as we increasingly integrate AI and machine learning features into our daily lives and create a greater need for physical computing space to power that demand.

Borrowers that took on leverage too aggressively and are in weaker performing real estate sub-sectors will find it much more difficult and could encounter financial stress and distress. For example, many employers are still allowing for hybrid or fully remote work post-pandemic, and the office building sub-sector is still under close watch by the industry for fear of a crisis when these loans come due. Rebound rates can vary vastly city by city.

Arm your firm with resources and industry expertise

In a long game like real estate investing, we all know there will be times of feast and times of famine. Real estate managers can’t control the macroeconomic factors – only the way in which they run their funds, select their investments, create value, and manage risk.

When facing headwinds like the impending wall of real estate debt maturities we find ourselves with now, it’s essential to focus on the operational elements that are under a firm’s control. In getting back-office operations in order, funds can free up their teams to focus on value-added activities rather than getting bogged down in the administrative and technical challenges that come with managing a complex portfolio of properties.

Alter Domus has guided real estate managers through multiple cycles of the market over the last two decades. We’re prepared to help you operate through this challenging credit market with your choice of service model – outsourcing, co-sourcing, and lift-outs – as well as full back-office services including fund accounting, loan servicing, transfer agency, and far more.

Ready to empower your staff to outsource challenging workflows so they can work on higher-value problems and processes? Reach out to our team to start a conversation.

The real estate sector has endured a volatile 24 months, with real estate operators and investors not only having to manage the impact of higher interest rates on the sector, but also the long-term changes to real estate usage sweeping across the industry following the pandemic.

In the face of these multiple headwinds, global private market deal activity fell 47 percent in 2023, with real estate fundraising falling by almost a third year-on-year.

As the industry emerges from this period of dislocation, however, the outlook is improving. Interest rate stability will help to bring mainstream buyers and sellers back to market after a year of pausing for breath; while investors with the conviction to pursue deals in a still unpredictable market could be rewarded with bargain valuations.

Interest rates remain elevated from recent levels, but amidst uncertainty, real estate opportunities are emerging for savvy real estate players.

In this article, we’ll explore how three key facets will shape these opportunities in the months ahead and drive real estate fundraising and transaction activity.

Deal volume rebound in the right sectors

Real estate dealmakers stayed cautious and deal volume remained low as we moved into 2024. However, interest rate stability (even in a scenario where anticipated rate cuts are delayed) can help to support a recovery in certain real estate deal markets under the right conditions, such as residential real estate and industrial real estate. As vendors and buyers align on valuations and form a clearer picture on how to price risk and build deal structures, we hope and expect to see the same effects roll out to the broader real estate space alongside these stabilizing interest rates.

While Q1 2024 still saw a 6 percent year-over-year decline in deal volume, as JLL reported, “the pace of declines continued to moderate across the Americas and EMEA, an early signal of growth.” We’ve seen a cluster of high-profile real estate deals progressing this year to support this outlook.

In one of the largest real estate transactions since the pandemic, Abu Dhabi investment fund Lunate and Saudi Arabian firm Olayan Financing Company acquired a 49 percent stake in ICD Brookfield Place, the iconic Dubai office tower. Deal value was undisclosed, but Bloomberg reports that the property has been valued at an estimated US$1.5 billion.

Other notable deals in 2024 include Blackstone selling the Arizona Biltmore Hotel to UK-based real estate manager Henderson Park in a deal reported to be worth US$705 million, and investment manager Ares and landlord RXR forming a joint venture to invest in New York office buildings.

Real estate dealmakers will be cautiously optimistic that an improvement in Q1 2024 real estate transaction activity will carry through into the rest of the year.

Fit for fundraising

As real estate markets reopen, managers will hopefully be in a better position to realize portfolio assets and increase distributions to investors.

Increasing distributions will in turn put investors in a better position from a cashflow perspective, and more able to recycle distributions into the next vintage of real estate funds.

Fundraising, however, is likely to continue tracking trends observed in 2023, where the market bifurcated in favor of large real estate platforms or managers running specialized and distinctive strategies.

Through the headwinds that faced the market in 2023, investors moved to consolidate manager relationships and coalesced around large platforms, enabling large cap real estate managers to continue closing jumbo funds despite the large drop in overall fundraising. According to McKinsey, five managers accounting for well over a third (37 percent) of closed-end real estate fundraising in 2023.

Large managers are set to continue dominating fundraising, but investors are also looking for exposure to specialist strategies, with analysis from PERE showing that a higher proportion of sector-specific funds are closing or exceeding target sizes than generalist funds.

Shifting usage patterns

Looking at the challenges facing real estate from an operational perspective, the sector is still grappling with how to adjust to the shifting usage patterns that have reshaped real estate following COVID-19 lockdowns.

Home working habits have become entrenched following the lockdowns, putting severe pressure on office space valuations, while the ongoing shift to online shopping has had severe impacts on retail space.

Inflationary pressures, cost of living and supply chain disruption, meanwhile, have made for a choppy logistics market, where demand has slowed and higher vacancy rates have been reported, according to JLL.

But while some real estate sub-sectors have suffered severe dislocation, others are thriving.

The data center market is red hot, with CBRE forecasts showing demand rising to record highs in 2024 as vacancies fall to all-time lows, supporting robust rental rates. Strong demand from large cloud computing service providers serving the market with computing power and data storage at enterprise has shown no sign of slowing down and bodes full for sustained growth in the data center space.

Other strong performing areas include purpose-built student accommodation, where investors have seen strong operating performance and demand after lockdown restrictions eased and campuses reopened, with demand for life sciences lab space also high, underpinned by advancements in diagnostics, personalized medicine and genetics.

Shifting usage patterns, however, will also provide opportunities for contrarian investors who have the conviction to lean into sub-sectors deemed “unfashionable” and back assets at attractive valuations.

Contrarian investment opportunities could include retail and shopping center assets that have survived the last decade and proven their resilience, or Chinese real estate, which has gone through a severe liquidity squeeze but may now be coming out the other side.

Overall, market dislocation has increased real estate investment risk, but also opened opportunity.

Take on real estate industry challenges with Alter Domus

The real estate sector has encountered considerable challenges in the past few years but signs of promise continue to emerge. To make the most of the emerging opportunities and push through the trials, having a trusted partner on your side is essential.

At Alter Domus, we have decades of experience in weathering the ups and downs of the real estate market and providing essential fund services through challenging times, from fund administration and property accounting, to AIFM services and depositary offerings, and more.

Reach out to our real estate services team to learn more about how we can help.

technology data on boardroom screen plus people in meeting

Interview

Q You have recently joined Alter Domus as chief technology officer. What background do you bring to the role, and how is that perspective useful for Alter Domus and its clients?

Most recently, I was a chief technology officer at Wells Fargo bank. Before that I was the CTO of the financial data and software company FactSet, which was my final role there over a 20-year period. In these positions I’ve been involved with a vast array of initiatives, from developing mobile capabilities and addressing challenges such as identity protection and fraud prevention to developing and executing artificial intelligence strategies and implementing generative AI.

Alter Domus is my first experience in a private equity-owned company. The mandate of the senior team here is clear: how do we use technology to make our services more efficient, more intuitive, and more impactful for our clients?

At Alter Domus, my team owns all the technology and app development efforts for the business, as well as the data analytics and engineering and some of the product strategy from a technology perspective. The goal is to help continue to scale an already rapidly growing business and drive several transformative initiatives, with one area of focus being the data and analytics business, where we see a lot of potential.

Q What is your perspective on AI and its adoption in private markets?

AI has been fundamental to many companies and products for a number of years. Companies such as Tesla have been working on self-driving vehicles for more than 10 years, and those are inherently AI-enabled. So, AI is not new.

What has changed is that last year saw probably one of the most successful marketing campaigns ever launched when Open AI unveiled its initial version of ChatGPT. We all started talking about generative AI and what ChatGPT would mean for us. Adoption of that tool went from zero to 100 million active users in just two months, making it the fastest growing consumer application in history. That showed the art of the possible with generative AI, and immediately drove that conversation in boardrooms.

Right now, what is important for business is to thoughtfully manage the gap between AI hype and practical business applications. Businesses need to prioritize opportunities in order of obtainability and then manage communications with stakeholders to create meaningful outcomes. Too often, companies become focused on what’s new, rather than what’s best, or more to the point in Alter Domus’s case, what’s best for our customers.

Q What steps are service providers like Alter Domus taking in AI?

We believe that before any concrete actions are taken in AI development, governance issues have to be addressed. Protecting both our clients’ data and business at large as well as our own is of the utmost importance.

It’s best practice to have a formal and mature intake process for AI applications and a multidisciplinary panel that considers and prioritizes opportunities for the business, as well as any implementation guardrails and cyber-security considerations. That panel should include representatives of technology, business, regulatory compliance and HR. Putting that disciplined collective effort into mitigating risks like data leaks or data breaches is essential.

The other element of this is the technology itself. The way a company like Alter Domus approaches that is with a platform construct. Instead of focusing on underlying infrastructure (such as GPUs), we chose to partner with cloud providers that offer robust ‘out of the box’ solutions that enable us to experiment, validate, and deploy AI solutions with little friction. Leveraging our partners that have robust end-to-end services that aggregate versus trained or partially trained algorithms is a smarter method for us.

For example, we have a relationship set up with AWS using some of their services, such as SageMaker and Bedrock, which deliver pre-packaged platforms of large language models. That is central to our strategy because we get immediate access to enhanced technology and capabilities.

One of the ways we approach AI governance is to consider use cases in three buckets: ready-made solutions we can buy (such as co-pilots that can be easily integrated into our workspace productivity tools); capabilities and tools, built by Alter Domus, that enhance the efficacy of our employees’ service delivery to clients; and AI capabilities embedded into products, delivering sophisticated analytical capabilities and meaningful insights to our clients.

Q Why is private credit a particular area of focus, and what advances are being made there?

We feel the private credit space really lends itself to the last two of those three categories. There are tens of millions of unstructured documents and data sources in private credit, with many in PDF, Excel or even fax format.

We have a product called Digitize that processes 30 million documents, extracting, classifying, and incorporating content into client-facing products. Then it becomes easier to use generative AI and the analysis of that data requires less human input, leading to better outcomes, faster turnaround times and cost savings for clients.

Q Is AI replacing humans in the use cases you see?

I think for the foreseeable future, AI is about creating substantially better tools for humans to use, but we still need humans. Instead of using manual tools to deliver outputs, you can speed up processes and get more reliable results using AI, and that is more rewarding work for the humans involved.

For now, we still need humans to oversee those processes, to check that AI is working properly, which means there is an upskilling opportunity and AI is simply taking away the more mundane elements of tasks. In the longer-term, AI will free our teams to focus on more strategic areas of work.

Q What do you expect to be the most exciting developments in this area in the near future?

We are focused on building out our data and analytics business as a comprehensive data platform making use of AI capabilities. That will take data from various siloes and make it available in a very secure and compliant way for our clients. We plan to employ AI to enable the data platform to deliver actionable insights and new analytical capabilities for our clients.

The key element in all of this is that you have to ‘feed the machine’: AI needs data to really learn and operate in the most effective way, and we sit on a treasure trove of data. We make certain to prioritize the use cases that will have a beneficial impact on our clients. We want to give them more visibility into their funds than they have ever had before, allowing them to make faster and better formed decisions.

Interview

Q To what extent do the SEC’s private fund rules impact the secondaries industry and how have these changes

been received?

Tim Toska: The US Securities and Exchange Commission’s new private fund adviser rules are certainly far reaching and there are significant changes involved. But, as it relates to the secondaries industry, it is the mandatory requirement for a fairness opinion or valuation in every GP-led secondaries deal that is the most directly relevant. There are also new disclosure requirements around material business relationships and activities, which must be formally documented and posted to a portal. In many instances, both are already happening, but the rules mean there is now a regulatory requirement to take these extra steps in what might well be a time sensitive transaction. That can always be a cause for concern. Managers want to be able to proceed with deals in as frictionless a way as possible. That said, compared to some other aspects of the rules, these provisions are unlikely to keep many awake at night.

Q Could a clearer regulatory framework around GP-led secondaries be welcomed, particularly when it comes to ensuring LPs are comfortable with these deals?

TT: Absolutely. This is a fast-growing market, and it has been exciting to see GP-led secondaries emerge as a valid avenue for generating liquidity, alongside traditional M&A and IPOs. But there are clearly some inherent conflicts of interest that need to be carefully managed because the last thing anyone wants is for questions to be asked in hindsight, should a deal not turn out as planned. These are not arms length transactions and so they lend themselves to being second guessed. Increasing the regulatory framework helps eliminate any of that doubt and so from the perspective of the ongoing growth and maturity of the sector, I think it is largely to be welcomed.

Emily Ergang Pappas: It also goes long way towards ensuring all investors are in the same situation. Yes, there were many funds that were already including fairness opinions in their deals and going the extra mile in terms of transparency, but now investors in every fund will be afforded that same level of protection from potential conflicts of interest. The codification of best practice means all investors are now in the same boat.

Q What modifications have we seen since the initial rules were proposed and where are we now in terms of when the rules will be enacted?

EEP: We are in a unique position as fund administrators in that these rules don’t technically apply to us, but they will apply to most of our clients and will affect the services we provide. We are therefore keeping a close eye on how things develop. There are a number of lawsuits that are ongoing, and no-one is entirely sure what the timelines are likely to be, but we are certainly paying close attention. I would agree with Tim though that this rule is not as controversial as some of the others. We have been heavily focused on the quarterly statement rule, for example, because there is a lack of clarity there and because it impacts our role as administrators particularly. There have already been some modifications made between the proposed rules and final rules when it comes to secondaries, with greater flexibility to choose between either a fairness opinion or a valuation. Beyond that we are in a wait and watch holding pattern, considering what the eventual outcomes are going to mean for clients.

Q Given the GP-led market’s growth, is it reasonable to expect it will be subject to greater regulatory scrutiny going forward, beyond these specific rules?

EEP: The short answer is yes, absolutely. Anytime something grows in size and popularity to this extent, particularly when it involves readily identifiable conflicts of interest, it is inevitable that the SEC and other regulators around the world are going to want to put some parameters in place to ensure investors are adequately protected.

Q Against this regulatory backdrop, how are you seeing the GP-led secondaries market evolve?

TT: I would say that the GP-led secondaries market has now reached a stage in its maturation journey where it sits side by side with other strategies. Certainly, in terms of deal volumes, GP-leds have been at or about 50 percent of the overall secondaries market for the past few years. In fact, there has been insufficient capital available to meet demand from GPs, who now view this as a viable exit route and means to generate liquidity in an environment where liquidity has been in short supply.

Q Will that growth trajectory continue unabated as and when M&A markets return?

TT: I believe that it will. There will always be reasons for GPs to pursue this type of deal, regardless of what is happening in the broader macroeconomic environment. It is true that a revival in M&A will lessen the need for GPs to turn to continuation vehicles to generate distributions for investors. However, there will always be sectors, or segments of the market, that are facing structural or economic hardships and where secondaries capital is required.

Furthermore, there will always be situations where the timing just isn’t right for a GP to exit, despite the fact it is running up against the limits of a fund’s life. Due to the intense growth in volume and awareness over the past few years, GPs know these GP-led deals are something they will always have in their back pocket.

Q The GP-led market is widely believed to be one of the most undercapitalized corners of private markets. How do you see the buyside evolving going forward?

TT: The secondaries market, and GP-led secondaries in particular, are undercapitalized relative to the supply of transactions in the market. But I don’t necessarily view that as a negative. In fact, in many ways it can be viewed as a positive, because it ensures buyers are able to originate and diligence opportunities in a disciplined manner rather than feeling any pressure to put money to work. Of course, we don’t want to see that undercapitalization continue forever. But it is no bad thing for supply to outpace demand as the asset class matures. That will help ensure everyone concerned has positive experiences, including LPs that decide to roll and the new investors that come in. The more of these win-win situations that we see come to fruition, ultimately leading to successful realizations over time, the better it is for the asset class in the long term.

Interview

Q How far has private equity come in terms of its willingness to leverage technology to support middle-and back-office functions?

The industry has certainly come a long way, particularly over the past few years. The ability to leverage technology to support operations has moved from a nice-to-have to a must-have. A lot of that movement has been driven by investors in terms of the timeliness and granularity of the data that they are demanding, and that has placed an unprecedented emphasis on efficiency. Technology has inevitably been part of the solution, but this isn’t something that investors have foisted onto managers. It doesn’t work that way – it is something that needs to be embraced and we have undoubtedly seen a marked shift in managers’ willingness to do just that.

Q How is technology being used in the investor onboarding process?

Onboarding is a fantastic use case for technology because it is an area in which the private markets desperately need to become more efficient. Historically, onboarding has involved a huge amount of back and forth across paper trails, e-mail communication and calls. The ability to digitalise subscription docs and streamline AML and KYC processes using tech tools that weren’t available just a few short years ago, is proving transformative for the industry.

It is also incredible to see how far we have come in terms of LP portal development within a relatively short period of time. Just 15 years ago – which isn’t all that long ago, in the grand scheme of things – investors were receiving call notices by fax machine or even mail.

These investor portals have greatly improved, and continue to greatly improve, communication with LPs, while also creating significant cost and time efficiencies both for the manager and the underlying investor.

Q In light of the US Securities and Exchange Commission’s new private fund rules, how important is technology going to be in meeting regulatory demands?

Reporting requirements are intensifying as a result of regulation, including the new SEC rules, but they are intensifying in re sponse to investor demands in any case. It is therefore critical to have timely and accurate data at your fingertips as a private equity firm or administrator, which is exceedingly difficult without the use of technology. Technology can help with the sourcing of data and with moving that data across channels, which is what needs to happen with any reporting process. Again, technology has really become a must-have in meeting the additional demands that fund managers face today.

Q What are the foundational steps that firms need to take to maximise the potential of the data that they hold?

Small firms can probably handle data requests and analysis in Microsoft Excel. That becomes increasingly difficult to manage, however, as the business scales. It is therefore crucial that firms have a regimented plan around data from the outset, otherwise things can quickly become complicated, particularly when it comes to establishing a single source of truth.

Back-office teams, investment teams and marketing teams, for example, may hold different data sets that can often overlap. That data needs to be aggregated, normalised and validated until everyone is confident that the data they are accessing is based on the most accurate and up-to-date information. Only then can firms consider moving on to the next step of gleaning accurate and meaningful insights from the data and automating processes.

Q To what extent are private equity firms leveraging automation tools and data analytics today and what are the most interesting use cases?

At the highest possible level, there are three areas where private equity is exploring the use of automation: operations, portfolio management and investment decision-making. It is in the operational arena that we first saw many of these automation tools come into play. Any time you are dealing with a recurring process, such as an invoice payment, for example, that is a task that can be streamlined through automation.

Communication with portfolio companies, meanwhile, is another tangible use case for automation. Managers require businesses to provide regular updates on financial performance that are then fed into a data model upstream. Automation can really help in processing that information, regardless of the format in which it arrives. There are tools that can be used to standardise the different balance sheet and income statements coming from portfolio companies, allowing the firm to compare apples with apples and to feed the data into valuation models. In some cases, this data is coming from hundreds of different portfolio companies and so the ability to process and standardise it without manual inputting is clearly a massive efficiency gain. Teams that would have acted as data aggregators are instead able to spend more time reviewing and analysing the output.

By contrast, we are still in the earliest possible stages when it comes to automating investment decision-making processes. The focus for GPs right now is very much centred on creating a single source of truth, then employing automation tools to pull the relevant data so that humans can make decisions based on the best possible information.

Q What are the next steps for private equity when it comes to tech adoption?

What is most important is that we have now reached a stage where there is near-universal recognition of the importance of tech adoption. Just a few years ago, not everyone was necessarily sold on its benefits and tech adoption certainly wasn’t always viewed as the priority. That situation has flipped entirely. Of course, different firms are at different stages of that journey, but thanks to the now ubiquitous coverage of the benefits of automation in the mainstream media, we have got over the most significant hurdle, which is the willingness to embrace what technology has to offer.

It is important to recognize that no one is trying to get to a point where automation software is being used to identify an investment target, carry out due diligence and then spit out a yes or no answer as to whether or not the firm should proceed with that deal. No one is looking to go to those extremes. Instead, firms are experimenting with using technology to identify market trends and carry out sensitivity analysis, and then build in the human judgement that sets them apart. The use of technology in private equity has never been about replacing people. Instead, it has been about maximizing the potential of that human resource.

Analysis

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