How would you describe GP-led dealflow right now?

Tim Toska: Conversations with our clients around GP-led secondaries are becoming increasingly common. Sponsors are identifying high-performing companies where significant value-creation potential remains and are putting them in continuation vehicles. These deals have become a valid fourth option when it comes to exiting businesses.

Brian Mooney: Almost every major private equity firm has completed at least one continuation fund and many have completed several. We observe that firms that have yet to do so are working on one right now or considering their first. However, there is a massive supply/demand imbalance. While the demand side (buyside capital) is growing, it is not keeping pace with supply, particularly given that so many LPs are suffering from the denominator effect. That is impacting fundraising in all asset classes including secondaries.

As a result, GP-led deal volume is down on last year, but those transactions that are taking place involve the highest quality sponsors and the highest quality assets. I would also add that there has been a marked shift towards the mid-market. Very large single-asset or concentrated portfolio deals, meanwhile, are proving more challenging

What impact are those supply/demand dynamics having on pricing?

BM: Only 25 percent of all GP-led deals were priced at a discount to NAV in the first half of 2021. By the first half of 2022, that had increased to 50 percent, and I think that is still true today. We are also seeing more transactions with some kind of structuring involved in the purchase price. It could be a simple deferral or in some cases a portion of the purchase price is based on a contingency such as hitting a certain level of EBITDA at a given date.

How should sponsors prepare their assets and processes to maximize the chance of a GP-led deal completing?

TT: Transparency is paramount, and I think the GP-led secondaries market has benefited from enhanced transparency more broadly in the wake of the pandemic. Historically, there was criticism levelled against the asset class with regards to a lack of readily available information and stale information.

During the pandemic investors began to demand frequent data points and communication around specific companies, which forced managers to put the necessary infrastructure in place to deliver on that. That means that when a GP raises the prospect of a continuation vehicle with a particular asset today, the LP base is already well versed on how that company is faring and why a continuation vehicle might make sense.

BM: Sponsors today are communicating with their investors early and are focused on transparency, both with buyers and the existing LP base. In terms of preparing companies, it is all about finding the ideal candidate and having the right motivations.

What are secondaries buyers looking for in a GP-led deal in terms of alignment?

BM: At an absolute minimum, a GP needs to roll at least half of its capital. For us, as a buyer, the GP must be a net buyer or else the transaction is of no interest to us. We tend to become really interested, however, if the GP is proposing to roll all its capital, meaning the original investment plus carry crystalised through the sale to the continuation vehicle. A GP-led transaction becomes even more interesting if the GP wants to write an additional cheque, which could mean a commitment from its new flagship fund.

Meanwhile, economic terms tend to be more favorable, with lower management fees and tiered carry, which serves to further enhance alignment.

What role can technology and data analytics play in supporting a GP-led process?

TT: With a GP-led process, as with so many areas of private equity, it is vital for sponsors to have a single source of truth in-house. Get your data systems in place and then you can overlay that with market insight to help identify the perfect candidate for a continuation vehicle. Investors are also relying on data analytics to evaluate manager performance. But I would add that data analytics is fundamentally about taking the robot out of the person. It takes away all the laborious legwork and enables teams to bring a new and more valuable set of skills to the table.

BM: Underwriting a continuation vehicle is a very intensive process. You need to underwrite the sector and the company, but you also need to underwrite the sponsor. You need to evaluate how that sponsor has added value to that business and whether that is consistent with the strategy being proposed for the continuation fund. All of that involves pattern recognition and, if you have the data and analytical tools to gain that insight, you can better assess the risk/return profile of the deal.

What other areas of private equity do you see as ripe for tech disruption in the future?

TT: I see the real value of technology as supporting due diligence at the front end of a transaction. I also believe that automation can help streamline processes, making data requests that might previously have taken days almost instantaneous. Meanwhile, the more standardised that data becomes, the more easily it can be integrated into investors’ systems as well.

BM: I think data analytics will play an increasingly important role in LP secondaries, where you are often building portfolios with hundreds of fund interests and thousands of underlying companies. Technology can help make that market much more efficient and support our ability, as buyers, to submit offers more quickly, while also informing our portfolio construction around underlying risk and return drivers.

I agree with Tim that technology in this asset class is about taking the robot out of the person. This is still a people business. As investors, we are betting on the teams that we believe are the smartest and best at what they do.

This article was originally published in PEI’s US Mid-Market Report.

What do you think are the factors driving the incredible growth in distressed debt and special opportunity funds?

First, there’s the legacy effects of a long-term zero interest rate environment, and the proliferation of dividend distributions from a lot of LBOs, especially from the sponsor finance community, or private credit funds. They were done when rates were low – one floor or two for reference rates – and now it’s ticking up to the five range.

And with these legacy spreads and the current reference rates, some of these companies can’t afford that debt service as part of their operating model. That’s starting to trigger a lot of the EBITDA covenants within their underlying credit and lending agreements.

So we’ve seen a lot of our traditional private credit lenders and opportunistic managers launching special situations and credit opportunity funds, where they can step in, restructure the debt, and maybe put it on non-accrual or non-cash pay for a period of time to work these deals out. There was a bump in these funds being formed at the beginning of covid, with the assumption the pandemic would create a boom in distressed situations for the then pending economic distress.

However, due to all the government stimulus, that boom was delayed. But with the prolonged increase in rates, even with the continued economic performance, a lot of these managers are expecting that boom to commence. There are also situations like the collapse of Silicon Valley Bank that suggests there will be interesting portfolios coming to market, priced to be offloaded quickly and able to be worked out at significant returns to investors.

Do you think that same environment is fueling a rise in asset-based lending funds?

Traditional asset-based lending is typically lending where there’s a lag time between when corporate borrowers need to finance their commercial operations and bridge the period of time that their customers are paying them for the product that’s been delivered.

Up until recently, that’s been the world of a money center bank, or a super-regional money center bank that have these facilities where they will make those loans, monitor those loans and pledged collateral, and keep that relationship with a borrower. But given the ultra-sensitivity of those super-regional bank market events, those are really good loans to shed because they have high market value, without the bank to reserve against them.

So we’ve seen a number of those portfolios come to market where it’s private capital that will take on those ABL facilities on behalf of the borrowers at a pretty good rate from the original bank lender.

And then there’s the role of the traditional investment bank on providing portfolio leverage, which we now see large insurers and actual funds coming in to replace them, despite all the compliance issues and strict rules around what’s applicable, what’s admissible, and substitution rights if a particular asset goes wrong. This is now becoming the realm of large insurers, since they have a more permanent capital base, one that isn’t based on deposits.

We’ve had a few clients entering into lending or refinancing arrangements, and they really liked the term loan and the borrower. The borrower then brings up the fact that they also have this ABL and would like to have the same provider for both.

So the manager decided to meet that market need, and as a result, we ended up exploring what we could do to service them, and licensed a product dedicated to the ABL space that provides transparency to the lender, the borrower and us though the operating infrastructure.

For managers looking to launch their first credit fund to take advantage of this environment, how should they think about the operational infrastructure to administer it?

When I speak with PE managers that are used to underwriting and investing in a portfolio company and valuing their portfolio once every quarter, they’re in for a very different level of activity in the credit space. The same underwriting process and the ongoing valuations occur, but additionally the bank debt pays at a minimum quarterly, and the rate resets typically quarterly. There are amortisation payments. Loans are typically originating below par. So they’ve got non-cash income that they need to recognise.

These deals get amended constantly, so there could be different compliance rules under the credit agreements. Furthermore, the maturities get extended, the size of the deal could move up and down, and all this requires a great deal of monitoring of the underlying borrower. And they need a system that will address and support all those things.

They have to decide who will be the administrative agent on the credit, whether it’s done internally, or outsourced completely.

Then there’s SEC oversight around the custody of investor assets. How are they going to build an infrastructure where they’re not co-mingling investor monies across multiple funds or different borrowers and everything else required to withstand the scrutiny of the SEC? And that’s just on the legal and operational side of things.

As a result, our clients invest a lot of resources on attorneys, compliance experts and our services because we have the appropriate systems for the agent components, the loan administration, which is tracking and ticking and tying all the cashflows, positions, rate resets, amortisation schedules, and then ultimately the fund accounting and investor reporting. Because a direct result of this growth in private credit is there is a dearth of people that know how to do credit accounting because it is very different than PE, or fund-of-funds accounting.

This ends up producing a massive amount of data to monitor and manage. The front office wants credit monitoring. The middle office needs to monitor the compliance with the credit agreements. And then the back office needs the data to produce the reports and everything else. There are big ticket systems available that cost millions to implement or off-the-shelf systems that support various functions for credit managers.

There are much lower cost solutions for data warehouses where they can build report writing software on top of the warehouse – these become a kind of integral hub for the spokes that go out to address reporting requirements. And then there are other inexpensive add-ons that can offer portfolio view technology as well.

Most clients want that data in-house, but it’s a daunting task to build internally. This is why we’re confident that outsourcing will continue to offer a compelling value proposition for the GPs looking to make the most of this particular moment in the credit markets.

This article was originally published in PDI's US Report.

The US Broadly Syndicated Loan market (“BSL”) is a proven asset class with a track record of over 30 years (from the earliest leverage loan ‘prime rate’ mutual funds). CLOs are significant investors in this $1,5tn+ market. Other investors include regulated mutual funds and ETFs, and private account investors.

While BSLs offer high yields and could be attractive under an environment of increasing interest rates, they also come with several risk factors that can affect their pricing and complicate the management of a portfolio of BSLs.

Credit risk, interest rate risk, market risk, and prepayment risk are several key factors that BSL managers consider. In this article, we’ll explore the drivers of leveraged corporate loan prepayments and how BSL portfolio managers (whether it is a CLO, ETF, open end mutual fund, or private account) can potentially improve their performance and better manage investor expectations by using more sophisticated quantitative models.

Specifically, we’ll examine some of the key factors that would drive critical quantitative models to estimate prepayment risk and how these models can help BSL managers make more informed decisions to improve investment performance. 

Why prepayments matter for investors

The benefits of accurately anticipated prepayments in a BSL portfolio could be significant for investors in terms of better performance, lowers costs and more efficient portfolio management. A few examples of how a market participant could benefit from a model driven approach to better anticipate and manage prepayment risk include:

• Managing prepayment cashflows can allow BSL managers to better prepare for their next investment decisions (e.g., complying with reinvestment criteria, avoiding incurring transactions costs to meet a purchase commitment) or to better manage investor redemptions – as in the case of open-end mutual funds.
• Any time a prepayment occurs, the loan’s correspond rating bucket will make up a lower portion of the total portfolio (this is especially relevant for CLOs where ratings criteria are critical drivers for ensuring compliance with trading rules). This balance shift can have downstream consequences on whether the portfolio manager can meet the ratings portfolio criteria (i.e., WARF, Caa/CCC limit). Being able to anticipate the distribution of prepayments by rating buckets can allow a manager to better plan for these risks and enhance their ability to preserve the credit risk profile of a fund/portfolio.
• Prepayment modeling can complement the underlying investor’s expectations of returns and cash flows. For example, in static private accounts or for vehicles that are no longer in their reinvestment period, the portfolio prepayments will have a significant impact on the underlying cash flows distributed to investors.
• Proper management and projections of prepayments will assist managers to more efficiently redeploy those funds to minimize negative carry. Negative carry could have a significant impact on a BSL portfolio’s returns.
• For funds that are part of a larger fund (some CLOs and SPVs for example are consolidated into a larger fund) can incorporate prepayment management into the asset-liability management of a parent fund.
• As BSL investors increasingly demand sophisticated and quantitative approaches before investing in a particular fund, a manager that utilizes cutting-edge methods increases their opportunity of raising funds and meeting investors’ expectations – above and beyond direct links to better performance, such as market best practices, surveillance, forecasting, etc.

Factors that can influence loan prepayments

BSL prepayments are driven by a host of factors. Our analysis shows that the most pertinent fall into three categories – (i) Age of Loan, (ii) Loan Spreads and Prices, and (iii) Loan’s Recent Prepayment Activity.

Age of Loan

The first significant driver is the number of months-on-book. Recently originated loans are highly unlikely to prepay. However, as prepayments continue to increase linearly with time, there are some nuances to consider.

The linear trajectory of prepayments may have a different slope depending on the loan’s term structure, with shorter-term loans having steeper slopes. Additionally, towards the end of a loan’s term structure, there is a substantial increase in prepayment as loans get closer to their final repayment.

Loan Spreads and Prices

Loan Spreads – at the loan level

The loan’s spread is another factor worth discussing. The loan’s spread can influence prepayments in either direction. A higher spread can indicate the credit worthiness of a borrower who must allocate more cash to consider a prepayment, making doing so more challenging. However, higher spreads can also increase the borrower’s incentive to prepay, as the potential to reduce interest payments is higher.

This can especially be the case where a borrower’s credit profile has improved. Our findings suggest that higher spreads have a positive relationship with prepayment, indicating that the benefits of prepayment outweigh the costs of higher rates.

Market Loan Spread

However, loan spreads don’t affect the loan in isolation. The average spread of other loans on the market is important. The lower the average market spread, the higher the current loan’s propensity to prepay holding all else equal. This relationship suggests that when spreads are lower elsewhere, borrowers attempt to prepay either to refinance or partially take advantage of lower spreads elsewhere.

We found that when the broader market’s spread is included in a model, the current loan’s spread exhibits a stronger effect. This change suggests that the difference between the two spreads plays a key role in driving prepayments. However, this relationship becomes complicated once the next factor – Price – is introduced into the model.

Loan Price – Current

A loan’s current price is a strong predictor of prepayment probability. More specifically, a loan has a marked increase in prepayment rates if its price is between 99 and 100.5, with the peak occurring at 100. A very large proportion of all prepayments occur when the price of the loan is within that range.

Furthermore, certain factors including the loan’s spread and the market spread become irrelevant once price is controlled for – this is not surprising since the specific loan facility spread and market spreads are generally considered in the price. Thus, even though spreads likely play an important causal role in driving prepayments, the market is accounting for loan spreads and market spread when pricing loans.

Thus, when trying to predict prepayments, the loan’s price carries a good degree of information available in other loan characteristics and will generally dominate many other, though not all, explanatory variables.

Loan Price History

Another factor that matters for a loan’s prepayment activity is the loan’s price history. If a loan is priced at 100 because it was recently issued, one wouldn’t expect that loan to prepay. However, once the loan has been on the books for some time and experienced price fluctuations, then its higher price becomes more meaningful.

Recent Loan Repayment Activity

A loan’s recent behavior can affect the loan’s propensity to prepay in one of two ways. A borrower could have just made a substantial prepayment and consequently have little capacity to prepay for some time. Or they could stagger their prepayments across multiple periods. We found the latter to happen more often. Thus a loan’s most recent period’s prepayment indicates a higher likelihood to prepay again.

A few words about private debt prepayments 

In this paper we provide some insight into prepayment modeling for BSLs, and we find that a very powerful indicator of prepayments in the price of the BSL. For pure private lending, however, market prices are not readily available. In such cases more modeling around fundamental prepayment drivers – such as economic variables, broad market variable or even underlying company financial statements – would need to be explored and analyzed.

Alter Domus has performed extensive fundamental prepayment analysis for private loan portfolios. Our Alter Domus Risk Modeler provides the platform to perform and deliver such analytics. Risk Modeler is also applicable to the broader BSL marketplace for advanced analytics, including prepayment.

Conclusion

The large, established and growing BSL market presents both opportunities and challenges for underlying investors and their respective portfolio managers. Prepayment risk is a critical factor to consider, as it can impact a BSL’s portfolio performance. By employing a model-driven approach to managing prepayment risk, BSL managers can better plan their investment decisions, maintain the risk profile of a fund, manage investor cash flows (including redemptions) and better cater to investor expectations.

Key factors that influence prepayment activity for BSLs include months-on-book, loan and market spreads, current and historical loan prices, and recent prepayment behavior. By understanding these factors and their relationship with prepayment probabilities, BSL managers can make more informed decisions to optimize their portfolios. For private loan investors, modeling and managing prepayment risk may be a little more challenging given the lack of observable market prices. However, more fundamental techniques around prepayments is a field where Alter Domus has significant expertise and capabilities through our alter Domus Risk Modeler platform.

Embracing advanced quantitative models and keeping abreast of factors affecting loan pricing and prepayment risk will ensure that BSL managers can successfully navigate the complexities of the market, ultimately benefiting both the portfolios they manage and their investors. While the insights above based on aggregated market data can provide value to Alter Domus’ clients, a deep dive into an individual portfolio can significantly improve a manager’s ability to better manage prepayment risk. 

What macroeconomic drivers do you see influencing the infrastructure debt market share?

The COVID-19 pandemic and energy crisis both brought a lot of attention to the infrastructure industry, pushing the ESG agenda and increased investments into renewables. Currently, investors seem to be rebalancing their portfolios away from core strategies to avoid the adverse impact of higher interest rates, and toward higher-yield core-plus strategies. In this context, infrastructure debt is gaining popularity, notably because of its highly attractive risk-adjusted returns.

What opportunities and challenges does infrastructure debt bring LPs in more stringent markets?

Competition is certainly increasing, with both traditional equity and established debt investors coming into the space. There have been a lot of new players drawn in by the opportunities that infrastructure debt offers. This increasing competition also extends to competition for the right assets.

It is likely the space will see more capital concentration in the market as larger firms pick up the bigger projects. On the other end, many new players are coming to market with smaller funds and pushing for projects in emerging sectors, particularly renewables. In the next five years, we will likely see even more smaller participants entering the industry with stronger specialization in these verticals, which can be good news for investors. Diversification is always attractive – not everyone necessarily wants to put all their eggs in the “larger firms” basket.

What should LPs new to infrastructure debt know about entering a niche market?

One needs to keep in mind that niche markets like infrastructure debt often have specific needs and characteristics. Infrastructure and debt managers will certainly be knowledgeable, but combining the two components may present a learning curve for some. Infrastructure debt funds can prompt more involvement from the administrative side, in particular around loan servicing or portfolio monitoring.

Efficiently managing a loan portfolio and its revenue base requires a solid understanding of debt, but equally as important is the ability to gather, aggregate and analyze data related to the loan portfolio, the borrowers and agreed covenants. This is what allows managers to gain insights into the portfolio’s performance, flag any credit risks as early on as possible, and simply take timely and informed portfolio management decisions.

Both managers and LPs need to ensure their back and middle offices adapt to fit the needs of a multilateral strategy, and ensure that their tools, systems, processes, and their team’s skill sets are in place, either in-house or through the use of external resources.

How can infrastructure debt evolve as the US puts more energy into national infrastructure projects?

Infrastructure has always been a way for governments to spend themselves out of a crisis, create jobs and get the economy back on track. Over the past two years, the US legislator voted on two major Bills which have contributed to raising the US market’s appeal among global infrastructure investors, specifically to accelerate the energy transition. Governments will partner with the private sector to execute on these projects, including with private equity types of investors.

Of concern, however, are both the availability and cost of debt, and the fact that many banks seem reluctant to finance anything riskier than core strategies. Consequently, many managers are looking at non-bank lenders and debt funds to finance new projects or to refinance existing ones. This opens up a lot of opportunities in this niche asset class.

This article was originally published in Preqin’s Infrastructure Quarterly Update.

We’ve heard loud and clear from our customers that their ability to continue to compete and succeed in the alternatives marketplace is increasingly dependent upon their capability to integrate advanced technologies into their data management and decision-making processes. This was the driving factor behind our acquisition of Solvas from Deloitte in May of this year.

Empowering insight and client growth

Having Solvas’ best-in-class product suite as part of our operating model enables us to support and accelerate the growth of our partners like never before.

Backed by experienced, specialist teams, these scalable, flexible software solutions provide clients with a clearer, holistic view of their portfolios, helping them to get ahead of regulatory change and to better manage risk for a more resilient future.

Please do not hesitate to contact us at [email protected]. if you have questions or would like to learn more about how our data and analytics services can help support your business.

We are proud to announce that Alter Domus has won the award for Best Debt/Loan Administrator at Private Equity Wire’s US Credit Awards 2023. Held in New York City on June 22nd, the award ceremony recognizes fund performance and service provider excellence across credit funds in the United States.

Alter Domus was selected as the winner of the “Best Debt/Loan Administrator” based on a widespread survey of more than 100 credit fund managers.

We’re thrilled to have been recognized by our credit clients for outstanding service. This is one of many recent awards the US private debt team has won, and we’re incredibly proud of the added value we’re providing our clients day in and day out. A big thank you to everyone at Alter Domus North America for helping to make this achievement possible!

Tom Gandolfo, Head of Sales & Relationship Management North America

What facilities of data collection do you believe will become prevalent in a more stringent market?

While navigating the extreme volatility in the current market, data collection facilities will be geared toward traversing three key mega trends. The first is the emerging convergent industry model. The financial, administrative, and advisory sectors are morphing together to create a new business model that will require a more integration-based approach to data collection.

Secondly, sovereign wealth funds (SWFs) are looking to shift more in private equity investment. This transition will demand greater due diligence around compliance and guidelines.

Finally, ESG conditions are becoming an important facet of SWF investing. As such, many firms have set out to eliminate their carbon emissions by 2050. All these trends require an evolved level of data analysis that will set the course for data collection in the future.

How can clients utilize and incorporate data to navigate market turbulence, particularly vehicles with lower-risk tolerances like SWFs?

Future data collection will need to introduce a new tool kit, ensuring data is not only collected, but organized in a way that can be assessed efficiently and offers investment insights. New technologies will play a big part, helping to deliver a deeper form of data retention. The industry demands data-driver models that incorporate traditional and non-traditional research sources. For example, social media can now serve as an insightful resource. Moreover, the industry must look for ways to blend machine learning, such as AI, and human efforts. These practices work best when automation is performed with AI to optimize data gathering, and then humans weigh in on analysis.

Can sustainability extend to data collection? If so, how do these changes vary for funds with more robust regulations?

Sustainability initiatives are challenging for more regulated clients, such as SWFs. Now, information linking ESG resources and financial performance lacks consistency and transparency. We see many initiatives around regulations to establish more transparency and even create a potential benchmark.

One initiative is ESG data convergence, which would demand both GPs and LPs agree to report and collect the same ESG metrics, from board diversity to carbon emissions. Ultimately, it is a matter of defining the data points that can be collected and monitored in the same way, then normalizing them. It isn’t easy, but there is a lot of attention around the topic.

What impact do you envision this form of sustainability practice having on the private sector as a whole, or the data collection industry specifically?

Data collection around ESG will influence other sectors by providing comparable information to the private sector and establishing a coherent marketing approach. These sustainability practices will also need to be specific to the client. The same data points won’t be relevant across all strategies in the private sector. It will be about identifying which data points are relevant to the specific underlying assets.

This article was originally published in Preqin’s Sovereign Wealth Funds Report.

We are delighted to announce that Alter Domus has won the award for Fund Administration: ManCo Services at The Drawdown Awards 2023. Held in London on June 7th, the awards were judged by a highly experienced panel of leading industry experts and we faced strong competition in our category.

The award was accepted by Matthew Molton— Country Executive UK— on the night, with Andy Clark, Tim Trott and Sam Wade also present to celebrate our achievement. We are particularly proud that this award was given by a panel of leading GP and LP judges.

We are delighted to win this prestigious award, which reflects the quality of the services we provide and the trust our clients have in Alter Domus as their chosen ManCo provider.

Matthew Molton, Country Executive UK

This is the second consecutive year that Alter Domus has won the award for ManCo Services at The Drawdown Awards, following our previous win in 2022.

This news follows hot on the heels of Alter Domus being ranked one of the top-5 third-party AIFMs, and a top-10 third-party ManCo in PwC’s 2023 Observatory for Management Companies Barometer.

How have the issues facing private credit managers evolved in the past decade?

Andrew Kyung: The private credit asset class has seen significant growth over the last 10 years. The challenges for managers have become more com­plex in a variety of different ways. In addition to rapidly increasing interest rates, there have been notable increases in tax and reporting regulations and the general information needs of investors.

Greg Myers: Private credit managers comprise a much larger proportion of corporate lending and M&A lending compared with 10 years ago. As banks retrench, direct lenders are among the first group of people contacted when there is a big deal or borrowing require­ment from corporate institutions. Com­petition for those deals has increased and there is now an almost institutional expectation from borrowers that wasn’t there in the past when these funds were regarded as opportunistic lenders.

Now, the expectation is of a formal­ised infrastructure on a par with what borrowers would see from a large bank­ing institution, placing pressure on cred­it managers that did not exist a decade ago to build out the requisite platform to support direct lending operationally.

What are the biggest challenges and opportunities they face today?

AK: I think one of the biggest chal­lenges for managers is how to best col­lect data and use technology to stream­line workflows and enhance processes across the firm. Many alternatives man­agers have invested in some type of data warehouse for that purpose.

Identifying the right system to achieve those goals for credit invest­ments can be especially challenging due to the additional data points, cal­culation requirements and volume of transactions related to the asset class. Partnering with a good fund adminis­trator specialised in credit investments can make a big difference, and can help to find the right balance between lev­eraging technology and use of limited internal resources.

GM: Management companies need to decide how they are going to allocate staff, systems and costs in a world of limited resources. Do you build all that institutional grade infrastructure inter­nally or opt for external providers? Or is there some way to marry the two that differentiates you from other managers in terms of raising capital and meeting your reporting requirements? Given the breadth and depth of third-party service providers, many managers elect to build in-source/outsourced models that marry the best systems, internal and external resources.

How can fund administrators provide support to managers looking to keep their back-office functions efficient and compliant?

AK: It can be difficult to find a single service provider to augment what you would otherwise have to build in-house for accounting, operations, reporting and performance tracking for private credit investments. Investment ac­counting, fund accounting and investor accounting can require their own ded­icated systems. Fund administrators specialised in loans can enhance a cred­it manager’s ability to find a scalable solution and take advantage of these specialised systems.

GM: What is important for most as­set managers is to make sure the fund administrator has the systems to satisfy all those elements of their organisation and to enhance and support all those different areas of the business. Giv­en the different needs from the front, middle and back offices, it is important to consider the various requirements of those constituencies when selecting that administrator.

ESG has been a big theme in the past decade, and ESG data will be a big theme for the next decade. What do managers need from fund administrators in that area?

AK: For managers seeking to integrate ESG considerations and collect data points during the investment process and throughout overall portfolio opera­tions, getting that data into a system and a useable format is one of the best ways that fund administrators can help man­agers to leverage those with ESG goals.

GM: What managers need here really varies. Our systems are able to capture and track the different ESG data points, so it becomes a question of the extent to which it is collected and reported on. It is the ability of an administrator to track that data and report consistently on the results that provides the most valuable support to managers.

Ten years from now, what do you think credit managers will be focusing on in relation to ESG?

AK: Ten years from now, I think credit managers focused on ESG will be look­ing to see the impact on their invest­ments.

GM: Being a realist, I think there is going to be a divergence of managers based on their investor base. There are going to be ESG funds and non-ESG funds, and it will be interesting to see how the two perform when we look back.

I will be curious to see how the Se­curities and Exchange Commission and institutional investor groups agree to a coherent approach to ESG and DE&I, so it is hard to imagine how the approach will play out.

Which regulatory developments on the horizon will most impact private credit managers?

AK: I think there will be more convergence between US and international regulations. I imagine developments will continue to focus on tax and performance reporting. The growth of the asset class will likely lead to an increase in regulations specific to credit investment managers and direct lenders.

GM: Because of the proliferation of private lending across the US, a lot more states are going to start regulating asset managers’ direct lending to companies based in their states. That is going to become a big focus because that framework exists for banks but does not so far exist for direct lenders.

How is investor demand for private credit evolving over time, and what strategies and regions are currently attracting the most LP interest?

AK: Leveraged senior loan portfolios have been successful in a few forms and there seems to be some renewed interest in mezzanine funds. I believe LP demand for private credit continues to grow, but so is the competition for those commitment allocations. Manag­ers will need to continue to differenti­ate themselves. I think it helps to have the right mix of strategy offerings, and the service and technology infrastruc­ture to provide the information trans­parency and portfolio data investors desire.

GM: Credit is now a very well under­stood asset class compared with a dec­ade ago, so allocations will continue to increase, just as they have in private equity. Investors are going to maintain those allocations moving forward – a big attraction is that most of the assets are in variable rate assets, so they can track up as interest rates increase.

As far as regions are concerned, Eu­rope and North America continue to be strong. Asia will continue to have at­tractions for private credit managers as manufacturing leaves China for other parts of Southeast Asia.

On strategies, we see a growing number of asset managers focused on lending to funds, almost as a compet­itor to the traditional role the invest­ment banks played in providing sub­scription lines. That is a relatively new strategy, but the ability of managers to source and access leverage for funds has become increasingly challenged. Those credit lines that managers use to increase or enhance returns, or for the bridging of investor capital, will be a growth area for private credit in the next decade.

What have been the biggest drivers of the outsourcing trend to service providers in the past decade?

GM: There is a much better under­standing in the institutional investor space that these funds have certain expenses that need to be allocated to them, and that fits well with having an outsourced fund administrator model where those costs can be directly borne by the fund. You do not need as many internal staff to monitor the outputs of those external service providers, so it ensures a leaner infrastructure. Given skill shortages and the dearth of hiring talent, the other big driver is the access we provide to experienced profession­als.

AK: The ability to tap into technology that would otherwise have to be devel­oped in-house, alongside a stable ser­vice team, has definitely become more important through covid and an unex­pectedly more challenging post-covid era.

What will fund administrators need to do to stand out and meet manager demands in the next 10 years?

GM: The priority will need to be con­tinued capital investment in technolo­gy, systems and delivery mechanisms to get data out of fund administrators’ systems and into managers’ data ware­houses. The number one requirement for our clients is data.

AK: When it comes to data and tech­nology, managers and fund admin­istrators all seem to be at a common crossroads regardless of size. Every­one is trying to find a way to collect and use data to build efficiencies, cre­ate additional value and differentiate themselves. One of the biggest chal­lenges is finding the right mix of tech­nologies and services to achieve those objectives, at a cost that makes them scalable. 

This article was originally published in PDI's Decade of Outsourcing Report. Greg Myers is Group Sector Head of Debt Capital Markets at Alter Domus and Andrew Kyung is Controller and Vice-President, fund administration at AEA.

What are the key drivers for private markets to embrace artificial intelligence and other advanced tech?

The rapid growth and large size of the alternatives market has been matched by a growing amount of data that needs to be managed. As managers and funds get bigger, we are heading towards a point where that data becomes too much to handle, and we need more thoughtful discussions about how all of this information gets put to good use.

Secondly, the amount of data that is being demanded and delivered to GPs – even without that market growth – has broadened immensely. There are ever more reporting demands, whether they be ESG-related or linked to a greater need for transparency in certain aspects of the business, as well as in financial metrics.

Thirdly, the ultimate investors in the alternatives space are also demanding more information and transparency from their GPs.

All of this is happening against the backdrop of technology having rapidly evolved over the last five to 10 years. A lot of these demands to process more data – to use that data and to communicate that data more quickly – are happening just as the possibilities offered by technology are profoundly more expansive than they used to be.

A lot of tools that one needs to process this data are now available off the shelf from technology providers – especially from the cloud providers. Those providers have become a lot better at providing more than just software or hardware, and are instead offering enhanced computational capabilities, with AI falling into that camp.

So, demands have grown exponentially, and at the same time capabilities have come along significantly, which makes this a good time for private markets to embrace advanced tech. For a lot of participants, it is important to think about how to adopts me of this modern technology while preserving the investments made previously. We don’t have perfect information about how technology will continue to evolve, but anyone thinking about what to build today needs to consider their ability to pivot down the road as new technologies continue to emerge.

Is it now essential that private markets participants get on board with these tools?

Yes, it is, but the specifics will vary on a case-by-case basis. The more expansive and demanding the operation, the greater the need will be for investment and adoption of these tools and technologies, including big data warehouse platforms, modular application architecture, high speed computation and AI. More investors will be demanding more information, and portfolios will be larger and products more complex, and this means adoption needs to be more involved.

The extent to which managers get on board with these tools depends on what they really need in terms of modern tech and modern capabilities. A lot of firms could fall into the trap of overshooting and investing a lot more than they need to. Many will also fail to invest enough, and of course investment from the organisation is a lot more than just money, but also people, infrastructure, time and culture.

For a large expansive fund, it will be a big investment to adopt the tools to address complex problems, but a smaller operation may want to be a little more surgical in how much they adopt. Even so, the technology challenge does need to be addressed with modern tech, whether your fund is €300 million or €3 billion. Even a smaller fund, if they don’t think about this properly, could be building a trap around technology for the future, by making decisions now that in three years’ time will leave them with an archaic and unscalable infrastructure. It is expected that any technology transformation will embed some tech debt due to the nature of trade-offs that will need to be made, but it is also important to understand the extent of the tech debt that is being built into the system as part of the planning process.

Building a function for the future often involves wider discussion in the business to include key decision-makers. Unless you have a technology strategy in place that is consistent with the demands and expectations of your key stakeholders, you are going to encounter many challenges.

In my experience, almost every manager I speak to understands there is an organisational challenge around the technology capabilities of their institution. Even those at the beginning of the journey understand it is a complicated problem and a huge investment decision that should not be taken lightly. This journey is as much an organisational challenge as it is a technology challenge.

How can firms mitigate the risks associated with implementation?

The first risk is the risk of doing nothing. That is fairly significant, because it leaves you saddled with whatever you are doing now in a world where your competitors are surpassing you. The key question here is whether others around you are moving rapidly with advanced technology and whether you feel you are going to be at a disadvantage in terms of raising money, delivering performance, providing investor transparency and executing on decision-making if you fail to keep up.

The other extreme is the risk of diving into this with an old-school mentality, making a huge investment and simply laying out your requirements and asking someone to build you a solution. The concern there is that you expend a lot of resources to get something built and then find it is not really what you needed. Unfortunately, buyer’s remorse is not uncommon.

Another risk is building something good but not being able to maintain it. If you outsource the work and don’t really understand how it all operates, you may find out later that the total cost of ownership is exorbitant and the cost of changes is unacceptable. You want a solution that is manageable and nimble rather than unwieldy.

At Alter Domus, we work with our clients to approach tech transformations in stages, with discrete deliverables along the way. Success is users starting to see practical and usable solutions relatively quickly and often that they can begin using in their everyday work, which reinforces the project as stakeholders become more engaged.

A third mitigant is that solutions need to not be so intricately connected that the system is a monolith. It is preferable for the system to operate as a series of cogs that can be enhanced, replaced, or removed without impacting other parts of the solution. A lot of pieces need to be independent of each other but architected in a way that creates one elegant experience for the customer. Today’s technologies afford this possibility.

We are firm believers in building solutions for clients that can be maintained in a low-cost way. We don’t want our clients burdened with a system that will slow them down and prove costly to change and update.

What kind of shift in mindset is required to embed modern tech capabilities?

Going about this journey requires a cultural transformation, which needs careful change management that starts during the planning process. The possibilities and the limitations of the technology need to be understood. It begins with the leadership team to ensure that the organisation understands what is possible with technology alongside a focus on what the business really needs.

The change management aspect is also significant. The shift in mindset has to be around change being a good thing: we are going to be more efficient, and your job is going to be focused on more high-value activities. The organisation needs to communicate extremely well, manage expectations, and be ready for consistent enhancement and improvement.

What challenges with legacy systems might firms encounter and how can those be overcome?

A lot of legacy providers are on their own modernisation journeys, so it is important to understand how those systems themselves are going to be transformed, with some taking a more proactive approach than others. You may find that your legacy provider is not aligned with your technology journey. It’s wise to think about ways to adopt your modern technology and embrace it, without taking it for granted that all your requirements need to go through the legacy system. Maybe you can bypass your legacy system and find a new way to solve a problem. This would be a classic case of disintermediation for some legacy systems providers. If you think your legacy system is going to impair your ability to make decisions, it may be better to just start afresh.

But you definitely want the provider of your legacy systems, whether internally built or not, to be thinking about how they are going to modernise. If they are not, that may be a worrying sign.

What are the key elements to get right for a smooth transition to modern tech?

The key elements are communication, managing expectations and identifying early wins that will spur you on to the next phase. Breaking a problem into smaller chunks, with wins along the way, is really important. This is not a ‘one and done’; this never ends. You need to be always thinking about your total cost of ownership and what it is going to cost to not just build a new system, but also maintain it. Ask yourself all the time whether you are getting what you really want, which means being careful on your requirements, involving all your stakeholders, and being sure to build something that is really fit for purpose.

This article was originally published in PEI’s Fund Services Report.