Honing operating models to capture growth opportunities

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.