Are Private Equity Tech Systems Ready for Main Street?

With the push toward retail investing, PE firms will face an array of new data management challenges

Private market investing has evolved dramatically during the past three decades, moving from niche to mainstream as investors flock to these alternative investments. Private equity – in which capital is raised and aggregated for the purpose of making investments in non-publicly traded companies – includes investing in real estate, venture capital, hedge funds, commodities, and other tangible assets.

Why are investors turning to private equity?

For one thing, they are finding fewer public stocks to invest in. In the mid-1990s, more than 8,000 companies traded on the New York Stock Exchange and Nasdaq combined. That number has fallen to about 6,000. Even though 25 percent fewer stocks trade, the market capitalization of public equities has soared, hitting $53 trillion at the end of 2021, up from $15 trillion a decade earlier.[1]

Other factors have prompted a surge in demand for and access to private market investments: market volatility, high valuations, and a growing lack of confidence in strong returns across public markets.[2]

Recent studies have shown that private equity investments have outperformed public equities in the past (which, of course, is no guarantee of future performance). UBS, for example, found that they generated annual returns that were 4 percent (400 basis points) higher from 1994 through 2020, with far less volatility.[3]

This potential for market-beating returns and a lack of correlation with the overall market have lured institutional investors to alternatives and private equity. Only 5 percent of investable capital was allocated to alternative assets in 2000, according to Willis Towers Watson’s 2020 Global Pension Assets Study. That number grew to 25 percent in 2019. Brookfield Asset Management, a leading alternative investment firm, estimates that by 2030, 60 percent of all pension asset allocation will be in alternatives.

The reality of retail

The next frontier is retail investors. Only 1 percent to 2 percent of the estimated $80 trillion held by individual investors worldwide is allocated to alternative investments, according to PitchBook Data Inc., which tracks private markets data. Regulators are loosening restrictions and allowing more retail investors to participate in private equity funds and other vehicles. And private equity asset managers are rolling out new products geared toward individuals. Given these trends, it’s likely that before the end of the decade, alternatives will be alternative no more; they will have gone mainstream.

Creating a retail-accessible product while satisfying regulatory requirements will demand a new approach to the business for most private equity firms. Retail investment products need more liquidity, lower minimum investments — which currently can be $10 million or more — fewer capital calls, and a streamlined process for opening accounts. Access is also an issue. Top funds today are often oversubscribed and not open to new investors. Finally, fees can be extremely high for certain products, which can affect performance. While the Securities and Exchange Commission is exploring ways to remove some of these hurdles, the bigger challenge for many private equity firms may be managing the internal processes for handling retail accounts.

Technological challenges

Most private equity firms (excluding those that have gone public, like Blackstone and KKR) typically handle a few hundred clients. They now face demands to provide reporting, performance updates, and other account information to an investor base of thousands.

Currently, most private equity firms rely on customizable programs such as FIS Investran to track what are typically low-volume, illiquid investments. Investran and other similar systems aren’t designed for large numbers of retail investors. These programs are focused on complex partnership accounting and reporting functions, such as investor commitments, cost, fair value, income of underlying portfolio company investments, as well as the distribution and capital call notification documents for investors. Most do not offer real-time data. They send letters to fund participants notifying them of dividends and other changes to the portfolio.

With a few hundred investors, these systems can be complicated to use, and portals are designed for institutions. Retail investors need applications and portals that are simpler and more responsive to their requirements. They want real-time data to track portfolio performance and an easy user interface for online transactions. To meet retail investors’ expectations, these systems must handle large volumes of data every day.

None of existing private equity systems can marry retail investor needs with the information offered to traditional private equity investors. To build these capabilities, firms need the IT infrastructure, technological resources, and the expertise to oversee expanded internal systems but also work externally with cloud providers and data security services.

“It comes down to whether the systems are designed to ingest a certain amount of data, which is growing exponentially,” says Jason Haft, vice president of sales for LemonEdge, a cloud native, partnership accounting solution for portfolio management, fund accounting, and reporting that is designed to help private equity manage this transition. “The systems are designed for 100, not 1,500 or more investors. They’re experiencing serious performance issues trying to generate data and process transactions.”

The demands will only increase. Firms are moving to daily reporting, and the regulatory trends are moving toward greater reporting frequency and transparency, Haft says.

Finding the right partners

While some fund managers are partnering with registered investment advisors (RIAs) such as Vanguard and Fidelity to offer public-facing access to closed-end funds, the need for faster, more efficient systems remains. GFT is working with clients to guide the complex transition to private equity retail investing.

That’s why GFT has partnered for these purposes with leading technology partners and cloud providers such as Azure, Amazon Web Services and Google Cloud Platform. Our practice is designed to leverage the power of the cloud to help with these types of transitions.

We work with clients to understand their unique technology needs. Once we understand the technology environment and identify any gaps, we develop a road map to build a new cloud-based infrastructure. GFT can facilitate stakeholder meetings to bring everyone together and get them to agree on guiding principles for the transition. We help clients understand how to allocate resources more effectively and adjust procedures to ensure the best outcomes for their own operations and their customers.

As private equity firms open to more retail investors, the technological demands on their data management and reporting systems will intensify. By working with a partner that knows how to manage the different providers, platforms and technologies, private equity firms can not only manage this transition more efficiently but also build systems that will be flexible and adaptable to future demands.

Key questions for private equity CIOs

What is the functional impact on your IT infrastructure of meeting the requirements for retail investing?
Is your IT infrastructure capable of handling those demands?
Do you have people in-house to handle the complexity of this transition?
Do you have the skills and knowledge to do the assessment of the technological demands?
Can you build the systems necessary to process an exponentially larger number of transactions?
Can you design and modify your policies and procedures to accommodate the needs of retail investing?

Want to learn more? Message us at info.USA@gft.com!

References

[1] https://siblisresearch.com/data/us-stock-market-value/

[2] https://financialpost.com/pmn/press-releases-pmn/business-wire-news-releases-pmn/retail-access-to-alternative-investments-top-of-mind-for-financial-advisors-cais-survey-finds

[3] UBS, Alternative Investments: Improving portfolio performance, December 2020