Investors call for improved communication from GPs

Against a backdrop of the most brutal fundraising market suffered by the asset class, institutional investors are increasingly unimpressed with the accuracy and timeliness of the information they receive from their GPs.

Off-record conversations with investors make it clear that, while reporting methods for capital markets investments become more user-friendly, frequent and provide much greater clarity thanks to tighter regulation, the information supplied by private equity is outdated and vague in comparison – too little, too late.

Anecdotal evidence is supported by research recently published by State Street, which found that 56% of the 400 buyout houses it surveyed globally believe the biggest driver for change is investor demand for greater transparency into risk and fund performance.

LPs point to lacklustre communication on portfolio performance and risk management

This is backed up further by fund administrator SEI's recent private equity survey, which found that only 38.7% of LPs surveyed are satisfied by the information they receive from GPs, whereas 83.1% of managers believe they provide investors with enough information.

According to one investor speaking privately, information from GPs was only supplied after it had been demanded. And according to a second LP, who was invested in several of the same funds as the first, GPs would refuse to supply any information if the first investor had not already demanded it.

As it becomes progressively more challenging to convince investors to carry on supporting private equity, it is vital to understand why buyout houses are still failing to keep their investors updated. Of course, increased reporting and portfolio transparency requires more man hours as well as better software and IT systems, which generally means more costs.

However, LPs have concluded that private equity's lack of concern towards improving reporting standards is a matter of poor attitude. The muffled lines of communication between both sides have been highlighted and referenced countless times over the past five or six years and have been a key focus for associations such as ILPA.

That institutional investors have limited resources is nothing new. For decades past this has often meant practically guaranteed re-ups for the majority of managers, as small or even one-man investor teams have been unable to seriously drill into individual fund performance.

But the tide is turning. The small and one-man teams are now able to fully interrogate data from capital markets investments, being able to determine their exposure to one sector or geography at the click of a button. For those investing in private equity, it can take nearly two days to find out the same information. Naturally, investors want to be able to analyse private equity in the same way as their other investments.

In desperate need
So what exactly is it that investors want? According to Steve Langton, vice president of State Street Alternative Investment Solutions: "Investors are looking for more clarity. They want to understand where the underlying performance is coming from. If an LP is invested in 50 funds, it wants to know what companies it is actually invested in and what markets, sectors and geographies it is exposed to."

Langton also points out that investors are increasingly concerned about alignment, and whether it truly exists. "They want to ensure that management fees are calculated in line with their expectations. They also want to know if the necessary risk management controls and operational procedures are in place. More specifically, investors want to know the process behind the investment decision. They want reassurance that risk is mitigated."

Greame Faulds, co-founder of new company TopQ Software, says the business was set up in reaction to the lack of sophisticated analysis tools available to the asset class, and the frustration felt by LPs with many fund managers only providing whole-firm performance information when seeking fresh capital.

Faulds is also disturbed by the level of inaccuracy incurred by the over-use of spread sheets: "Because cash flows are often aggregated into monthly, rather than daily, figures, the given IRR figures can differ from the actual IRR figures by as much as 10%."

There is no feeling from LPs that managers are attempting to cover up risky deals or funds that are underwater – sentiment rather points to an atmosphere of complacency. Its proponents will argue that private equity can offer out-sized returns and that the model clearly provides the best level of alignment from investor right through to portfolio company employee. But it would seem that this understanding and awareness has become assumed knowledge.

And it is a sad truth that many LPs are under-resourced. However well-qualified and knowledgeable that one person in charge is, there is only so much one person can do. This becomes incredibly dangerous when funds use questionable metrics to show their performance in a far more favourable light than is truthful.

As institutional investors continue to cull their number of GP relationships, it is crucial the industry doesn't allow something as simple as clear and consistent reporting to deter investment.

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