Fund administration and servicing is a hot button topic in alternative investments. The conversation has moved on from whether to outsource, to one where service levels and takeover activity are being increasingly scrutinised. Each week, participants see headlines of titanic mergers and acquisitions being financed from the huge pool of commitments that have flooded into buyout funds in the last decade. With high costs of change for customers and high barriers to entry maintained by governments, regulatory bodies, and entrenched interests, newer players can find it daunting to break into the market.
Linnovate Partners is a next generation asset and fund services provider, with fintech and process automation forming the solid base from which our advisors deliver our premium services to clients. Fund administration is one of our core offerings, in which we have developed a set of automation tools that reduce manual processing by 80%, resulting in a quantum leap in service levels, accuracy and turnaround times. Today, Linnovate Partners has nearly USD $40bn of assets under administration (AUA), and monitors the direct and indirect portfolios of nearly 50 clients.
In this article, we will explore some of the underlying themes of the industry and explain our own ways of dealing with some of the challenges therein.
Hyperactive M&A market for service providers
The continued low interest environment, in place for nearly 12 years, has created enormous pools of commitments wanting to find a home that delivers any kind of return. For analysts at buyout firms, fund administrators and other service firms provide a stable, regular revenue stream, based on assets under management (AUM), that is difficult for customers to turn off or switch from. The business model is very attractive as part of a well assembled portfolio.
In addition, it is not a difficult exercise to source deals – a lot of administrators are owned by buyout firms already, and it is not hard to guess when a deal might start to be marketed to potential new owners.
These factors are contributing to unprecedented consolidations of service providers. Whilst we would expect such activity to yield benefits for owners of these businesses, what about customers? Do they really feel the benefits of an administrator who now has 8 jurisdictions instead of 5? Or that now has 8,000 employees rather than 2,000? The jury is out…
Market research suggests that clients are seeking more from their service providers, but the evidence suggests that instead of meeting these new levels of service, the M&A activity is resulting in prioritisation of growth instead. When all things are considered, it is difficult to imagine the CEO of a PE-owned service provider to commit to and undertake the modernising changes needed in technology and service provision, whilst trying to prepare the business for an exit.
Customer service levels – doing better for clients
Just because we are in the business of fund services, a professional activity, it does not place us in a position of assumed superiority over our clients. We are after all in a service industry – a service that is paid for, ultimately, by investors. Why then, are there consistent reports of poor customer service, long turnaround times and inflexibility to accommodate even small requests? We have to really understand that GPs are also under testing conditions where they have to respond swiftly to LPs’ new requests. Inability to respond in a timely manner can result in loss of trust in the quality of the service and the provider.
Some key factors affecting current levels of customer service are:
- Job insecurity. The M&A environment has added dramatically to employment instability. Therefore, the customer pays a high price for this instability – through account management, key person reassignment, handover activities (and the inevitable “dropped file”…), and worst of all, reduced service levels due to lower staff morale.
- Constant operating model changes. A smaller administrator might have once internally handled change requests. As a member firm of a larger conglomerate though, it’s usually the case that change requests are now sent to a remote centre, a ticket issued, and the waiting game starts. We have not heard of a single instance where this method has resulted in a faster service for a client – and this is reflected both in our own research, and our recent hires.
- Proliferation of systems. Victims of their own success, the buyout investment model does not really allow for sufficient time to develop and implement truly innovative and integrated tech-based solutions. Whilst everyone pays lip service to automation, the reality is quite different. Most consolidated firms struggle to maintain and even keep up to date, a legacy stable of conflicting software systems, where even a customer address change is a process that takes days. For example, a customer might have previously been clients of both the acquirer and the acquiree, resulting immediately in a duplicate record problem.
Increased investor sophistication
The modern day fund manager of PE and VC finds themselves scrambling to deal with exponentially higher investor demands for transparency, combined with increasing pressure on operating margins. It is a perfect storm of:
- High investor expectations
- Lower margins due to increased burden of reporting and software maintenance
- More complex legal agreements – not only in investment structuring, but also in the LPAs and side-letters
We ought not to be surprised. No longer an exotic and speculative asset class where low visibility and zero data access was normal, PE and VC are now at the centre of allocation decisions, as all investors scramble to make a return. Alternatives, to put it simply, are getting less alternative. As this trend continues, the expectations towards a “traditional” markets level of data access will grow, and become impossible to ignore.
Today’s investors into the asset class are often feeding GP-supplied data into complex and sophisticated modelling tools and data lakes, on which time critical decisions are made. So why are PDFs and paper acceptable methods of investor communication in 2020?
The due diligence processes of investors now cover not just the GPs that they are proposing to invest in, but also the suppliers to those GPs. Rightly so – the service providers are vital components of the investment management and accounting process and should be included in DD activity.
The difficulty of entering the market and changing providers
We have looked at market dynamics in the fund administration business. However, there are also natural barriers to entry for new players who want to increase disruption in the industry. Key among them are:
- The desire for a “one stop shop”. It is true that there are advantages to dealing with one firm for all required services, across all jurisdictions. At the minimum, the threat to leave the supplier would be taken seriously enough for there to be action taken. However, the advantages of a “one stop shop” are somewhat exaggerated:
- Two member firms of a global conglomerate face cross border regulatory issues in the same way as two separate and unrelated firms do – because they report to two regulators.
- Some regulatory requirements may require Chinese walls within the same firm, obviating any advantages of having a one stop shop.
- “One stop shopping” goes against the prevailing wind of specialisation. The wide roof of a one stop shop instead provides a shield for inefficient, non customer-centric practices to continue and flourish. Worst of all, pricing models include the customer paying for all of these.
- Regulatory barriers. When starting a business, cash is obviously a top concern. The process of meeting regulatory requirements is a difficult one – first of all the time required, secondly, the cost of getting authorisation, thirdly, prohibitive capital requirements.
- Technological innovation. Whilst technology is one of the ways to unlock efficiencies, many potential entrants come from an accountancy background rather than a tech one. This means that the technology is selected from a shrinking set of suppliers who are able to service this industry. It also means that most new entrants fall into the same doctrine of selecting someone else’s software rather than push for true innovation on their own.
What makes Linnovate different?
When we started in 2016, we put fintech at the heart of our operations, by setting out our vision of a unified ecosystem where all participants in a private market transaction could communicate by invitation through the use of blockchain. This cutting-edge ecosystem sits at the heart of our service, enabling our analysts to go beyond bookkeeping by providing a value-added premium service to our clients.
In the customer oriented environment at Linnovate Partners, our team of developers have built a comprehensive stack of automation tools that free our client managers from the burden of manual labour drudgery. In all aspects, from maintaining an address record, to calculating a distribution waterfall, our mantra is “tailored automation” – not for the sake of replacing people, but for repeatable results, for accuracy, and for speed in turnaround and delivery – all the while bound up with meeting customers’ specific requirements. Far from the tired argument of “replacing people with machines”, our team is enabled to provide a much more risk-based approach to fund servicing – for example, to actively look for irregularities rather than straight inputting and checking. This approach harnesses human creativity and insight, to deliver better service and a more rewarding professional life.
Charles Yu, Chief Operations Officer, has spent over 25 years in the financial services industry. Among his other duties, Yu is the executive in charge of Linnovate’s customer service and data management procedures and templates. Speaking about the automation at Linnovate, Yu said: “We are incredibly proud of the efforts that our team has gone to in order to provide a unified, centralised and automated environment for our valued client facing team to use. Take the simple example of a client address change. Whereas at other firms which have siloed applications, and workflows involving multiple teams, at Linnovate this is a one touch update process, once the manager has verified and approved the address change. It is fast, and simultaneously updates all our internal platforms in one hit. Our team are simply not encumbered by the manual labour which we so frequently see in the private markets.”
Cecilia Cheung, Managing Director for Alternative Fund Services, joined Linnovate in January 2020. Cheung joined Linnovate having worked in senior capacities with some top names in fund administration, such as IQ-EQ and Sanne Group. Asked about the unique propositions we are enabling for the market as a result of our fintech-powered base, Cheung said: “Technology should be at the heart of asset servicing and fund administration, but too often, we see the same problems in large firms – duplicated and siloed systems requiring manual re-inputting, long manual workflows for change requests, and not meeting clients’ needs.
“Linnovate’s commitment to developing an ecosystem for private markets participants has allowed our team to provide a unique experience combining professional service with process automation and cutting-edge technology. Indeed, several of our clients are able to rely on the AFS team at Linnovate to contribute to internal reporting. What this means is that we can pursue new areas of growth for the business, completely confident in our unique technology stack to do the manual lifting. It is a boon to candidates who have the same passion and belief who want to join us, and an assurance to potential customers that we are not going through the motions of ‘picking software applications’. Our technology stack forms an integral part of our service and continually delivers more value by raising the bar in asset and fund services.”
Linnovate Partners is privately owned by its employees. This has allowed us to focus on our own goals for changing the whole conversation about tech-enabled service provision. With nearly 20 years of experience in alternative assets operations and systems, Managing Director for Europe, Redmond Lee, has been at the forefront of many trends in PE and VC. Noting the continuing M&A activity in this industry, Lee said: “Linnovate’s customers benefit from a stable ownership structure, which is a comfort for clients who value continuity. When paired with an extraordinary level of automation in the business of asset servicing, we can afford to be flexible and fast in dealing with the ad hoc requests that our clients expect to receive from their investors. Whilst our peers are busy examining new ways to repay their investors by shrinking the windows for change requests, and by locking down SLAs, we are providing our clients with flexibility and unmatchable response times to new requests. We want to go beyond bookkeeping, and move both our people, and our clients up the value chain.”
Conclusions
We had the opportunity to build in an integrated technology stack when we started this company, alongside a vision of connecting parties to private transactions in an ecosystem. We believe that this vision sets Linnovate apart from the rest of the industry, and raises the bar for asset and fund servicing. Our unique tech-enabled premium services allow us to conduct client business with a highly integrated and automated platform, and enables our advisors to help clients with personalised levels of service, and to help them deal with increased complexity and challenges in today’s alternative assets industry.
Copyright (C) Linnovate Partners Limited 2020