Faced with increased competition, investor scrutiny and pressure on fees, private equity financial chief officers are looking to increase operational efficiency, but according to the EU 2018 Global Private Equity Survey, there is not a single clear strategy followed by the industry.
Nearly three-quarter of private equity firms said they have experienced significant pressure from investors to reduce management fees, and as a result, a third of CFOs report they have experienced some form of margin erosion.
To counter this effect, 19 percent of CFOs strategically cut expenses and tried to grow top line revenue. Growth, in particular, remains a top priority for private equity firms, which saw record fundraising in 2017. It is thus no surprise that 55 percent of CFOs said they expect to raise a new fund in 2018, and 60 percent of CFOs expect the fund to be larger than the last fund raised.
“The capital that continues to pour into the private equity industry – with more than $640 billion in new capital commitments for 2017 – is a positive sign for CFOs and management teams focused on planning to raise new funds or increase the size of funds in 2018,” said Jeff Short, Wealth & Asset Management Sector Leader for EY in the Bahamas, Bermuda, BVI and Cayman Islands.
To achieve operational efficiency and revenue growth, forward-looking CFOs are reevaluating where they want teams allotting time, preferring value-add activities such as investment portfolio analytics, technology transformation and investor relations, the EY report noted. Their aim is to divert time from tactical, routine areas such as fund accounting, treasury and human resources.
One way of achieving this objective is to leverage technology, but most CFOs reported that they are still in the early stages of developing innovative technology for practically every finance function, especially management reporting (51 percent) and valuation services (53 percent).
Although PE firms understand that using and managing data is an important focus, 62 percent of surveyed CFOs believe their data is not well integrated in their organization.
There was also a marked lack of confidence from CFOs that their organization could easily implement new technology solutions. They mainly blamed roadblocks such as updating fund accounting systems (83 percent) and management reporting solutions (75 percent), followed by valuation (65 percent), investor relations (64 percent), and cybersecurity (59 percent).
However, this does not mean that the firms do not plan to invest in new technologies. Two-thirds of private equity firms stated they are already or plan to invest in next-generation technology.
For the moment, they focus their investments on digital data delivery (37 percent) and advanced analytics (20 percent), with a small group implementing robotic process automation (4 percent), although more CFOs said they are planning to do so in the future (14 percent).
The annual survey of 110 private equity CFOs determined that larger firms with more than $2.5 billion in assets under management consider technology transformation and talent development as key priorities, while smaller firms are more likely to pursue outsourcing.
“While ideal operational maturity may be defined differently for private equity firms by size, it is clear that this needs to be their focus in order to compete for talent and investment capital,” said Mike Lo Parrino, partner, Ernst & Young LLP.
In addition to the larger firms’ focus on technology, talent management remains one of the highest strategic priorities, as 48 percent of respondents identified talent attrition as a top risk.
“CFOs of private equity funds are increasingly focused on how to attract and retain the best talent,” said EY Cayman Partner Baron Jacob. “Many large private equity complexes are using employee rotation programs to help employees get exposure to all areas of the business. The goal is to maintain a 3:1 ratio of investment to finance professionals, while outsourcing lower order tasks to another party or covering these tasks through the increased use of in-house technology solutions.”
CFOs confirmed that they prefer a 3:1 ratio of investment professionals to finance professionals, but only 20 percent said that this is their current ratio. This indicates that many have yet to find the optimal technology or outsourcing solution for their finance function, the report said. At the same time, CFOs are more confident that they have a strong pipeline of future investment leaders (76 percent) than finance team leaders (54 percent).
Although CFOs are trying to engage millennials and tech-savvy individuals to stay within finance functions, 35 percent noted that it is difficult to attract talent in these functions.
As a result, firms are increasingly offering other incentives beyond compensation to retain talent, such as expedited title changes/promotions (62 percent) and flexible work arrangements (51 percent).
For smaller firms, outsourcing is an attractive alternative to making significant investments in technology or talent in order to gain operational efficiency and remain competitive.
The desire to eliminate a finance team’s routine activities and replace them with more value-add activities could best be achieved by outsourcing activities like fund accounting (67 percent), tax (67 percent) and regulatory compliance (62 percent) to a third-party.
This also allows staff to focus on client-facing functions that require a more personal touch, with an average of 37 percent of CFOs saying they will continue to handle investor onboarding internally, and 37 percent saying they will do so for investor tax questions.
Cybersecurity breaches are a reality
Cyberattacks are a real, recognized threat for private equity firms, irrespective of their size.
More than a fifth of the private equity firms surveyed (22 percent) reported that they have experienced a cybersecurity breach, but many more may have been unreported. Most of those who had a breach (58 percent) considered it at least moderately serious.
To identify vulnerabilities and manage risk, 70 percent of private equity firms rely on externally developed intelligence products to monitor cybersecurity.
Firms are beginning to recognize the effectiveness of a multi-pronged approach, taking steps to improve employee training (87 percent), email monitoring (80 percent) and using external vendors to perform ethical hacks (80 percent).