This article is sponsored by LCM Partners
Whether it is increased reporting requirements or requests for separately managed accounts, investors are placing far greater demands on fund managers these days. Private Debt Investor sat down with Paul Burdell, CEO of LCM Partners, to discuss the challenges GPs face when trying to meet these LP demands as they also continue to grow their own businesses.
What are the client service trends you are experiencing?
First and foremost, we are in a client service business. Although we are all trying to generate best-in-class returns, it is equally important to ensure we provide LPs with the highest level of customer service. With that in mind, as the industry has evolved so have we.
Something that we are certainly seeing more of is increased demand for separately managed accounts (SMAs). This has come from some of our larger LPs who have expressed a preference for their own account for security reasons or to allow some form of customisation to their investment mandate. We wanted to have the ability to accommodate these demands so made sure that, operationally, our platform can manage SMAs alongside our commingled vehicles.
From a client service perspective, the biggest development has been around client reporting. In addition to our standard reporting, we now receive a significant number of other reporting requests that can be broadly split into three categories.
The first relates to growing regulatory requirements. A good example is around European insurance LPs. Since January 2016 when Solvency II came into effect, we have had to provide data on our underlying portfolio investments in a Solvency II friendly template. Then, last year we received a whole raft of requests to help these insurance LPs demonstrate to their regulators, who are increasingly scrutinising their illiquid investments, that they are managing their commitments in compliance with the Prudent Person Principle.
The second category of requests is related to environmental, social and governance standards. ESG has always been a part of typical LP reporting and due diligence, but the majority of our LPs now ask that we complete a standalone ESG questionnaire on an annual basis. We are encouraged to see ESG considerations becoming more mainstream and expect this trend to continue both for LPs and GPs. Indeed, the EU Disclosure Regulation, which entered into force on 29 December last year, confirmed that European financial firms will be required to disclose how they integrate sustainability considerations into their processes in a standardised way from 10 March 2021.
A final development that we have seen has been LPs’ increased use of third-party data exchanges either via online platforms or consultants. Although many investors have scaled their private debt commitments materially in recent years, their teams remain lean. As a result, using some form of third-party data aggregator to collect GP data in a standardised format makes a lot of sense.
What has your experience been with the data exchanges?
In general, they have been good. I mentioned having to provide our underlying portfolio data in a Solvency II friendly template for our European insurance clients. In this instance, we upload one template to a data exchange and it generates the required information and reports for all our LPs who subscribe to the exchange. It’s a very efficient way of ensuring we help our clients meet their regulatory requirements.
In terms of reporting and data aggregation, many of the data exchange providers have developed sophisticated reporting templates. Typically, the templates have in-built checks that flag data inconsistencies, advanced performance analysis and attribution, and the ability to aggregate GP exposures and performance data at the click of a button. The benefits to LPs are significant.
If we have one concern, it is the extent to which the data provided to these exchanges could be relied upon to make comparisons between managers, not only because the asset class has become much more diverse, but also because even comparisons of similar strategies remain difficult.
As a start, a high degree of sophistication is needed for these exchanges to account for factors such as the use of subscription lines, asset level leverage and the impact of foreign exchange hedging programmes. Even then, managers are reporting under different accounting standards and in line with their own valuation policies, which can vary materially.
What challenges does this additional reporting present to GPs?
Greater LP demands increase the workload for the GP investor relations teams, and other support functions, that need to be appropriately resourced. Equally important is continuing to invest in technology and streamline internal processes. That’s not easy to do but something we challenge our staff to focus on. What makes it difficult, and is to a large extent out of our control, is when our LPs decide to select different exchange providers so you end up performing the same exercise five times but in a slightly different format for each provider.
The other main challenge is that when an LP uses a data exchange or a consultant to aggregate GP data, to a certain degree the GP loses control of how that data is being presented to the LP. This often leads to questions from LPs. It’s in this area where we really see the value-add of consultant data aggregation offerings over online data exchanges. The consultants have a deeper understanding of GP investment strategies and so are better placed to clarify any inconsistencies.
Moreover, we’ve been really impressed by the extent to which the consultants maintain a continuous dialogue with GPs to ensure that the data templates are being populated correctly. Looking ahead, it’s undoubtably a smart move on their part though. These consultants are building fantastic data sets on the leading GPs globally, which can only serve to improve their holistic offering to LPs going forward.
Do you think GP reporting standards are improving?
Undoubtedly yes – it’s a competitive fundraising environment and there is now a wider appreciation in the industry that a first-class client service offering is a ‘must-have’ rather than a ‘nice-to-have’. Having said that, in many cases we think managers are starting from a low base and that levels of transparency in particular can still be improved.
We have to be conscious that with our investment strategy in private credit, LPs do not generally have the benefit of either first-hand experience or alternative information sources. There are no observable public comparables for the acquisition of portfolios of consumer or SME loans and the investments tend to be relatively bespoke and granular in nature.
We cannot expect our investors to know the intricacies of particular servicing strategies, cashflow profiles and cost arrangements in a diverse pool spanning hundreds of thousands of credits over 12 European markets. It is our job to provide the level of detail which they need to ensure they fully understand the performance and risk profile of their investment with us.
In short, we’re providing complete transparency on a portfolio-by-portfolio basis. This kind of challenge is not that unusual across the private markets industry and yet in some instances we are surprised by the extent to which it is not being fully addressed by managers.
Nonetheless, the industry is certainly moving in the right direction and it’s an area where we recognise the need to be a market leader.