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How Private Equity Must Evolve to Meet Market Demands: SEI Study

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The private equity market has experienced dramatic growth over the past two decades—rising from $30 billion to $4 trillion—propelled by tremendous demand from a wide variety of investors, according to SEI Investor Management Services.

In a new study, SEI asked some 200 industry general partners, limited partners and consultants where private equity is heading.

Although the industry’s rapid growth rate is unlikely to persist, many survey participants said they expected growth to remain on an upward trajectory over the next 10 years, thanks to strong demand—a median $7 trillion, implying an annual growth rate of 5.8%.

GPs predicted that much demand would come from high-net-worth individuals, investing directly or through family offices.

Sixty-four percent of LPs in the study said they planned to increase their private equity allocation, up significantly from only 26% who said this five years ago. And some 40% of respondents said they would buy or sell secondaries over the next 12 months.

About a fifth of respondents said they preferred co-investments to traditional closed-end vehicles.

However, comingled closed-end fund structures will continue to be the vehicle of choice for the foreseeable future, SEI said, even as liquid options and co-investments continue to make inroads.

Operating Hurdles

The poll found that LPs and consultants were likelier to consider investment performance a critical consideration than any other selection criteria. Fund managers’ credentials and reputation were still important, but less so than in past years.

When evaluating managers, the survey showed, consultants were more likely than LPs to focus on risk management infrastructure, separation of investment and operations, and an independent administrator.

More than 80% of GPs said compliance costs were climbing faster than other operating expenses, making these a key operational challenge.

As well, they were receiving more scrutiny from both LPs and regulators. Sixty-five percent of LPs said they were increasing the level of operational due diligence performed on GPs.

Data management was also vexing many private equity firms. Thirty-two percent of LPs reported they were insisting that GPs provide data mapping into their portfolio monitoring systems.

SEI said although investors interested in this level of integration may currently be in the minority, their ranks will grow, especially as systems providers increasingly position themselves as being able to accommodate these requests.

“As evidenced by this report, the private equity market has experienced tremendous demand from a wide variety of investors, resulting in rapid growth and significant opportunities for the industry as a whole,” Jim Cass, managing director of the Investment Manager Services division, said in a statement.

“To capitalize on this growth, however, GPs must address the unprecedented obstacles facing them—mainly seen as an increasing talent shortage, the complex web of regulatory requirements and myriad new operational challenges.”

Business Models

Survey participants differed on the optimal private equity business model, with two approaches having both virtues and drawbacks.

Many considered a specialized business model more competitive than a diversified one. However, the poll found that consultants were more likely to tout the benefits of a diversified approach than were GPs.

SEI said it was clear that business models must remain open and ready to adapt to the increasingly investor-driven market, which includes understanding current processes and how a change in model affects operating platforms.

The survey found that outsourcing at private equity firms continued to be relatively rare except in the areas of custody, tax and accounting. Well over half of respondents continued to perform many functions in house, from compliance and valuation to research management and portfolio analytics.

Some firms said their existing staff did not have the requisite expertise, but that they ran up against a talent shortage when they tried to locate and recruit the necessary personnel.

SEI said outsourcing could enhance GPs’ ability to manage data, monitor complex investment strategies, handle customized portfolios and improve investor reporting.


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