21 July 2022 - Much has been made of the impact of rising interest rates and lower public market values on the Private Equity industry this year, amid a shift in the outlook for interest rates globally. Macroeconomic change has always impacted the private markets and the Citco group of companies (Citco) does not expect things to be any different this time around.
As in previous cycles, higher interest rates mean financing acquisitions with debt is more difficult, causing lower public market prices and lower exit values. This changing paradigm means two things for private equity managers.
Firstly, it moves the focus in the front office to true valuation creation in the portfolio based on enhancing existing assets and finding opportunities where true improvements to the target business can be made. Secondly, it puts greater focus on operating expenses. These can include a variety of professional fees, such as audit, fund administration, advisory, and internal staff costs. Within this, it is certainly true that there will be focus on service provider costs.
This focus on the value of fund admin will lead to the industry doubling down on efforts to use technology, data and digitization to generate value for scale. Technological change will no longer be seen as a good thing for the future or something the leading managers invest in, but as a necessity for all to drive efficiency. But digitization and automation can only be effective where there is a reasonable degree of standardization in processes, and where those processes have structured data as their inputs.
Against a backdrop which has seen the rate of growth become as fast at is has ever been, so the standardization of the private markets industry’s data and processes is long overdue. The expectations of institutional investors, combined with a rapidly growing industry, has shown the need for this, but the new focus on costs will create an obligation to deliver.
Given the interconnectedness of managers and administrators, this kind of change will require both parties to work closely together to develop joint roadmaps. It will also require cooperation at an industry level for the efficiencies to be realized. For example, if there is more consistency in reporting to investors across the industry, there will be more opportunity for automation in the production and consumption of the reporting.
If Citco is successful in these efforts, it will set the industry on a strong foundation for whatever may be thrown at it in the next 3-5 years, especially given many private equity businesses want to double their size during this time.
The old adage of investing in improving your house whilst the market is down is very apt here for both the front and back office. By investing properly in what Citco does now, it will mean not only us, but the whole market, is ready for the future growth we expect to see.