As private markets and assets grow in importance to institutional investors, so are the challenges they face; not least of all their data processes.
A report by Dynamo Software in February found that the biggest challenges faced by accounting professionals in private equity, venture and hedge funds were tech and data-related; manual data entry and reconciliation, financial reporting and a lack of integration with other systems were at the top of the list.
And yet, Dynamo’s annual Frontline Report three months earlier had shown that fund accounting was way down the list of departments receiving investment money for artificial intelligence and other advanced applications. Just 16 per cent of the almost 100 general and limited partners questioned in the report said they had applied AI to their accounting processes. The lion’s share of general partners’ (GPs) AI investment was being committed to portfolio monitoring and valuation, it found.
That gap indicates a technological immaturity in fund back offices that would have come as no surprise to fund accounting technology innovator Gareth Hewitt. The young London-based founder of start-up LemonEdge created his company because he recognised the yawning chasm between the technological needs of increasingly complex private markets and what they are capable of.
“I spent the last 20 years in four different companies building partnership accounting systems and there’s a huge frustration in the industry about these legacy systems, which haven’t moved on for 10, 15 years,” Hewitt told Data Management Insight.
In a classic example of the old maxim, “if you build it, they’ll come”, LemonEdge has grown into a leading provider of technology to the back-office administrators of some of the largest private funds operators, including Blackstone. It has disrupted a market that, Hewitt said, had become entrenched in time-consuming workarounds.
“The attitude is, ‘What are you going to do? The barrier to entry to build this type of product and compete is enormous’,” he said.
Meeting Demand
With many firms operating on decades-old technology stacks, performing complicated tasks such as reconciliation manually, it was apparent that the industry needed a shake-up. It needed a technology that could reduce the manual administrative burden on back offices and knit together their fragmented systems to give a unified view of their operations.
LemonEdge was formed in 2022 and now offers clients a cloud-based automation solution that Hewitt said has substantially improved efficiencies for its clients.
The company now employs 80 people and has more than 35 clients who range in size from small funds managing US$5 billion to huge tier-one institutions that oversee in excess of $100 billion.
“When you get to the high-volume, complex firms, they typically can be around T plus 90 to get reports out,” he said. “We’re pulling that down to T plus 30.”
Investor Appetite
The private sector is going through the sort of growing pains that public markets went through decades ago as more institutions and retail investors clamour for the higher returns that private equity, credit, real assets and a welter of other privately held financial instruments are offering.
They, like their more regulated cousins, are subject to new commercial and technological pressures as competition for their services intensifies.
Data and technology vendors are clamouring to bring the sort of transparency to private markets as investors are used to in public markets as they seek to fill an information gap to a sector that Preqin estimates will account for almost US$25 trillion of invested capital by 2028.
Consequently, automation has become a key word in the sector. But as markets that have long been opaque are being asked to open their doors to outside scrutiny, they are finding that their longstanding business models and processes are proving an impediment to the application of modern data-led technologies that can bring those efficiencies.
“Investors always want more data, more transparency, more look-through into underlying investments,” said Hewitt. “And all of that is harder unless you have a system that can give you that look-through.
“When you start having different products – not just a traditional closed-ended PE fund, but also an evergreen vehicle or some open-ended or credit vehicles or hybrid sitting alongside – an investor wants a view across all of that. And traditionally, that’s been done on different systems because they just can’t cope with it in one. And so it just becomes complicated and time-consuming to get that.”
Increasing Complexity
Private fund accounting is made more complicated than more traditional fund accounting by the variety of investment vehicles, asset types and investors involved. They rely on financial reports that don’t follow common schedules and data that is often incomplete. Most importantly, their fund structures are complex and increasingly diversified and geographically spread.
LemonEdge, Hewitt said, stands out from other fund accounting service providers because it understands the structure of funds in ways that its competitors don’t. Having spent two decades working for companies large and small within the sector, including two he formed and ran, Hewitt said he had built up enough “hindsight” to create a technology tailored to the accounting use case.
“The complexity from an accounting point of view is that you’re doing a fund itself, its structure – although the investors might see the top, it might have 20 or 30 vehicles in it. And the cash goes through that structured layer before it hits an investment,” he explains.
“And so not only are you accounting for all of that, but when you buy something for $100 million, you’ve got to divide it up by what each investor’s owner of that is because they’re limited partnerships.”
“Because we actually understand the fund structure, if you’ve got a parallel vehicle structure, a parallel fund structure that introduces a new Cayman vehicle, that’s three days of offline work in the legacy systems. Whereas for us, it’s done with the touch of a button.”
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