Target Operating Models for Private Investments

In the current dynamic financial climate, private markets have emerged as a highly enticing option for fund managers and investors seeking enhanced returns. As competition intensifies, the need for operational excellence has never been more critical. With average returns of 11.6% even in periods of high interest rates, private credit funds are growing more quickly than ever before. Over 1,000 of them are currently in market, according to Preqin. This demonstrates the significant challenges that companies must address to enhance their operational efficiency.

Managers today are competing to find their place in a world that demands top-notch performance and growth at an unprecedented pace and scale. However, many are discovering that investing in private credit presents unique challenges.

Difficulties in valuing investments, assessing credit quality, and identifying risks can make it hard to establish efficient operational processes. To make matters worse, many companies lack a standard system for middle and back-office operations, making it even harder to achieve efficiency and scalability.

Understanding the landscape

Private markets aren't just diversifying; they are becoming more complex. New asset classes and investment strategies introduce a burden on operational processes, which often rely on outdated tools like spreadsheets and manual data entry. Many firms find themselves ill-equipped to handle the influx of data and regulatory requirements, leading to inefficiencies and increased costs.

Nuances of private investments operations

In the retail market, publicly traded business development companies (BDCs) have different distribution and reporting regulations as compared to private investments. Companies must adhere to these rules to ensure compliance and smooth operation.

Outdated methods, such as manual data entry and tools like PDF reports and spreadsheets, are often used for information flow, tracking, and reporting. Centralizing and digitizing information storage can reduce the risk of errors and improve efficiency. In contrast to mutual funds, private market companies often have limited access to established service providers. As a result, they may rely on monopolistic vendors or subpar systems that lack specialized knowledge, resulting in operational inefficiency and hindering progress. A company becoming public needs to change how it operates to meet higher regulatory oversight and transparency standards. This means they must carefully evaluate and often improve their current procedures and technologies.

The absence of universal standards for middle- and back-office operations exacerbates these challenges. Firms must craft tailored solutions that address their unique operational needs while ensuring scalability and compliance.

Common pitfalls

As firms seek to enhance their operational frameworks, they often encounter several common pitfalls.

Many companies often turn to creating multiple systems as a quick solution to problems, which can hinder business growth and lead to high maintenance costs. This is further compounded by manual processes and separate data sources, which can cause issues with data collection. A more effective approach is integrating systems and consolidating data to establish scalable processes that can support business growth.

Adding resources

While hiring additional employees may seem like a viable solution, it can result in over-reliance on certain individuals and fail to address underlying system inefficiencies. A better strategy is prioritizing automation and improving existing systems to reduce reliance on manual work and specialized skills.

Delaying action

Procrastination can have detrimental consequences in the long term, as it can lead to accumulated inefficiencies and increased expenses. To avoid this, it is important to be proactive in addressing operational challenges by prioritizing strategic improvements and investing in technology and processes that can facilitate long-term growth.

Relying on home-grown solutions

Although building technology in-house may appear to be a cost-effective and expedient option, it can ultimately be more costly and time-consuming and may lack important features due to shortcuts or a lack of expertise. Therefore, it is crucial to carefully weigh the pros and cons of building technology internally versus working with technology companies that offer pre-made solutions before deciding.

To navigate these pitfalls, firms should adopt a holistic approach that emphasizes integration and collaboration.

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Establishing a robust operating model

Creating an effective target operating model involves aligning three critical pillars: people, processes, and technology. Here’s how firms can establish a strong foundation.

Optimize team structure and roles

Rather than creating separate teams for various functions, firms can benefit from a streamlined approach. A small, skilled in-house team focused on governance can collaborate with external partners to handle data processing and reporting. This model minimizes the risks associated with staff turnover and enhances operational flexibility.

Important questions:

• Who will manage workflows and reports from multiple administrators and partners?
• Are the appropriate individuals checking data, reconciling records, and generating reports?
• Do administrators and trustees provide support for risk management, record-keeping, and reporting?
• Does the operations team possess expertise in various credit asset categories and their specific operational challenges?
• Are both the administrator and manager reconciling data?

Instill operational excellence

Operational processes for liquid and illiquid investments vary significantly. Firms must implement robust frameworks that can adapt to the unique nuances of private credit, ensuring accurate tracking and reporting of fund performance. By establishing flexible cash and liquidity management processes, firms can avoid costly overdrafts while maintaining compliance with regulatory requirements.

Key considerations for assessment:

• Is your fund and investor accounting team prepared to take on more responsibilities?
• Do you struggle to track cash flow or liquidity? Have you ever exceeded account limits?
• Are your investor reporting methods compliant with SEC regulations? Can you easily adapt to new rules?
• Do you face challenges with investor transparency?
• Can your systems easily scale as your business grows?

Integrate advanced technology

A unified data source is essential for ensuring that all stakeholders use consistent and accurate information. By adopting sophisticated technology solutions, firms can enhance efficiency, security and transparency. Regular system updates are crucial to maintaining compliance and adapting to evolving market demands.

Essential questions to evaluate:

• Can your front office prioritize investors' needs with well-organized data? How do you ensure data accuracy?
• Can your teams access tools to get data on their own at anytime, analyze it, and make reports or dashboards to understand their data better?
• Do your procedures help manage accounts, funds, investors and cash transfers?
• Is your system ready to enter new markets when needed?

Maximizing the benefits of partner support

Partnering with the right company can greatly benefit your team by providing valuable insights and proactive solutions. It is crucial to choose a partner who has a deep understanding of your business and the types of investments you make, allowing for customized support for your private credit investments.

By selecting the ideal partner, you can simplify your processes, access specialized knowledge and technology, and free up your internal teams to focus on strategic tasks. When evaluating different models for your business, you can select between cost-effective, non-expert vendors that may require more supervision, or expert partners who offer comprehensive support with minimal oversight needed.

Finding your north star

As the private markets continue to expand, companies must take a proactive approach in prioritizing strategic enhancements and investing in technology that supports sustained growth. By offering specialized expertise and advanced technology, the right partner can significantly improve a firm's operational capabilities, freeing up internal teams to focus on strategic initiatives.

In the world of private investments, no one-size-fits-all solution for optimizing operations exists. However, by understanding the unique challenges and leveraging best practices, firms can establish streamlined, efficient, and compliant operational frameworks that drive success in the competitive landscape of private credit.

A crucial aspect of this optimization process is discovering the firm's "north star" — the guiding principle that defines its purpose and influences decision-making. This could be a commitment to innovation, ethical investing, or delivering superior returns for stakeholders. Once this north star is identified, it becomes the cornerstone for developing and implementing operational strategies that align with the company's objectives. With the right partner and a clear north star, firms can navigate the complexities of the private investment industry and achieve lasting success.

Keep reading to learn more about optimizing operations for private markets.