In Conversation with Convergence, Episode 3: George Evans, Tom Gandolfo of Alter Domus, and Bill Pidgeon of CohnReznick Discuss Outsourcing and Cybersecurity

How did the private funds market grow from March 2020 to March 2021?

George Evans of Convergence opens by saying there are over 600 fund administrators and 500 audit firms servicing the private markets, and introduces two Convergence clients as guests: Tom Gandolfo of Alter Domus and Bill Pidgeon of CohnReznick. He says advisers disclosed over 93,000 private funds in the 12 months ending March 2021, an increase of over 4,800 funds, up 5.5%, with assets of $22.8 trillion, a net increase of $2.4 trillion, up about 11.5%.

Evans says the top 25 administrators won 47% of over 7,000 new funds disclosed, all other administrators won 19%, and advisers who self-administered stayed steady at around 34%. The top 25 won 55% of new fund assets, all other administrators 14%, and the self-administration market about 31%.

Evans says private equity assets grew about 19.2% and venture capital assets over 48%. He says advisers disclosed 23,600 hedge funds, down about 700 funds, about 3%, and that hedge fund assets increased close to 6%, driven by appreciating markets and new net inflows into existing funds.

How large is the self-administration market?

Evans says there are over 30,000 self-administered funds, up over 400 funds year over year, representing almost 33% of all private funds, slightly down from about 34% a year earlier. He says the value of self-administered assets totals about $5.6 trillion, up about 15%, which he calls a great and tremendous opportunity for administrators, especially in outsourcing or liftout transactions.

Which administrators grew fastest?

Evans says market asset growth was about 11.4% and that only administrators ranked one through five were not keeping pace, growing about 4.5%, about half the market rate. He says administrators ranked six to ten grew 16.5%, those ranked 11 to 25 grew 21%, administrators ranked 26 to 600 grew 17%, and the self-administered market grew 15%.

Evans says the top 10 administrators should study the pattern, that advisers continue to move down market, and that transaction activity continues, citing an acquisition of Strata and TMF Group's acquisition of Venture Back Office (VBO). He recognizes five Convergence clients for year-over-year performance: Gen II, SEI, Apex, Alter Domus, and Morgan Stanley.

Who is Tom Gandolfo, and what does Alter Domus do?

Evans introduces Gandolfo as head of sales and relationship management in North America for Alter Domus. Gandolfo says Alter Domus is a global fund administration and corporate services provider focused on alternatives, founded in 2003 in Luxembourg, operating in about 20 countries, with almost 1,000 employees in nine U.S. offices. He says recent milestones include crossing the 3,000 mark for employees globally and reaching $1 trillion in assets under administration.

Gandolfo says Alter Domus closed on acquisitions of two administrators, IPS Fund Services in Boston and Strata Fund Solutions in Salt Lake City, opened an office in the Cayman Islands, and acquired the London-based fintech Credit-Vision, an analytics platform for corporate credit investors that complements its debt capital markets business.

What did Gandolfo say about the market, adaptation, and what advisers ask for?

Gandolfo says all sectors are firing at the same time. He says fundraising paused for some smaller and mid-tier managers in mid-2020, that those firms are coming back to market, and that momentum built in the fourth quarter and continued into 2021, with interest in direct lending funds, logistics in real estate, opportunistic strategies, and the market for collateralized loan obligations (CLOs). He says fund administrators are doubly blessed by a strong market and a manager community continuing to move from self-administration to outsourcing, which he says COVID hastened as managers see the benefits of scale and technology and accept that their fund accountant need not be down the hall. He says the one surprise was the speed of the market's recovery, which he credits largely to government stimulus, and that it reinforced the resiliency of the alternative space.

On challenges, Gandolfo says the industry has not returned to a new normal, that most colleagues and clients work remotely, and that engaged executives and HR, flexible work arrangements, and the right tools will remain important. On the client side, he calls it an adaptation rather than a challenge: video conferences for client discussions and due diligence meetings, webinars and podcasts in place of in-person conferences, and a presence on LinkedIn and thought leadership. He says Alter Domus publishes on industry topics every couple of months.

Gandolfo says fund accounting and asset servicing remain the core of the business, and managers want competent, capable staff along with continuous investment in technology and processes: removing manual functions, automating, and using portal technology for data. He says Alter Domus rolled out a digital subscription process and uses robotics and optical character recognition (OCR) technology.

He says ESG is the other recurring topic. COVID put a larger spotlight on ESG priorities, most LPs have ESG standards that must be met before they participate in deals, and for private equity ESG is part of the process from diligence to sourcing investments and adding value. He cites a McKinsey study, often cited, that companies will pay a premium to acquire firms with strong ESG platforms, and says the data shows gender and racial diversity correlate with higher financial returns. He says Alter Domus has established an ESG mission and steering committees, and that ESG is part of its recruiting process.

How did auditors perform?

Evans says advisers disclosed over 92,000 private funds, a net increase of over 5,400 funds, up 6.2%, with assets of $22.5 trillion, a net increase of $2.3 trillion, up about 11.5%. The top 25 auditors won 70% of 7,200 new funds disclosed, all other auditors won 6%, and 24% of funds did not report a fund auditor. The top 25 won 89% of new fund assets and all other auditors 2%. He says the close to 15,000 funds not reporting an auditor, up about 4%, are either not subject to an audit or are selecting an auditor, which he calls a great opportunity for audit and assurance practices.

Evans says closed-end funds continue to show strong growth, with private equity close to 19%, venture capital close to 50%, and real estate close to about 9% in funds and assets. He says advisers disclosed close to 23,100 hedge funds, down over 500, and that hedge fund assets were up about $500 billion, about 6%, driven by appreciating markets and net inflows into existing funds.

Evans says market asset growth was about 11.6%, the Big Four kept pace at about 10.4%, auditors ranked five to ten grew about 16.5%, and auditors ranked 11 to 25 grew about 21%, almost twice the market's asset growth. He says advisers are clearly also moving down market in the audit segment, and he recognizes four Convergence clients for year-over-year performance: PwC, Deloitte, EisnerAmper, and BDO.

Who is Bill Pidgeon, and what does CohnReznick do?

Evans introduces Pidgeon as a partner and co-leader of CohnReznick's financial services group. Pidgeon says CohnReznick was founded in 1919 and has 25 offices globally, including the Cayman Islands. He says its alternatives investment practice provides audit, tax, and advisory services to over 900 funds, including hedge, private equity, venture capital, and real estate funds, at all stages from emerging managers to funds over $1 billion in assets under management, and also provides advisory services including due diligence and valuation.

What did Pidgeon say about 2021 growth, surprises, and challenges?

Pidgeon says new launches that stand out so far in 2021 include cannabis funds, debt funds, real estate funds focused on multi-family opportunities, and private equity funds focused on technology, health care, and renewable energy. He says that since the fourth quarter of 2020 CohnReznick has also received calls from established managers who felt they needed more personalized service and partner-level attention given the changing regulatory environment, and that he expects the trend to continue through the year.

Pidgeon names three surprises. The first is the rapid recovery in valuations from the March 2020 lows to year-end, with most portfolio companies recovering and several appreciating, especially in technology. The second is the limited number of fund drawdowns and closures, with most clients receiving no redemption notices and a good number receiving capital inflows. The third is the increase in fund launches and the ability to raise capital late in the year and into 2021, after the due diligence community and fund managers pivoted quickly to virtual meetings. Evans adds that Convergence's capital formation work shows a lot of dry powder.

On challenges, Pidgeon says CohnReznick shifted from conferences and dinners to an all-digital strategy of thought leadership and webinars, saw growing fatigue with seminar attendance, and pivoted to more curated events and smaller virtual meetings, while looking for new ways to keep employees and clients engaged in a work-from-home environment.

What did Pidgeon say about cybersecurity and ESG expectations?

Pidgeon says advisers care most about generating returns for investors and raising capital, and that two newer topics are drawing interest: cybersecurity and ESG. He says the SEC identified information security and operational resiliency as one of its top examination priorities for 2021, and that the Division of Examinations expects advisers to have measures to safeguard client accounts, address malicious email activity, and manage operational risk with employees working from home. He cites Federal Reserve Chairman Jerome Powell's remark on 60 Minutes that cyber risk is the risk the Fed watches most. He says CohnReznick's advisory practice has helped clients assess cyber risks and conduct threat analysis and breach detection.

On ESG, Pidgeon describes a February panel on the expectations of allocators and limited partners. He says participants want ESG truly embedded in the adviser's investment process, not an attempt to check boxes in a due diligence questionnaire; want to know advisers apply appropriate ESG measures in their own firms, such as diversity and inclusion measures; and want evidence that relevant factors are regularly monitored for each portfolio company, including an annual report showing the status of each investment and progress against the prior year. He says the SEC is also watching ESG investing closely and encourages reading the April 9, 2021 Division of Examinations risk alert related to ESG. Evans says Convergence recently published that SEC examiners are starting to see unsubstantiated and potentially misleading statements and questionable processes at some advisers, particularly with ESG products.

What did Evans say to watch next?

Evans says both guests were very bullish on 2021 and surprised by the speed of the market's recovery and valuations. He says they saw a lot of client adaptation to COVID, thought leadership was important, and technology investment, particularly cybersecurity, was an important issue. He adds that they discussed strong ESG programs at advisers and the ability of advisers to raise capital, with lots of dry powder in the marketplace.

Evans closes by saying it is important to operate across all asset types, that closed-end growth will continue to outpace open-end growth, that he sees European-based administrators giving the large U.S. administrators a run for their money, and that he sees some shakeout in the top 10 audit firms.

How do the league table figures compare by group?

The figures below are as Evans states them, rounded or approximate. His administrator and auditor sections use different totals, so both are shown.

Market totals as stated in the administrator and audit sections, March 2020 to March 2021, by George Evans

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Share of new funds and new fund assets won, March 2020 to March 2021, as stated by George Evans

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Asset growth by tier, March 2020 to March 2021, as stated by George Evans

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These are 2021 figures; Convergence's current league tables are published in its monthly league tables post.

Topics Covered