In Conversation with Convergence, Episode 4: George Evans, Jason McLinski of Apex Fund Services, and Irena Gershengoren of EisnerAmper Discuss Regulatory Complexity and ESG

How did the private funds market grow from April 2020 to April 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: Jason McLinski of Apex Fund Services and Irena Gershengoren of EisnerAmper. For the 12 months ending April 30, he says advisers disclosed almost 95,000 private funds, a net increase of over 5,100 funds, up about 6%, with assets of close to $23 trillion, a net increase of $2.4 trillion, up about 12%.

Evans says the top 25 administrators won 47% of about 10,000 total new funds disclosed, all other administrators won 21%, and advisers who chose self-administration stayed around 32%. The top 25 won 53% of the $1.37 trillion in new fund assets, all other administrators 12%, and self-administered funds kept a steady pace at about 35%.

Evans says private equity funds were up about 7% with assets up very close to 20%, and venture capital funds up 20% with assets up close to 50%. He says advisers disclosed close to 24,000 hedge funds, down about 600, and that hedge fund assets increased about 6%. He says there are almost 31,000 self-administered funds, about 32.5% of all private funds.

Which administrators grew fastest?

Evans says market asset growth over the last year was about 12% and that only administrators ranked one through five were not keeping pace, growing about 5%. He says administrators ranked six through ten grew close to 18% and those ranked 11 through 25 grew 21%, and that the growth down market continues, which he says the top 10 administrators should study.

Who is Jason McLinski, and how did Apex perform?

Evans introduces McLinski as head of business development for the Americas at Apex Fund Services, a Convergence client. McLinski says he has been with Apex a little over two years and runs business development across Canada, North America, and Latin America.

Evans says Apex ranks number 11 in new funds added over the last year, up almost 11%, with its share of total private funds up about 2% to almost 5% of the market, driven by private equity, venture capital, and real estate funds. He says Apex's private assets increased almost 30% and that it maintained its league table position of number 14.

What did McLinski say about regulation and compliance?

McLinski says the largest issue he sees facing the alternative asset industry is the regulatory environment, which he says is ever growing and becoming structurally more complex. He says it layers cost and complexity into the model for hedge funds and private equity funds, increases the number of advisors involved in structuring and operating a fund, and lengthens time to market. He says Apex works with managers to provide a single source that reduces the number of counterparties they deal with.

Evans says that among about 650 administrators, compliance and regulatory services have not been part of the typical administrator model, and that a handful of administrators have begun investing in compliance and regulatory technology (RegTech). McLinski says Apex has invested in people and in a third-party provider to deliver compliance for clients, and that he expects most of the top 10 administrators or asset servicing firms globally to have some compliance function in their offering within 12 to 18 months, without a third party, as clients put more of these things off-premises.

What did McLinski say about ESG?

McLinski says the driving factor behind the need for an ESG framework and the reporting it requires is limited partners (LPs) in the alternatives community, who are demanding it, and that managers can feel they are serving many masters. He says the reporting is nuanced and expensive to build on one's own, that Apex built its ESG product with its London team and sees a first-mover advantage whose duration is unknown, and that Apex uses clients as part of product development, spending time with new clients and prospects on their ESG frameworks. He says the buying market for ESG products does not yet know what they will look like in 12 or 24 months, but that ESG comes up in every conversation.

What did McLinski say about the hedge fund market?

Evans notes that hedge funds have lagged closed-end funds for three or four years and that some of the top-performing hedge funds of 2020 had not yet performed in 2021. McLinski says the hedge fund market itself has not made a comeback, but that asset raising and new launches are active. He says most of Apex's new hedge fund business comes from referrals from the prime brokerage and audit communities, that Apex layers Convergence data into its prospecting, and that long/short equity launches are fairly active.

McLinski says a deluge of crypto and digital asset hedge funds is coming through Apex's door, that Apex looks for critical mass, potentially over $25 million or $50 million, before striking a net asset value (NAV), and that subscriptions and redemptions in fiat rather than coin raise know-your-customer (KYC) and anti-money-laundering (AML) concerns. He says mutual fund clients serviced out of the Atlantic franchise Apex bought in Portland, Maine, are launching hedge funds on a side-by-side basis, that large mutual fund complexes are getting into the hedge space, and that launch size is not what it used to be but is still healthy, with the average launch on Apex's books slightly over $150 million or $200 million.

What did McLinski say about Archegos?

Evans asks how Apex is protecting itself from bad actors after the Archegos situation. McLinski says it is a popular conversation in both the prime brokerage and administration communities, and that a strong KYC and AML policy is a protection when producing a NAV. He says it was realistically one investor, a family office or single-investor fund, and not an endowment, pension, or sovereign wealth fund, which he hopes limits the impact on investor sentiment.

Drawing on his earlier work as a risk manager in prime brokerage, McLinski says there is a key difference between a standard total return swap and a bullet swap, and that he expects the market to look hard at variation margin, the terms of the governing agreements, when positions can be liquidated, and how much credit is extended to one entity. He says he speaks two to three times a week with colleagues at a prime broker or another administrator about it, and that the lesson is to know your client and to plan for what can go wrong as well as what can go right.

How did auditors perform?

Evans says that for the 12 months ending April 30, advisers disclosed nearly 94,000 private funds, a net increase of about 6,000 funds, up about 7%, with assets of about $23 trillion, a net increase of about $2.5 trillion, up a little over 12%. The top 25 auditors won 70% of the 9,700 total new funds disclosed, all other auditors about 6%, and the remaining 24% of funds did not report a fund auditor. The top 25 won 89% of the $1.3 trillion in new fund assets, all other auditors 2%, and 9% of funds did not disclose an auditor.

Evans says Convergence sees strong growth in private equity, venture capital, and real estate, most notably in venture capital, where funds are up almost 25% and assets close to 50%. He says advisers disclosed over 23,000 hedge funds and that hedge fund assets were up about half a trillion dollars, or about 6%. He says almost 15,000 funds do not report an auditor, either because they are not subject to an audit or because they are selecting one, which he calls a big number.

Evans says asset growth was over 12%, the Big Four kept pace at almost 11%, auditors ranked five through ten grew 27%, auditors ranked 11 through 25 grew 20%, and auditors ranked 25 and beyond grew about 21%, and that the market continues to spread down market.

Who is Irena Gershengoren, and what did she say about ESG and the market?

Evans introduces Gershengoren as a partner of more than 10 years in EisnerAmper's financial services practice and a Convergence client. He says EisnerAmper ranks number six in total private funds, with its funds up almost 32% over the last year. Gershengoren names unknown market volatility as a risk, saying uncertainty in the global macro economy, including commodity prices, remains and that a year into the pandemic the virus is still a global issue.

On ESG, Gershengoren says EisnerAmper recognizes the importance of ESG and diversity and inclusion and is working with clients with such mandates, noting that not many CPA firms offer expanded consulting services on ESG and socially responsible business models. She says investors are demanding transparency, accountability, verification, and results, and that businesses are struggling to find professional guidance. She says more investors want their money in stocks and funds that are profitable and reflect their social values, that the younger generation entering investing is paying active attention to how its money affects the world, and that she expects ESG to grow in importance under the Biden administration, whose White House is focusing on policy for the transition to a green economy and on inequalities across income, race, and gender.

What did Gershengoren say about hedge funds, Archegos, and deal making?

Evans notes that closed-end funds have outpaced hedge funds in recent years but that many believe a resurgence is under way. Gershengoren cites record-high hedge fund activity in the first quarter, says 2021 is shaping up as a very good environment for hedge fund managers, and says managers are focusing more on fundamentals. She says larger launch sizes and manager optimism reflect favorable market conditions and interest from institutional investors using hedge funds as an alternative to low-returning fixed income. She says many institutional investors could not meet allocation goals in 2020 because they could not conduct normal due diligence, and that increased allocations should flow into alternatives as the world opens up.

On Archegos, Gershengoren says EisnerAmper is enhancing its use of technology, analytics, and external research tools in its audits to look for risks embedded in portfolios, and that institutional money managers continue to add middle office and internal audit capabilities, some of which can be outsourced to independent service providers.

Gershengoren says the venture capital market is strong, with a lot of capital going into the strategy and venture capital funds posting higher returns in 2020 than other private market strategies. She says deal making declined sharply in the first half of 2020 as transactions were put on hold and general partners focused on stabilizing portfolios and providing operational support, then rebounded strongly in the second half. She says 2021 could be a year of robust deal making as investors deploy capital they could not put to work last year, with opportunities in sectors helped by the pandemic such as health care, technology, life sciences, home delivery, and information technology. Evans adds that there is a lot of dry powder.

What did Evans say were the main takeaways?

Evans summarizes six themes from the guests: a more structurally complex post-COVID market, with added layers of cost in operating models and the regulatory framework at advisers; unknown market volatility; ESG, which both firms said is key to new business and driven by a younger generation investing with impact; a hedge fund market that has lagged the closed-end market but that both firms see as on a comeback, with EisnerAmper citing record-high first-quarter activity; embedded portfolio risk after Archegos, with more stringent risk structures anticipated at many firms; and resilient alternative markets, with private equity back to deal execution and opportunities in sectors such as life sciences and home delivery.

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, April 2020 to April 2021, by George Evans

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

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Asset growth by tier, April 2020 to April 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.

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