Eighteen months ago, Robert Caporale was head of strategic business development at JPMorgan Chase & Co.'s Treasury and Securities Services, overseeing a group that focused on growing the unit through acquisitions. Now, after a complex chain of deals, he’s running Private Equity Fund Services, a brand-new unit of the bank’s Worldwide Securities Services. The goal: to grab a juicy slice of the growing but still highly fragmented private-equity-administration pie. Can he reach it? That will depend on several factors driving the move toward outsourcing private equity services.
Most obvious is the spectacular amount of money going into this asset class. In 2006, private equity firms raised a record $221 billion, according to Thomson Financial. McKinsey & Co. believes that by 2010, managers will invest 30 percent of their money in alternatives such as private equity. “That’s a compelling case for a big move by a custodian,” says Caporale.
With more and more institutions putting money into this area, PE firms are considering ways to add safeguards to their businesses. In addition to wanting sophisticated technology, institutional investors often prefer that the funds they invest in use third-party service providers. Doing so adds a level of independence to a fund’s recordkeeping. It’s a model the investors are familiar with from the long-only world.
As private equity firms increasingly do complex deals, they are more inclined to outsource their operational work to a back-office specialist that is also a big bank and can provide cash management and other banking services.
And given the high-profile operational blowups that have occurred recently in the hedge fund world, the opportunities available to large banks in the field may be particularly ripe. The recent collapse of Archeus Capital, for instance, is being blamed in part on faulty recordkeeping at its administrator, undermining investor confidence. It’s a problem that can’t be ignored. Custodian banks are pitching their status as banks and global brand names as an additional safeguard against sloppy procedures.
Big banks have long provided custodylike services such as pensions and endowments to their traditional institutional clients, who need to track and oversee their growing alternative investments alongside their more traditional holdings. More recently, banks with large custody arms have automated many of these processes and added sophisticated services such as risk measurement and performance analytics. Now they are moving to offer these services directly to private equity firms, in hopes of getting in on some of the more lucrative back- and middle-office business. It’s a natural extension of much of the support work they have started doing for mutual funds, separate accounts, hedge funds and other investment managers.
Finally, the competition is fragmented. Players include Roseland, N.J.based administrator Bisys Alternative Investment Services, with about $60 billion in private equity money under administration; Boston-based Investors Bank & Trust Co., with about $30 billion; and HSBC’s Alternative Fund Services, with about $8 billion in private equity assets.
And the field is about to expand. Bank of New York is building capabilities for private equity using its Alternative Investment Services platform, initially designed for hedge funds. Northern Trust Corp., one of the largest offshore private equity fund administrators in Europe after its acquisition of Baring Asset Management’s Financial Services Group, is now readying its platform for the U.S. Citigroup is considering a move into the arena in the latter part of 2007. There’s plenty of PE money out there waiting for the right service provider to come along. “We see private equity administration as a cottage industry,” says JPMorgan’s Caporale.
Caporale launched Private Equity Fund Services out of the back-office activities of the bank’s two private equity arms: JPMorgan Partners (since spun off into CCMP Capital Advisors) and One Equity Partners, acquired as part of JPMorgan’s 2004 purchase of Bank One. The unit’s original $25 billion stake has since grown to $35 billion, thanks in part to last month’s agreement to manage the assets of Dallas-based HM Capital Partners, the successor firm to Hicks, Muse, Tate & Furst.
Some prospective clients might see Private Equity Fund Services’ close ties with Morgan’s private equity business as a conflict. But Caporale believes its origins as the back end of a top-tier PE firm should give it a leg up on the competition, thanks to its special expertise in handling complex global structures. Meanwhile, he expects that the bank’s position as a mergers and acquisitions adviser to private equity firms will serve as a door-opener to firms looking to outsource their back offices. “JPMorgan’s investment bank is the leader in providing M&A advice to private equity firms,” he says. “Our goal in Worldwide Securities Services is to lead on the fund administration side as well.”
JPMorgan offers the standard menu of fund services: fund and partnership accounting systems for the firm’s books and records, systems for tracking investors and generating reports, and capital call and distribution processing. To eliminate much of the paper processing, the unit has also created Web-based reporting and transactions for investors as well as Web sites clients can use to handle capital call communications, distributions, notices about acquisitions and other information. Though he won’t say exactly how much JPMorgan is spending to build up the business, Caporale notes that the bank has already made significant investments in the group -- and WSS as a whole is in the middle of a $600 million technology expansion.
The bank’s push is being closely watched by existing and potential competitors. Chris Coleman, director of alternative investments at Investors Bank & Trust, with $225 billion in alternative investments under custody, including hedge funds, says the ability to provide both global custody and administration services is an attractive combination. IBT, he says, moves huge cash piles every day for capital calls and distributions. “The fact that a client can make a capital call to investors through an administrator that is also a global bank is a huge advantage,” he says.
IBT too is seeing a big increase in the number of potential clients looking to consolidate multiple services, such as tax support and cash management, with one provider. And if that provider is a bank, even better, says Coleman, who adds that a number of IBT’s wins in the past year have been driven by the desire for one-stop shopping.
Some institutional investors are even pushing the funds they invest in to hire service providers with brand-name recognition, Coleman notes. “Having an administrator with a bank behind it is becoming increasingly important, given the growing number of institutional investors in private equity and the very public collapses that are being attributed to back-office service providers,” he says.
As for the increased number of custodians crowding the field, Coleman believes private equity firms will demand even more sophisticated technology. “Among custodian banks, the leading-edge providers are those that run an integrated technology platform that can handle the complex accounting and tax recordkeeping for private equity partnerships on one system.”
HSBC is using its Alternative Fund Services -- one of the largest hedge fund servicing groups with about $200 billion in assets under administration -- as a springboard into private equity, launching the new PE unit in late 2005. Drew Douglas, head of product management for the new unit, says the bank has $8 billion in private equity assets on the platform for outside managers. The increasing number of hedge funds that are taking private positions also pushed HSBC into the area. “It’s a natural progression for us,” says Douglas.
HSBC is focusing on providing services in addition to administration, including foreign exchange, credit, liquidity financing on capital calls and access to investment banking. “Most administrators can get valuations and accounting right. But if custodians can tie in all the components, such as forex, international banking and bridge financing,” they are bound to win, Douglas concludes.
