Back in 2011, Lorelei Graye took a contract reporting position at the South Carolina Retirement System Investment Commission (SCRSIC). This was her first exposure to investments, and importantly private market investments, but she was a seasoned accountant and brought great experience in reconciliations and reporting.

SCRSIC had recently diversified into alternatives for the first time, and a state rule required it to disclose all costs. How hard could it be?

That question is still plaguing Graye, who is now the founder of the Adopting Data Standards Initiative (ADS) aimed at building collaborative global data standards for private capital.

“Investor statements were coming in the door and they were all different from one investment to the next. I couldn’t find anything wrong from an accounting perspective; it’s just the presentation was different,” she says of the experience.

SCRSIC set out to build a system that could assess all investments across consistent data points which would allow measurement, management and comparison across the returns and costs of the investments. And it is now a global leader in transparency.

“We built a process that was the highest level of assurance we could do at that time,” she says. “We were validating the waterfall of every investment, every quarter, and compiling it on an annual basis.”

The in-depth work was necessary to accurately tally the pension’s total investment costs given the inconsistent data in the regular reporting.

“In the absence of a standard, what develops is the variety of presentation formats we see today. I didn’t believe there was any conspiracy,” Graye says. “Occasionally there is some sensitivity around fees, but I’m not sure there’s a valid argument for not disclosing them in aggregate, and I have to say hats off to the GPs because nearly all of them participated in our efforts.”

PE cost transparency

The process piqued the attention of CEM Benchmarking, the independent global benchmarking and research organisation, which was hired to do a review of the pension fund’s investment costs and performance.

CEM found that only about 50 per cent of the investment costs that South Carolina reported in its annual financial report could be benchmarked to its peers, leading the experienced researcher to conclude that US public pension funds across the board were disclosing less than half of the private equity costs they were incurring.

It found that South Carolina for all its work and transparency was criticised for having higher fees when in reality it was just disclosing more of the associated costs than its peers at the time.

In a subsequent paper prepared in collaboration with Graye, The time has come for standardized total cost disclosure for private equity, CEM analysts broke down the complicated cost structures of private equity and looked at the reported fees versus the fees actually incurred by Limited Partners.

The report shows that carried interest, other fund-level fees and portfolio company fees represent more than half of the total private equity costs and pension funds that don’t report these are excluding substantial amounts.

Among other inaccuracies, highlighted in the paper, CEM concluded that the LP share of portfolio company fees was misrepresented by the industry as a management fee rebate or offset, or in other words full management fees minus the LP share of portfolio company fees. In fact, the actual costs incurred by an LP, the report said, are full management fees plus the GP share of portfolio company fees.

The authors analysed the CEM universe over the period 2012-2013 looking at private equity estimated costs and reported management fees. The analysis showed that estimated total direct LP costs were 3.82 per cent but the reported management fees were only 1.8 per cent.

“Due to the difficulty of collecting all cost components and the lack of standardised cost definitions, many funds are unable to report full PE cost,” the authors said.

(A more recent study by CEM shows the differences in implementation styles and related costs are a key driver of a wide dispersion in private equity results. See The bright and dark sides of PE.)

The CEM paper detailed the extent to which the SCRSIC staff worked hard to get fee transparency and consistency of reporting. The pension fund looked at their provided data including assessing contributions, invested value and distributions, and compared the expected full management fee and performance fee to the partnership contract terms. If there was any discrepancy the fund asked managers for explanations and documented it for future validations.

CEM said SCRSIC’s extensive validation process, that attempted to capture total investment costs, demonstrated the need for standardisation.

“People all over the world called to ask what we were doing to get the data – and I said: ‘we asked for it’. We challenged the notion that GPs were hiding information. In my experience GPs were willing to disclose but still it was such a massive undertaking for just one investor to obtain the consistent information. I am doing something similar with the ADS Initiative today because our objective of a common data standard defies conventional reporting practices. People in our field tend to believe it’s too complicated to solve but we are challenging the industry to think differently.”

Shifting the mindset

Graye thinks the reluctance is due to complexity and a belief that stakeholder groups cannot work together, rather than any motivation to hide anything. Part of that complexity comes from LPs and providers using their own templates to meet their individual needs.

South Carolina created a template for collecting data from its managers at the time, and many pension funds have followed suit meaning there are multiple templates in the market.

“With so many template versions the requests to GPs are burdensome. And everyone is using excel. Excel was not designed to be a mode of transport for data, it is a tool for analysis,” she says.

“We have to carve a path for the industry through the complexity. The problem is complex, but the solution is simple. Not easy, but it is simple.”

Graye’s experience has motivated her to be a part of the solution in heading up the ADS Initiative to develop global data standards for private capital.

With a hashtag #NotAnotherTemplate, the initiative aims to create a taxonomy or common framework that can be adopted for the exchange of data. Rather than saying what data points must be disclosed, ADS seeks to create a dictionary, or common language, for what might be disclosed and is looking for representation from all parts of the industry including LPs, GPs, administrators, consultants and custodians.

“To create a standard through cross collaboration we need a forum for representation from the different stakeholder groups – and that’s exactly what we have established,” she says. “We recognise neutrality is needed to lead the effort and that an independent body like ADS has to be created as a non-profit with balanced stakeholder participation across the industry to establish trust and legitimacy. Personally, it is a sacrifice, I’m leading ADS because I care about it. The purpose is optimisation and efficiency in LP and GP data exchange which is in the best interest of everyone.”

A common language with generally accepted definitions that allows a compliant reporting file to be ingested by any technology or system is the ultimate goal – data interoperability.

The ultimate benefit: Shave the extra layers off

Full transparency around fee disclosure has many benefits. Firstly, it allows investors to have a full picture of the costs they are paying and so assess value. This could lead to conversations with managers about fee levels and implementation styles. But it also leads to a conversation about the hidden costs of investment.

“Anything that improves an investor’s ability to analyse, slice and dice portfolios obviously feeds better decision making because there are better inputs.

“Currently GPs spend resources to have their data assimilated into PDF reports sent to LPs who incur costs to disaggregate again. It’s silly. PDF statements and excel sheets should only be a rendering of the actual data, but they are currently treated as the vehicle.”

There needs to be an acknowledgement that this is not “anyone’s fault” according to Graye but an inefficiency due to the lack of accepted data standards.

“What this does is address a hidden cost of data in our industry that is not yet quantified,” she says pointing to the fact the back offices of both GPs and LPs are paying for the assimilation and presentation of data. “There is duplication of data sets in the reporting chain and data must be cleansed to or normalised to be useful. These layers are not easily measured. It comes down to inefficiency which has a direct corelation to cost. GPs need relief as much as the LPs. It’s terribly inefficient on both sides.”

The South Carolina story in 2020

The fact that SCRSIC was a leader in fee reporting has meant cost and fee analysis is now part of its DNA. According to the fund’s executive director, Michael Hitchcock, this means its staff fully understand the gross net fee spread and can make informed decisions with “actionable intelligence”.

“We are very supportive of the industry moving towards more transparent fee disclosure,” he says. “With the managers we deal with, we don’t get any meaningful pushback it’s something they’ve come to expect. I’m not saying it was the sole focus or catalyst for us to push into a co-investment platform, but it was part of the reason why. We understand what the gross net fee spread is, and to an extent it pushes us to capture that through negotiation when signing up to the fund. This is money that is going straight from managers to our pocket, co-investment is a way to capture all or a significant part of the gross net spread, and immediately adds to your return.

“Once fully ramped the co-investment program will be 450 basis point saving on 3 per cent of the plan,” Hitchcock says. “It’s a true saving and enhancing returns at the same time. The goal for fee savings is not to save fees but to reduce management fees and enhanced returns. There needs to be an economic impact otherwise its meaningless.”

In addition, Hitchcock says the focus on transparency has created a culture. “It has pushed us to do a lot of things, we want to see the value, it influences behaviour.”

The focus on fee transparency has also resulted in a fee reduction. Back in 2013 the fund’s fees were 1.59 per cent, now they are 96 basis points.

 

Two things seem clear to me at present:

  • Our well-being critically depends on the richness of the current culture and leadership that we are experiencing in the multiple settings we inhabit – government, employer, home, etc
  • This culture and leadership will be changed by the circumstances we are living through and by the responses we make, and we have the chance to make these better and not to waste this crisis

Leadership and culture work well together. Good culture produces better behaviours and organisational outcomes in concert with good leadership. If better culture can emerge from our current adversity, it will do so with more purpose, resilience and effective leadership attached. Here are three things to unpack.

Purpose has been a growing feature in our lives. It desperately needs to step up in the organisational setting. We need to see profit simply as a result of pursuing purpose and something that helps support that purpose.

We need some craft in finding purpose, it can never be imposed. It is the authentic reason organisations exist, expressed in terms of the differences they make to their workforce, clients, and other stakeholders.

Purpose provides certain meaningfulness and motivations and makes certain differences. The ‘certain’ here means specific but needing context to specify.

Resilience deepens when purpose, meaningfulness and motivations are engaged. Think of the resilience of those health workers in the coronavirus crisis.

Leadership is broadly defined as the acts of anyone who steps out of their regular tasks to help and motivate others.

Leadership in our industry narrative has typically meant dominant and accomplished operators whose powers were granted from high up.

But there is a movement towards servant-minded and quietly inspiring leadership types where powers are granted from lower down (think of those health workers again).

This version plays out in organisations that have created inclusive and psychologically safe conditions and help people with their resilience during tough times.

Of the two types of leadership outlined here, we need some of both, but with more of the latter.

In ‘Investment Professional of the Future’ (CFA Institute | 2019) it is suggested we need leadership that:
• Speaks out. People crave strong leadership shaped from rich values; leaders have scope to craft messages that go further than the strict confines of the business
• Draws on legitimacy. An effective leader speaks within the sphere of competency and reach
• Is empathetic. Leaders should feel close bonds with their followers and demonstrate genuine understanding and concern
• Shows the courage necessary. Courageous leaders can convey the need for change effectively
• Is clear and consistent on values. Organisational values should authentically sync with actions.

On leadership action, I am struck by the need for improving the physically-distant but socially-connected environment for leaders to engage and motivate colleagues. Do we need a new model for this?

With greater use of technology alongside more savvy processes this socialising can go far deeper. The secret sauce may well lie in a combination of improved methods of chairing, facilitating, feedback, coaching and turn-taking that rolls back the tide of group-thinking that has dogged organisations in the gazillion physical meetings that the world endures.

Culture is a key source of resilience to deal with crisis conditions by supporting positivity of mindset and action. At its best it uses a strong purpose in helping colleagues and clients through very difficult times. If we can produce a vivid visualisation of a better future for our industry and society that would help a lot. If we can then be focused on contributing to its fulfilment, we will be in much more resilient shape.

Roger Urwin is global head of investment content at Willis Towers Watson, and a Future of Finance council member at the CFA Institute. 

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The US Federal Reserve’s decision to make its treasury bond-buying program open-ended will not be enough to ease the  extreme liquidity crisis despite Wall Street rallying on the news, according to one top US academic.

Earlier this week the Fed pledged to buy corporate debt and to introduce a number of new lending facilities to support the corporate sector and households. It comes just one week after the central bank re-opened a special credit facility to purchase short-term corporate paper from issuers and a primary dealer lending facility as well as pledged to buy $700 billion worth of bonds.

Campbell Harvey, finance professor at Duke University, said the policy measures  were “nowhere near enough” to stop the credit market paralysis.

“There are extreme liquidity issues in the market and credit markets have been in extreme stress since last Thursday so while the Fed is trying to calm down the market, these measures won’t be enough,” he said, before warning that next week could get ugly after the US jobless claims data is released. “It’s the lull before the storm.”

Maximum fear

Harvey, whose PhD showed that inverted yield curves predict recessions, predicts that the data due on April 2 could show a  jump in initial claims for unemployment from 281,000 to over 2 million and then to 5 million the following week.

“Mark next Thursday as the maximum fear day,” he said. “The historical standard deviation of the weekly change is 17,876. If claims jump to 2 million, that is 96 standard deviations and beyond anything we have seen in history.”

His comments come just as a new report from Morningstar said that the credit market has evaporated and extended even into high grade sovereign bonds. The report identified a number of bond managers that have raised the sell spreads on their fixed interest funds to avoid their existing investors from bearing the higher transactions costs incurred from liquidating the assets.

“To navigate this crisis, it is crucial to have an expectation of its severity, timing, and recovery,” Harvey said. “Before the global financial crisis, we had no idea how long it would last. But with biological crises, we have got a path and that is the vaccine and then we have some clarity as to when the end will occur.”

Meantime, he said it was crucial that Washington did not introduce policies that would be counterproductive for future economic growth. These include putting the US in a Japanese situation where the only buyer of government debt is the country’s central bank, keeping real interest rates negative for an extended period of time and choking off small and medium sized business lending by allowing banks to favour big customers.

Liquidity trap

Harvey has long been critical of the Japanese central bank driving interest rates to zero. In his view, it is an extreme policy and risks setting up a Japan scenario. He fears that the “liquidity trap” has arrived largely because the Fed has also cut rates to zero.

“It seems that we’re there now and we need to escape very quickly,” he said. “If people don’t buy bonds, and hold cash effectively at zero, then it’s really difficult for corporations to get finance. So, there is no new investment and growth slows like Japan.”

Harvey noted that this health crisis was different to the global financial crisis. “It’s not like the GFC which got worse and worse over the years,” he said. “It is moving faster but also; it can be resolved faster.”

He pointed out that the short horizon could be fairly short and that there was a chance there could be a dramatic downturn in the short term followed by a dramatic upturn.

“There is a sudden stop where the country grinds to a halt but it can also be a sudden start,” he said. “The coronavirus outbreak looks really terrible in the short term but if we play our cards right it will be a V-shaped recession rather than a U or an L- shaped recession.”

Meanwhile, former Fed adviser Danielle DiMartino Booth queried whether the US central bank’s new $100 billion facility would help the US$10 trillion US corporate bond market.

“We will know soon enough as the number of coronavirus cases in the US crosses the 10,000 daily pace, there is a risk the facility is seen as inadequate,” she said.

The chief executive of Quill Intelligence said that it was notable that that Fed’s new program was facilitated via a Special Purpose Vehicle housed at the US Treasury so it did not violate the Federal Reserve Account, which prohibits the Fed from holding corporate bonds on the balance sheet.