Transforming Private Fund Management Operations: ‘At Your Fingertips’ Liquidity Transparency

By Phil McKendry, Head of Business Solutions for EMEA

Active treasury management is fundamental to an alternative investment manager’s ability to understand their liquidity landscape, streamline operational capabilities, and minimize operational and systematic risk. In early 2023, private fund managers learned – as hedge fund managers did back in 2008 – that being tied to a single financial institution (FI) poses a concentration risk to funds under their stewardship and delivered a wake-up call that private fund managers must diversify their FI relationships. Much like the hedge funds realized back then, banking with a single FI always comes with embedded technology to manage cash that deceivingly eases fund operations technology needs. Bringing in a diversified FI group to a private fund complex promotes continuous competition among FIs, shining a bright light on service-level and fee-level differences, often for the first time. However, the multi-FI diversification also makes the challenge of staying on top of all treasury activities inefficient, at best, without advanced technology solutions.

Having the ability to effectively manage all sources of liquidity – free cash, available credit line capacity, and committed, uncalled LP capital – is critical to a private fund manager’s ability to maintain a competitive advantage. Predicting and planning liquidity requirements over the near-, medium-, and long-term trajectories is also fundamental to ensuring the deal team always knows how much dry powder it has access to. Proper, timely liquidity transparency allows managers to plan exactly where, when, and how liquidity needs will be met. While most managers are still performing that analysis the old-fashioned way (a team of associates managing projection spreadsheets), forward-leaning industry participants are investing in technology solutions that allow for continuous liquidity transparency and the swift operational movement of liquidity-related transactions through the fund structure to precisely where it needs to be. We can think of this as ‘Just-in-Time’ liquidity.

In the current market environment, cash has become increasingly valuable, with USD interest rates rising by over 5% and fund leverage, therefore, more expensive to traditional private equity managers (excluding private credit or similar strategies). It is essential to have the ability to move cash exactly where it needs to be and precisely when it needs to be there. Although the goal for most private fund managers is to hold zero cash, there are occasions when large cash values may be held for shorter periods, such as following a capital call for deal funding. A treasury management system (TMS) can enable the treasury and finance teams to increase returns by automating the investment of any cash held (even for the short term) in money market funds (MMFs) or similar products. Using advanced technology, a TMS built for the private fund industry will help reduce the drawdown period by automating the drawdown process, thereby minimizing interest charges by automatically recognizing that cash balances or invested cash held in MMFs can be utilized to pay down outstanding credit.

This sounds simple enough, right? In reality, many private fund managers are stifled in their ability to manage liquidity by data and technology challenges. Not only are many TMS platforms not built-for-purpose for the private fund market (instead, being “it’ll work here too” variants of TMS technology built for corporations), but often managers struggle with not having a single source of truth for their data and face other data normalization challenges. Unfortunately, this critical data collection and normalization work is still very often executed in Excel and performed by manually sourcing files from multiple counterparty portals; as a result, it makes it difficult to have accurate forecasts. It goes without saying that these types of bespoke processes and the need to maintain and back up the data leave private fund managers vulnerable to significant operational risk.

Also, many private fund managers only have rudimentary methods of tracking interest accruals on lines of credit, often solely relying on the lending counterparty to get it right. This leaves them somewhat ‘blind’ to knowing their entire liabilities at any given time and leaves them reactive to upcoming liquidity requirements.

To summarize, private fund managers need to weigh up whether to ‘do nothing’ about upgrading their liquidity planning processes (which leaves them exposed to the risk of being left behind). Or, as is too often the case, wait until a significant loss occurs due to weak processes, at which point they need to do something to remediate the gaps. The alternative option – which would appear to be more prudent – is to prepare to grow into the future, put in solid data management and technology processes, reduce operational and systematic risk, and increase efficiency. If done right, the investment into systems and data can be entirely self-funded through increased profits from the effective use of lazy capital and ongoing increases to the generation of alpha – not to mention mitigating risk.

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Learn more about Hazeltree’s Treasury and Cash Management Solutions here.