Private equity firms often find themselves bereft of options when they seek out technology to improve their operations. But some leading firms are not sitting back and waiting for the market to come to them. KKR, for instance, is developing in-house technology and expanding its operations capabilities to keep up with the growing complexity of investments and investor requirements while managing risk.
“We now own more than 80 companies, and that’s a lot of financial data coming in every month. It used to be on spreadsheets, which was disjointed,” says Edward Brandman, Chief Information Officer at KKR. “Now we have proprietary technology to provide investment management, analytics back to the investment team, investor reporting, benchmarking and additional transparency.”
Historically, more technology was available for hedge funds because they are more heavily involved in trading, Punater says.
But the lack of supply does not indicate that technology options are not useful for private equity managers.
At KKR, the proprietary technology plays a major role in its investment decisions and activities. For the firm’s core private equity business, it uses analytics to help assess current and future risks to the business and its portfolio companies, Brandman says. This helps determine what type of proactive stance the firm should take on its investments, including how to be more “aggressive” at managing the debt maturities and covenants of specific companies within its portfolio, he says.
On the public markets side, the firm employs risk systems to actively manage the exposure to credit, hedge funds and funds of funds. “We’re constantly analyzing the different investment strategies,” Brandman says. The funds of funds unit is a growing business for KKR, and the firm is building a platform to manage it, he explains. “In our funds of funds business, we get data from the hedge funds within our funds. And we use it all to manage liquidity and redemption. [We determine] who needs what cash when and intra-day risk.”
KKR is also developing a proprietary tool to manage investor relations. “We had a unique set of relationship management issues because it’s all about high touch with investors, looking at how they invest with us over time, who their advisors are and which products they are focused on,” Brandman says. Because alternative products have long lead times and a complex set of relationships and business entities to manage, the firm opted to build its own customer relationship management system.
Private equity firms also have unique technology needs when it comes to automating the distribution of capital to the fund’s investors, a process generally referred to as a "waterfall," says Karl Ehrsam, principal at Deloitte & Touche, speaking generally about private equity firms. How these returns are prioritized is highly nuanced, and there are significant differences in how waterfalls are calculated and distributions are timed.
“Even the leading technology vendors up until recently have not had good solutions when it comes to the waterfall, which is the most complex operation requirement of a private equity fund,” Ehrsam says.
It is also difficult for vendors to anticipate the technology needs of private equity firms because private equity deals are varied and less standardized than the trading process at hedge funds, says Shawn Pride, partner at Ernst & Young, speaking about the overall private equity industry.
“It’s very uncommon to see home grown systems,” Pride says. But for firms with a more evolved IT organization, he says they have the option to consider both buying and adding systems. As private equity firms broaden their reach into other areas of the investment market, expanding beyond the traditional buyout features to include distressed debt and other trading strategies, their technology needs will increase, says Ehrsam.
When KKR decides which part of their operations functions to outsource and which to boost internally, Brandman says the philosophy is to “buy the back end and build sophisticated risk and allocation engines.” The amount of capital KKR spends on technology is directly correlated to how the business is doing, he says.
The firm’s technology team, which started out with seven in 2007 and now has 65 employees, has a close working relationship with all the business teams in the firm, a vital factor in understanding what technology to develop, says Brandman. “We built out the macro element with input from Henry McVey [KKR’s head of global macro and asset allocation] to help him with his view on different regions of the world,” he says.
And relationships extend beyond KKR’s own teams for perspective on where to move next in technology.
“We participate in a roundtable with [chief information officers] at other private equity firms,” says Brandman. The firm also hosts an annual gathering of chief technology officers and chief information officers from its portfolio companies, he says.