Will seeing what lies beyond bring new opportunities into focus?

Many private equity firms are moving to adopt more mature business processes, from internal reporting and compliance to fully developed financial planning and analysis (FP&A) functions. While larger firms, those with excess of $15 billion in funds are leading the way, all firms are stepping up their game as they keep pace with the larger players in this space.

This shift toward a more institutional mindset is reflected in the 2022 survey results. Besides asset growth, the top three strategic priorities listed by private equity firms are talent management, product and strategy expansion and ESG initiatives and offerings. This reflects the fact that many CFOs believe they have adequately addressed back-office issues by building out infrastructure and creating a scalable operating model.

When asked to rate the institutional maturity of their management company, 84% of the largest fund managers said they are generally ahead of other managers, compared with 71% of midsized fund managers and 56% of smaller firms. Fund managers were less likely to say they were best-in-class, however, with only 19% of large fund managers, 14% of midsized fund managers and 11% of smaller firms, considering themselves as best in class. This seems to indicate that although managers feel relatively comfortable with their management company operations today, there still is room to mature and take a step forward.

Further reflecting the sharpened focus on building out a broader set of processes, more than 43% of the largest firms said they had significantly increased their investment in people, processes and technology over the past two years. Smaller companies were less likely to say they had done so, but roughly one out of five midsized companies said they had increased their investments significantly, 19% and 23% respectively.

As private equity firms continue to build a more mature, sustainable operation, they have also focused on how to expand their talent management program. Improving diversity, equity and inclusion (DE&I) is a key to building a sustainable private equity brand that delivers greater value to investors.

As firms have developed more rigorous talent management policies, many investors have said they are spending more time reviewing the effectiveness of their private equity firms’ talent management programs. Some 43% said they have increased their scrutiny on these programs during due diligence, with 30% saying they were confident that a better talent management program signals their ability to retain and attract top talent.

Over the last several years, we have seen an increase in fund managers hiring women for positions in both the front and back office and this year was no different. In the survey, the ratio of firms with more than 30% of women in the front office increased from 12% in 2020 to 23% only two years later. Nearly half of all firms reported that women accounted for 11%-30% of their front-office workforce. In the back office, the ratio of women continued to far surpass that of the front office.

Fund managers also continued to focus on hiring more people with racially and ethnically diverse backgrounds in both the front and back office. Approximately one in five private equity fund managers increased their proportion of these groups in front-office positions to greater than 10%, and one in six increased their proportion in back-office positions to greater than 10%.

In last year’s survey, we discussed the emergence of ESG as a competitive differentiator. While ESG continues to be a focus for some firms, our survey still indicates that the majority of fund managers had yet to develop an ESG offering as they wait for greater clarity on how to measure its effectiveness as an investment vehicle. However, our survey also indicates that ESG product offerings have risen over the past three years as firms address how they will respond to ESG requests and questions by investors.

Overall, 42% of the largest fund managers say they consider ESG issues either seriously or very seriously in their decision-making process, while a further 39% say they consider these issues seriously in certain risk areas. Investors are looking for managers to invest in-line with their ESG policies and procedures, while also returning capital that outperforms certain benchmarks. Investors no longer see investments based on sustainability as a trade-off, and fund managers must be ready to strategically think through decisions around ESG to continue securing the investors of the future.

DE&I is one area of ESG currently getting a lot of media focus. Surprising, given the focus that firms have on ESG, only 2% of managers in the survey responded that they’ve turned down an investment opportunity because of a portfolio company’s DE&I policy. As firms expand their ESG footprint, managers may want to build out a formal investment review that has “deal-breaker” potential if portfolio companies do meet certain guidelines. 

Firms have also taken a cautious approach with cryptocurrencies. Only 3% of the largest firms have invested in crypto-related or digital assets. We believe that cryptocurrency and digital assets will continue to be an area that many private equity and venture capital firms will consider going forward. The survey results also show that most firms are exercising caution as they watch how governments and regulators treat cryptocurrency and determine how it fits into their strategic vision of the suite of alternative investment options in the future.