Transparency Defeats Skepticism
For Private Equity, Venture Capital, Real Estate, and Hedge Funds Transparency Is Both a Competitive Moat, and Creates Brand Credibility
There’s a reason that the grocery store prints out that list of two hundred items, which, if you’re like me, you barely glance at—the damage, after all, has been done. But, it’s the grocery store’s way of ensuring you’ve been treated fairly. If I ever wanted to doublecheck that I paid for an item, or what I paid for an item, the grocery store, through transparency of cost, ensures that I know they’ve treated me fairly.
It is this way with everything, if we really think about it. Transparency is credibility. When someone chooses a roofer, or plumber, they want to know enough about the process to know they’ve been given a fair price to warrant the deliverable. This is the human condition, to require transparency to defeat skepticism.
And, we seem to understand this, as human beings, in the world—but somehow, surprisingly—we forget it when it comes to where we put our money. When investing in a blind-pool fund, most limited partners feel they are putting their money into a black box. It goes in. Something unseen happens. When it comes out (ideally) more of it is there. What happens inside the box? Very few limited partners really know!
The limited partner pays fees, they know, and they bought investments. But, it’s never clear to them exactly how much in fees or the appropriateness of the fees—and this, in our experience, is frustrating for the limited partner. They want what the grocery store gives them: they don’t want to pay less, they just want transparency to see where the money is going.
In the past, funds have had a difficult time being exact in their transparency, largely because there is an inherent labor and technology problem. Someone (high-salaried) has to code and update the Excel spreadsheets, and the spreadsheets need to be coded to the last detail. These issues limit transparency, which leads to skepticism, which hurts the manager’s brand. These things can happen, and do happen, even when the fund is doing everything above board, and with reasonable fees in all areas.
Thanks to the Bernie Madoff’s (among others) of the world, the lack of transparency is also, now, at least in the State of Maryland, illegal. The Maryland Employees Retirement and Pension System is now required to disclose the amount of carried interest paid to general partners. This, Socium believes will become the new norm.
What is lost, though, for many firms—is the opportunity waiting inside transparency. The best way to show a fund’s credibility, its above-benchmark returns, while building client trust and furthering relationships with limited partners, is just like Jerry Maguire: Show them the money. Show them, exactly, where the money goes when it goes into the black box. Without being shown the exact allocation of costs and investments, the limited partner must adjust their own internal records to meet what the general partner sends in a quarterly statement. This can hurt credibility and leads to skepticism.
Transparency is often misunderstood. It’s not a threat to a fund manager, it’s a competitive moat waiting to be exploited. Transparency is, in our experience, a brand-building and client-retention tool. ILPA (e Institutional Limited Partners Association) agrees, writing recently “It is imperative to the health of the private equity ecosystem that market actors adhere to the highest ethical and professional standards, deal fairly and honestly, invest responsibly and act with integrity and transparency.”
But transparency is expensive. Co-mingled funds, particularly young ones, struggle with the labor costs of transparency and often do not have the institutional investors who have the ways and means to digest so much detail or even often don’t care to receive such levels of detail. So, what is the right way to approach the transparency issue?
Our solution: consider outsourcing those costs to reliable, and technology-impressive, fund administrators (like Socium Fund Services), who can not only help you make the critical “goldilocks” decision of what level of transparency is just right, but provide you the ability to scale your reporting as you grow your firm and focus on those IPLA-level investors who require the highest levels of disclosure.
When the legislators and limited partners ask for transparency, funds immediately, probably, see costs. But there don’t have to be additional costs, in fact, strong fund management can reduce costs. And in addition to reducing costs, strong fund management also creates trust, increases retention, and improves brand.
With the right fund management partnership, transparency is competitive moat.