SEARCHING FOR ALIGNMENT

2011 SEI Private Equity Survey SEARCHING FOR ALIGNMENT 2 PART TWO OF THREE

The Survey A total of 411 institutional investors, consultants, and fund managers took part in SEI s 2011 Private Equity Survey. Just under half of the survey participants are based in the United States. Another 30% are domiciled in Europe while Asia, Latin America, Australia, and Africa represent the remaining 21% of the survey universe. Investors and consultants participating in the survey report a wide range of experience with private equity. More than half have been in the asset class for ten or more years. The remaining 47% are evenly split between those with seven to ten years experience and those with six or fewer years as private equity investors. Survey results are being presented in a three-part series of papers: I: THE LOGIC OF FUND FLOWS analyzes where, why and how institutions invest, asset allocation trends among investors, and how private equity fund managers are evaluated and selected. II: SEARCHING FOR ALIGNMENT explores a variety of challenges facing investors and fund managers, contrasting perspectives on transparency, and the operational investments and budget priorities among fund managers. III: TURNING CLIENT KNOWLEDGE INTO A COMPETITIVE ADVANTAGE examines obstacles facing fund managers, changes they are making to better serve clients and attract capital, key challenges faced by managers in satisfying investors, and factors keeping investors from raising allocations to private equity. 2

MIND THE GAP After a grueling few years, the private equity market is returning to health. While welcome news to industry participants, it does not necessarily imply a return to the status quo. Fund managers may be tempted to view recent developments as a cyclical return to normality and prosperity, but the concerns and expectations of investors were profoundly influenced by their experiences during the financial crisis. 2011 SEI Private Equity Survey: Part Two of Three Searching for Alignment 1

2011 SEI Private Equity Survey: Part Two of Three Searching for Alignment A lack of liquidity continues to haunt some investment committees, and many struggle to ascertain current value and risk exposures across their portfolios. Issues like these are likely to manifest themselves in a variety of ways over the coming months and years. Downward pressure on management and incentive fees will be exacerbated by the huge stockpile of unutilized capital and lackluster performance of recent fund vintages. Investors will almost certainly continue to ask for more detailed information from their fund managers. Some fund managers will attempt to operate as they always have. Others will choose to upgrade various aspects of their operating infrastructure in response to actual or perceived client needs. In an effort to explore and possibly bridge this expectations gap, SEI conducted a survey of 411 private equity fund managers, investors, and consultants. Results are being released as a three-part series. As part two of the series, Searching for Alignment is focused on: Challenges facing investors and fund managers Contrasting perspectives on the issue of transparency Operational investments and budget priorities for fund managers INVESTORS WILL ALMOST CERTAINLY CONTINUE TO ASK FOR MORE DETAILED INFORMATION FROM THEIR FUND MANAGERS 2

Challenges & Concerns Investments are once again being made, the number raise the prospect of more attractive sales and IPO of successful exits is rising, and fundraising climate valuations. According to placement agent Triago, continues to improve. Amid this surge in activity, the net asset value of all private equity funds private equity investors and fund managers agree worldwide rose 40.1% over the seven quarters on at least one issue: Both groups say that finding through the end of 2010, bringing valuations close quality investment opportunities is the most pressing to their previous peak at the end of 2007. 2 It may challenge facing the industry today [Figure 1]. The not yet be a seller s market, but improved market growing concern over the availability of quality sellers conditions mean only 17% of investors and 8% of comes just as private equity firms are regaining their managers in the survey expressed concern over poor appetite for new investments. According to a survey conditions for exits in the next 12-18 months. The by RSM McGladrey, 60% of private equity executives fact that managers are the least concerned with poor are focusing in 2011 on acquiring new businesses, conditions for exits is notable, given the pressure a shift from a year earlier when most were looking to they are under to improve liquidity and build investor add onto existing portfolio companies. 1 confidence. Consultants, apparently more focused on the big picture, are particularly concerned with Rising valuations may be causing the pool of the uncertainty pervading a still underwhelming attractive investments to shrink, but they also economic recovery. 2011 SEI Private Equity Survey: Part Two of Three Searching for Alignment Figure 1. What is the most significant challenge facing the private equity industry in the next 12 to 18 months? Investors Consultants Managers Finding quality investment opportunities Economic uncertainty Investor hesitancy Poor conditions for exiting existing investments Addressing new regulatory requirements Geopolitical uncertainty 0 5 10 15 20 25 30 35 40 45 50 55 Percentage of participants 3

2011 SEI Private Equity Survey: Part Two of Three Searching for Alignment Figure 2. What are your top 3 concerns about private equity investments? Poor performance Failing to achieve primary objective for investing Valuation Uncertainty of exit dates Level of fees Headline risk Paying of management fees on uninvested capital Burden of fulfilling capital commitments 0 10 20 30 40 50 60 70 80 Percentage of Investors & Consultants Note: Multiple choices allowed Concern over the supply of attractive investments does not mean that investors are content with the state of their existing portfolios. Almost three out of four express anxiety over the prospect of poor performance [Figure 2]. This is at least partially due to the relatively high expectations of private equity investors. According to Preqin, virtually all limited partners (LPs) in private equity funds expect returns to exceed those generated by their investments in the public equity markets. 3 More than two out of three expect their private equity investments to generate excess returns of more than 400 basis points. Poor performance is of particular concern to foundations and endowments, family offices, and funds of funds (FOFs). Meanwhile, more than a third of investors are concerned with valuations and uncertainty over exit dates. This is especially true for public-sector investors with liability-matching needs. A significant number of investors express dismay at the fees they are paying. The consternation over fees did not arise in a vacuum. Instead, investors are perturbed by being asked to pay relatively steep fees for lackluster performance. The problem is not fees per se, but the perception that value is not being delivered for fees that are in many cases significantly higher than those charged by other types of asset managers. FOFs, already facing acute pricing pressure in response to the extra layer of cost they impose on investors, also tend to be more concerned with having to pay management fees on capital that has not yet been deployed. Given their larger numbers of stakeholders and higher public profiles, it should come as no surprise that corporate investors and public pension plans are the most concerned with headline risk, echoing concern expressed by the same types of investors in response to SEI s 2010 Hedge Fund Survey. 4

The Transparency Gap Transparency has been a hot topic among managers more satisfied, with a majority reporting that they are and investors in all types of alternative assets over content with current level of information provided by the past several years. The breadth of information their managers [Figure 4]. This contentment may provided to investors as well as the frequency with reflect a complacency borne of their relative lack of which it is delivered has changed a great deal during experience with private equity as an asset class, but this period. Private equity fund managers largely it could also stem from a lack of resources necessary think they have got it right, with 85% saying they to analyze massive amounts of additional data. feel that their investors currently receive all of the information they need [Figure 3]. Consultants are even less happy than investors with the status quo, with 85% saying they do not Investors are not so sure. Only 43% say they receive all of the information they would like. Data receive all of the information they would like to and information are the lifeblood of consulting get from their fund managers. Foundations and organizations, so this hardly comes as a surprise. endowments often the most experienced with This concern extends to other alternative asset private equity investing are the least satisfied, classes as well: 100% of consultants surveyed by SEI with only one in eight saying that they get all the in 2010 said a lack of transparency ranked among information they need. Public plans appear to be their biggest worries about investing in hedge funds. 4 2011 SEI Private Equity Survey: Part Two of Three Searching for Alignment Figure 3. Do you feel your investors currently receive all of the information they need? Percentage of Managers Yes: 84.8% Uncertain: 10.9% No: 4.3% Figure 4. Do you currently receive all of the information from your private equity managers that you would like? Percentage of Investors Percentage of Consultants Yes: 42.9% No: 31.4% Uncertain: 25.7% Yes: 10% No: 85% Uncertain: 5% 5

2011 SEI Private Equity Survey: Part Two of Three Searching for Alignment Fund managers are largely meeting expectations when it comes to more traditional forms of transparency. A majority provide their investors with information on exposure to sectors, large holdings, geography, and asset classes [Figure 5]. A majority even provide full position transparency. That being said, investors and their consultants would like more information on areas such as the leverage used by their fund, volatility statistics and, to a lesser extent, counterparty risks and the results of stress tests. In each case, fund managers appear to be falling short. The types of information desired can vary according to the type of investor involved. Foundations and endowments are the most likely to consider counterparty risk information and stress tests to be important. Public plans are the most likely to want portfolio volatility information. Transparency also differs by the size of the fund manager. Large firms with more resources at their disposal tend to lead the way, providing better visibility of leverage and counterparty risks. While there is widespread agreement among all parties that increased emphasis has been placed on portfolio transparency and client reporting over the past several years [Figure 6], this difference suggests that managers are more focused on what they are already providing instead of what investors need and want. FUND MANAGERS ARE LARGELY MEETING EXPECTATIONS WHEN IT COMES TO MORE TRADITIONAL FORMS OF TRANSPARENCY 6

Figure 5. What level of risk information is provided or considered most important? Investor & Consultants Managers Industry sector Geography Asset class Largest holdings Leverage 2011 SEI Private Equity Survey: Part Two of Three Searching for Alignment Full position transparency Volatility of portfolio Counterparty risk Stress tests 0 10 20 30 40 50 60 70 80 Percentage of Managers Figure 6. Has there been increased emphasis on the level of portfolio transparency and client reporting in private equity over the past few years? Percentage of Participants Yes: 79.4% Not Sure: 9.7% No: 10.9% 7

2011 SEI Private Equity Survey: Part Two of Three Searching for Alignment Operational Investments & Budget Priorities for Fund Managers With the memory of the financial crisis still fresh, it is understandable when fund managers say that satisfying investor expectations poses the single greatest operational challenge [Figure 7]. Some slow years amid a competitive market have taken their toll, however, and if budget priorities are any indication, operational efficiency is every bit as important as investor relations [Figure 8]. Fund managers of all shapes and sizes are being torn between the desire to be efficient and the need to be Figure 7. What is your firm s greatest operational challenge? as responsive as possible to clients in an increasingly competitive environment. Motivations for operational investments vary by the size of the manager in question. Large firms tend to be more interested in enhancing their client experience and reducing costs, while small firms are understandably more likely to be focused on attracting new investors and reducing operational risk. Satisfying investor expectations Increasing efficiency Reducing operating risk Satisfying regulatory requirements Reducing costs 0 5 10 15 20 25 30 35 40 45 50 Percentage of Managers Figure 8. What is your firm s primary reason for investing in operations in 2011? Increase firm's efficiency Enhance compliance and risk management Attract new investors/clients Enhance investor/client experience/reporting Reduce firm's operational risk Reduce costs Not applicable 0 5 10 15 20 25 30 Percentage of Participants 8

MOTIVATIONS FOR OPERATIONAL INVESTMENTS VARY BY THE SIZE OF THE MANAGER IN QUESTION 2011 SEI Private Equity Survey: Part Two of Three Searching for Alignment As industry growth regains momentum, many managers are ramping up capacity by hiring portfolio management personnel [Figure 9]. The increasingly regulated environment in which they operate means many are also directing resources toward compliance initiatives and resources. Investor reporting is low on their priority list, putting managers at odds with the many investors [Figure 4] who do not feel that they are receiving the proper amount of information from their managers. Overall budget priorities tend to differ according to the size of the manager. Small firms those with less than $1 billion of assets under management (AUM) are the most likely to be focused on adding to their investment team. Mid-sized firms ($1B - $5B AUM) are also looking for investment expertise, but many are also focused on investing in compliance and portfolio management systems. Meanwhile, large firms ($5B+ AUM), which are likely to already have full portfolio management teams in place, are the most likely to be adding to the size of their marketing and sales teams. Figure 9. What are the top areas of investment for your firm in 2011? Hiring portfolio management personnel Compliance/regulatory Portfolio management systems Back office operations & technology Hiring marketing & distribution personnel Investor reporting 0 5 10 15 20 25 30 35 Percentage of Managers 9

2011 SEI Private Equity Survey: Part Two of Three Searching for Alignment Figure 10. What do you anticipate the effect of new regulations will be on your firm s profitability? Percentage of Managers Significant: 29.3% Insignificant: 70.7% The cost of new regulation may not be as onerous as once feared. More than 70% of fund managers surveyed say that new regulatory initiatives are anticipated to have an insignificant effect on profitability [Figure 10]. This does not mean that managers are not concerned about the global spread of regulation or that it will have no effect on operations. The Foreign Account Tax Compliance Act (FATCA) in the U.S. and the Alternative Investment Fund Managers Directive (AIFMD) in Europe, for example, may very well impose high enough costs or resource drains that new GPs are discouraged from forming altogether. 10

Aiming for Alignment As the private equity sector picks up steam, fund managers will want to be mindful of the gap between their newfound optimism and the often more skeptical perspective of institutional investors. With harrowing memories of the recent financial crisis still fresh, investors have understandably raised their expectations. Many are quick to voice concerns over performance, fees, and valuations. In short, investors are more likely than ever to ask managers for evidence of the value they are meant to be providing in return for the fees being paid to them. Fund managers are responding in a variety of ways in an attempt to placate their investors. Some have reorganized and invested in resources. Others have responded by allowing limited partners to trim the size of their commitments or in some cases returning management fees for capital that had yet to be deployed. Nevertheless, many fund managers continue to find themselves at odds with their investors as private equity emerges from its three-year coma. service models with investor needs, there is one area in particular that stands out: Transparency. The vast majority of fund managers are mistaken in thinking that they already provide adequate information to their LPs and consultants. In reality, investors and their advisors are considerably more savvy and risk-averse than they were only a few years ago. As a result, many of them are looking for more data, information, and insights. Leverage, volatility, and stress tests are all examples of the areas where investors are clamoring for more information than is currently being provided. Fund managers with proactive client service models will be ahead of the pack when it comes to attracting new capital. Listening to investors, managing expectations, and aligning operational investments with market needs will prove a winning combination as private equity regains momentum in the months and years ahead. Any manager who is ahead of the curve in terms of transparency will possess a particularly critical competitive advantage. 2011 SEI Private Equity Survey: Part Two of Three Searching for Alignment As allocations rise and asset flows pick up, the stakes continue to get higher. A service orientation is a must for managers wishing to compete for new dollars. For those looking to align their operating and client 1 RSM McGladrey and mergermarket, 2011 Managing Portfolio Investments Survey, 2011 2 The Triago Quarterly, June 2011 3 Preqin, The Preqin Quarterly, Q2 2011 4 SEI, Institutional Hedge Fund Investing Comes of Age, January 2011 11

2011 SEI Private Equity Survey: Part Two of Three Searching for Alignment About SEI SEI (NASDAQ:SEIC) is a leading global provider of investment processing, fund processing, and investment management business outsourcing solutions that help corporations, financial institutions, financial advisors, and ultra-highnet-worth families create and manage wealth. As of June 30, 2011, through its subsidiaries and partnerships in which the company has a significant interest, SEI manages or administers $430 billion in mutual fund and pooled assets or separately managed assets, including $180 billion in assets under management and $250 billion in client assets under administration. For more information, visit www.seic.com. SEI s Investment Manager Services division provides comprehensive operational outsourcing solutions to support investment managers globally across a range of registered and unregistered fund structures, diverse investment strategies and jurisdictions. With expertise covering traditional and alternative investment vehicles, the division applies customized operating services, industryleading technologies, and practical business and regulatory insights to each client s business objectives. SEI s resources enable clients to meet the demands of the marketplace and sharpen business strategies by focusing on their core competencies. The division has been recently recognized by HFMWeek as Most Innovative Fund Administrator (Over $30bn AUA) and Best Funds of Hedge Funds Administrator (Over $30bn AUA) in both the US and Europe. Additionally, SEI has been recognized as Service Provider of the Year by the Money Management Institute, among other industry awards. The SEI Knowledge Partnership is an ongoing source of action-oriented business intelligence and guidance for SEI s investment manager clients. It helps clients understand the issues that will shape future business conditions, keep abreast of changing best practices, and develop more competitive business strategies. The Partnership is an initiative of SEI s Investment Manager Services division. About Greenwich Associates Greenwich Associates provides research-based strategy management services for financial professionals. Greenwich Associates studies provide benefits to the buyers and sellers of financial services in the form of benchmark information on best practices and market intelligence on overall trends. Based in Stamford, Connecticut, with additional offices in London, Toronto, Tokyo, and Singapore, the firm offers over 100 research-based consulting programs to more than 250 global financial services companies. For more information on Greenwich Associates, please visit www.greenwich.com. 12

2011 SEI Private Equity Survey: Part Two of Three Searching for Alignment 3

1 Freedom Valley Drive Oaks, PA 19456 610 676 1270 www.seic.com/ims managerservices@seic.com The Investment Manager Services division is an internal business unit of SEI Investments Company. This information is provided for educational purposes only and is not intended to provide legal or investment advice. SEI does not claim responsibility for the accuracy or reliability of the data provided. Information provided by SEI Global Services, Inc. 2011 SEI 110952 (09/11)