The business of asset management has grown exponentially more complex over the last decade. As system technology and data management improves, managers are devising ever-new investment strategies to find that elusive source of alpha.
Bank loan funds, direct lending funds, liquid alternatives, separately managed accounts that offer institutional investors sub-sets of a manager’s equity long/short strategy for example; all are bubbling away in a heady alchemical mix. This is putting an incredible strain on the operational model; one that no longer holds water compared to a decade again when the product universe was simple and managers operated free of regulation.
Today, as SEI points out in latest recent white paper, entitled “Evolving in the New Operational Frontier”, it is no longer good enough to simply create a product, meet the investment objectives and distribute the product effectively. A fourth component – being operational adept – is needed. As the report points out, managers “need an operating infrastructure that will equip them to better meet client needs, satisfy regulators, and compete effectively in a business that keeps growing more costly and complex”.
The white paper highlights nine key challenges for why operations have become so critical. A few of those challenges are discussed below and at the end of the article, a link to the white paper is provided for readers to digest the report in full.
Speaking recently to a senior financial director at a global asset manager, Giles Travers (pictured), Director, Alternative Investment Funds at SEI Investment Manager Services, recalls him saying that there used to be a view that institutional quality operations were a differentiator; a way to stand out from the crowd. These days, it has become more of a “ticket to play”.
“If you don’t have a solid operating model that is flexible enough to allow you to step up to the types of challenges that we identify in the report, you’re not going to be able to compete. Managers need to evolve to innovate,” says Travers.
Challenge 1: A more competitive business climate
Since 2005, the alternative investments universe has doubled in size. Continued convergence between traditional and alternative fund managers has created an enormous ecosystem of funds – to illustrate, there were over 8,300 single manager hedge funds in June 2014, 25 per cent higher than in 2008, whilst the US mutual funds universe has over 28,000 products and some 815 managers. Liquid alternatives have seemingly exploded overnight, already topping USD300 billion in the US, whilst ETFs have proliferated across the four corners of the earth.
From an operational standpoint, it is incumbent upon managers to think about how they can differentiate their strategy.
For quantitative managers this might involve having a systematic algorithm for an investment strategy that can outpace their competitors. For a private equity manager, it’s showing they’ve got a track record to drive operational change in the portfolio companies managers invest in. For a private debt manager, it’s showing that they’ve got a platform with the right links in the right jurisdictions to support the right people in finding new lending opportunities.
“A customised and differentiated strategy across the industry is, I think, becoming more and more critical and investors are casting a much more critical eye over track records, fee structures and benchmarking. Managers also need to tie such strategies into new distribution channels. For example, with respect to private equity, we are seeing more managers leveraging private bank relationships as distribution channels into wealthy investors.” says Travers.
Philip Masterson, the London-based Senior Vice President and Managing Director, SEI Investment Manager Services, thinks that perhaps the biggest opportunity for both private equity and hedge fund managers is in the customised target date fund arena within the USD4 trillion-plus DC market in the US.
“Target date funds dominate the DC space with upwards of 80 per cent of flows now going to these funds,” says Masterson. “At SEI, we have agreements in place with 15 of the top DC record keepers, which in itself represents USD3 trillion, giving clients a leg up on meeting their distribution challenges.”
This convergence trend means that asset managers can no compete in their accustomed silos. The bar is higher than it’s ever been. A manager’s operations must today provide sufficient flexibility so that they are at least in a position to be able to support a range of different products across multiple jurisdictions, to different groups of investors. If not, they’ll slip behind the curve.
“Operating systems need to be product-agnostic so they can support more complex products and more customised reporting,” says Travers.
Challenge 2: Amplified Risks
One can slice risk into many different sub-sets: operational, liquidity, counterparty, firm-wide, market, not to mention reputational and cyber risk. A lot of the reason for heightened awareness of risk is essentially down to investors and regulators. The kernel for this was the global credit crash in 2007/8 and the unedifying Madoff scandal, the repercussions of which are still being felt.
This placed risk front and centre in the minds of industry stakeholders and became a key component of regulatory directives such as the AIFMD, which detail clear risk management requirements that alternative investment fund managers must adhere to in their operating models.
As such, managers are reassessing how they evaluate risk.
“More and more managers are building that in to their investment strategy to give investors greater comfort when doing their due diligence. If they can’t get access to their data in a coherent and quick fashion, it makes undertaking a risk exercise much more difficult. And it’s not just the fact of getting the data that can be troublesome, it’s getting the right data for the task at hand.
“Managers who have real-time access to their data will be ahead of the pack in terms of risk management and best practices without having to delve into multiple legacy systems and Excel spreadsheets, which has its own set of data consistency problems,” explains Travers.
Hedge fund managers have been more proactive in bolstering their operations – either internally or by opting for third party managed services solutions. But the whole move towards greater system automation and integration has been slower within the private equity manager community. Take Annex IV reporting under AIFMD. According to Travers, some managers thought they could handle it themselves using existing operating models.
“However, they are finding the reporting cycle more challenging as they move forward and collect more data. Their systems are becoming more prone to error and they are increasing their “Key Man” risk, which can be avoided by adopting a more automated approach to regulatory reporting. Human oversight is important, but a systematic, automated approach mitigates human errors and the risk of overlooking or making a mistake in a filing,” suggests Travers.
One of the main implications to coping with amplified risks is for asset managers to assess operating systems in terms of the flexibility of their data management and their ability to integrate existing and future third party data streams. The more forward thinking managers will also integrate predictive analytics and other cutting-edge risk management techniques.
Challenge 3 – Heightened Investor Demands
In a recent Ernst & Young survey called “Positioning to win. 2015 global private equity survey”, one of the questions asked was “Beyond track record, what are investors most concerned with?” Some 49 per cent of respondents cited “Proven operational excellence”, underscoring the added scrutiny managers’ operating models are now under.
SEI conducted their own survey recently, this time within hedge funds, and these findings were also revealing. When asked what their biggest worries were about investing in this asset class, 38 per cent quoted lack of portfolio transparency.
Investors are getting more sophisticated and demanding more, and more relevant, information from managers. As Travers states: “It’s no longer the case that managers can just provide data as and when they feel like it. They need to show their track record benchmarked to the market, varying degrees of attribution and have core data at their fingertips to share with investors when they are both pitching for new capital and servicing existing clients.”
In the E&Y report, they point out that this increased demand for information within private equity, “has naturally led to an expansion of the CFO’s role. And CFOs are being asked to build operating models that are strategic as well as tactical”.
With a growing appetite for more and more data, it is clear that investors are looking to use it to assess managers and get a tighter grip on the performance attributions of all their alternative investments. The E&Y survey found that 67 per cent of respondents use financial information they receive from managers to perform portfolio analytics.
It’s a trend that is only likely to move in one direction and as such alternative asset managers need sufficient operational horsepower to cope with the challenge.
One slightly disconcerting, yet uncommon finding from SEI’s hedge fund survey was that when asked about the level of client service being offered, a huge disconnect was evident; whilst 57 per cent of asset managers said they were satisfied with their client service efforts, only 6 per cent of investors were in agreement.
How, then, can managers overcome this disconnect?
“I think the challenge for managers is that on one side they need to build a standardised system that allows them to provide good reporting across the board and allows all different business functions – management, IR, accounting, PM team – to work off. On the other side, managers need to provide a customised client experience and that is appropriate for the different types of investors on their roster. They might feel they are working hard to create detailed reports but if the data isn’t relevant to what a particular investor wants, that is where the disconnect arises,” says Travers.
Some investors will want a lot of data that they don’t receive in the standardised reports that managers send out. This creates a perception that the manager doesn’t understand them and a feeling that the client service level isn’t up to scratch. It’s a difficult balancing act.
Quite simply, client service is an opportunity to differentiate, SEI points out in their report. Moreover, today’s operating systems need to support the increased flexibility and customisation required to improve investors’ perceptions of client service levels.
Challenge 4 – Leveraging Big Data
Private equity firms have woken up to the potential of using Big Data. The technology heads and finance heads of some of the larger PE houses have been pushing the need for Big Data for a number of years now in order to create better data management and information on their underlying portfolio companies.
It is, however, only in the last couple of years where investors have been pushing for that data too and asking COOs to make those operational changes within their businesses for collecting data in a more streamlined and automated way.
Most PE firms still have the challenge of integrating the data they collect on their portfolio companies with their fund accounting data and regulatory data, says Travers. “But we are seeing some adoption of Big Data strategies and technology. Portfolio company monitoring tools such as Baxon and iLEVEL have gained traction with both finance and deal teams.”
“The challenge for private equity managers is how to ingest and integrate that data into their business environment to start learning and sharing insights, not only from an operational perspective but from an investment perspective as well,” opines Travers.
To utilise Big Data properly, all key heads of the business should be involved in the decision-making process. This should not be consigned as merely an IT issue. In short, it needs to be an enterprise-level strategy that is driven from the top down. This will help managers derive insights into areas of their business they might never previously have been aware of.
“Having a competitive operating model is no longer a differentiator. Firms who don’t see operations as simply just a cost centre but rather as a way to evolve the business in a more competitive market are going to be the ones who succeed and make use of new technology and new ways of thinking, to respond to market challenges,” concludes Travers.
One of the biggest challenges may be the lack of understanding of what good data management can actually achieve. Those who can turn data into information and business knowledge stand to gain a significant competitive advantage. To do so, managers need operating systems that can integrate varying volumes and types of data from both internal and external sources.
To read the SEI report in full, please click here.