Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
New pressures from maturing alternatives market
While a combination of factors is driving the alternatives investment sector towards full maturity, pressure is also mounting on fund manager and investor capabilities for efficiency and governance.
According to a short paper by Northern Trust’s asset servicing arm, the weight of money into alternatives leading to a broadening investor base, regulators and increasing congestion for managers are each applying different categories of pressures on the system.
The paper, ‘From Pressure Comes Diamonds – how industry forces will give way to a new level of maturity for alternative assets’ examines the three main sources of pressure, falling on the back office through to middle and front offices of both managers (General Partners in alternatives parlance) and investors (Limited Partners). They are:
- New products, strategies and distribution opportunities
- Elevated expectations for the LP experience, and
- Regulatory evolution.
There are many trends within those sources of pressure, mostly adding to the complexity and demands placed on systems and people handling data through its processes of extraction, sorting and analysis and usage.
Iain Carey, Northern Trust’s Hong Kong-based head of hedge fund services for APAC, says that a convergence of hedge funds and private markets offerings is one of those trends. Mainly coming from hedge funds, many of which have faced drawdowns due to underperformance against traditional equities strategies and index funds over the past decade, there is a new breed of hybrid emerging. These strategies blend more liquid elements of hedge fund styles with the benefits of private markets.
Carey says such hybrid structures have the benefit for the GPs of opening up distribution channels. “We have definitely seen this in Asia and in the US, too,” he says. “It’s something we have been noticing for three-plus years.”
Another trend is the increasing popularity of SPACs (Special Purpose Acquisition Companies), especially in the US but also in parts of Asia such as Hong Kong and Singapore. Private equity managers are raising their own SPACs as an efficient way to tap new sources of capital and using SPACs controlled by other players as an extra avenue for exits.
The paper includes a cautionary note on SPACs. It says that private equity managers may encounter a learning curve when having to deal with retail investors for the first time, rather than sophisticated institutions, and in the provision of new levels of transparency. This would be particularly so for managers which retain their traditional offerings alongside new SPACs.
The demands of big investors for customisation and more detailed insights from their managers further add to complexity and perhaps some operational pressures.
The paper says: “In turn, this has resulted in more segregated mandates, carve outs and side pockets, parallel investments, side letters with different terms, and joint ventures for large LPs, along with more complexity for GP operations. As large investors seek greater customization, GPs are often managing LP relations approaches as they go, creating multiple service models, varying expectations, and increasing difficulty in tracking and reporting systemically.”
And regulatory changes, invariably involving some sort of additional burden on managers and investors, are by no means confined to Australia, of course. The paper says: “Increasing regulation, as well as greater scrutiny as the industry grows, means more attention and focus must go to governance and compliance.”
Managers need good resources, Northern Trust argues, to help with objectives such as:
- Going global – opening funds in different domiciles or regions, with the attendant regulation that follows
- Adapting to new strategies as they expand their investments to incorporate opportunities like private debt or distressed assets
- Complying with privacy, anti-money laundering/know your client, registration and other laws in their chosen domiciles, and
- Staying current with new and existing local and regional regulations that are increasingly applied to the alternatives industry.
On the plus side, new technologies are helping ease some of the burdens of the increasing complexities, in particular digitalisation. Northern Trust is proud of its success as the first of the big global custodian banks to go live with distributed ledger technology (blockchain) for a fund, which it did with a private equity fund. It has similarly digitalised a bond offering in Singapore which allowed for fractions of the security to be traded.
