25 October 2021 - In the world of alternative investments, complexity isn’t a novel trend. The rise of hedge funds was followed by an explosion of illiquid strategies including private equity, infrastructure and real estate. More recently, asset owners are showing a growing appetite for direct debt and private deals simultaneously with a wider geographic focus, going beyond the financial safe havens of North America and Europe into a truly global investable universe. The side effect of this multi-faceted diversification has created a byzantine patchwork of service providers, systems, internal staff, technology and consultants needed to manage the resulting operational requirements. The resultant operational headaches for investment operations have only compounded with each expansion of the asset allocation landscape.
Books and records have morphed into many versions of the current reality
While alternative assets aren’t solely responsible for the current state of play, managing multiple versions of this reality became significantly more onerous as institutional portfolios added alternatives, mirroring the most sophisticated asset managers. Historically, an asset owner had one book of record for an investment portfolio, often provided by a custodian.
Affiliations with custody banks can last decades, providing assurance of asset safekeeping to institutional money managers and beneficiaries alike. However, custody platforms were built for traditional assets and currencies, designed for scale and stability, and taken as the settled accounting view of the assets in the portfolio. Alternatives have always been a difficult proposition for both technology and servicing, as evidenced by the constantly growing list of partnerships and acquisitions in an attempt to bridge the gaps.
Looking at today’s portfolio and the necessary capabilities, some key considerations for asset owners include:
- What segments of the investment mandate are best served by the custodian?
- How many books of record are needed for the organization, and who maintains them?
- Is a financial accounting system (G/L) required for the investment portfolio?
- Are there strategies which require specialist expertise?
- How does custodian data impact the core operational workflows? How should it?
As investment managers became more sophisticated, additional recordkeeping also ushered in new perspectives – an investment book of record, often referred to as IBOR, providing users a trade data view of the portfolio, without a fully featured accounting ledger.
Alternatives brought along new challenges. Different valuation cycles and performance return methodologies were needed as portfolios diversified, and for many, that meant another version of the current reality - a performance-centered version - eschewing locked periods and requiring an alternate lens for market value. Regulatory agencies, governments and tax authorities defined a series of guidelines, creating yet more versions. Instead of simple data transformations of accounting data, based on well-defined business rules, the more common picture now is an undecipherable bowl of data spaghetti where all of these variants must be simultaneously maintained and integrated to meet the needs of investment professionals, managers, governments, data aggregators and ultimately, beneficiaries.
New assets, new providers and a sea of data
Banks, exchanges, brokers and clearinghouses once allowed an institutional manager to price, trade, settle and report on their portfolios. Those days are long gone, and institutional investors have a pressing need for data from an enormous array of additional providers, including fund managers, fund administrators, analytics data providers, market data providers, software firms, investment consultants, valuation agents, collateral managers, direct counterparties, loan servicers, tax authorities, loan agencies, auditors and law firms.
Alternative asset allocations carry in their wake a proliferation of documents and manual workflows. Traditional assets operations are highly automated, benefiting from decades of standardization and integration. In contrast, alternative assets still rely heavily on documents, whether statements or legal agreements, as well as email. While these asset classes are going through the same incremental efficiency improvements, Straight-Through-Processing of transactions, valuations, exposure and reconciliations remain years away.
It is nearly impossible to source, validate and manage the necessary investment related data in-house, and virtually every asset owner relies on some combination of outsourcing and bundled data services through provider relationships. Bundling data services and financial software was once available through only the largest vendors, but it’s now common for even startup software firms to include services around data, easing lengthy and expensive integrations and standardizing user experience.
These niche providers work well in the domain of their technology, but struggle to exist within the larger asset owner operating model. Managing the avalanche of data from an ever growing spider web of sources is no simple feat, and asset owners must choose the right relationships to lighten the burden.
The snowflake problem
“Alternative asset” remains an umbrella term used to denote an investment besides stocks, bonds or cash. Practically speaking, alternatives is no longer a meaningful classification, giving way to a laundry list of asset types, all with their own unique requirements. The myriad of alternative assets has only accentuated the importance of accurate data provided in a number of flexible ways, across a multitude of systems. Asset owners share some commonality with asset managers in the mechanics of their operational support, but their priorities differ. Fees and transparency are consistently primary concerns for asset owners with the guiding principal of stewardship on behalf of their beneficiaries.
And looking beyond the investment portfolio, no two institutional investors are alike in their culture, regulatory/legal frameworks, or structure, leaving best practices as a theoretical exercise in favor of pragmatic, custom-fitted solutions across services, technology and human capital. Staffing constraints rarely surface for asset managers, but may loom large for many institutions resulting in tailored relationships with partners and service providers. These can lead to lean sourcing, co-sourcing as well as outsourcing but these must be adapted individually.
Today’s diversified portfolio puts a premium on multi-disciplinary staff, data skills, innovative technology tools and bespoke solution providers. The complexity of modern portfolios and entity structures creates an overwhelming paradox of choice for asset owners, where investment operations has become shorthand for the manufacturing and curation of those disparate data sets that are the lifeblood of pensions, endowments, family offices and sovereign managers the world over.
By Nick Eisenlau, Head of Institutional Services, Citco Fund Services (USA) Inc.