Alternative investments

About Knadel

Knadel is a specialist consultancy that combines business with technology expertise to provide a range of services to the investments industry. Knadel’s core areas of expertise are strategy, integration, target operating model design, systems architecture design, outsourcing, and change management programs.

---

  

For asset and fund administration managers (collectively ‘managers’) supporting vanilla structures and investing in traditional retail equities or bonds, there are a range of highly effective out-of-the-box technology solutions available for running the back office. However, for managers needing to support investments across alternative asset classes (not just hedge funds), particularly those requiring complex structures, the technology challenges remain.

For the purposes of this article, the term ‘back office’ refers to post-execution activities, i.e. all of the fund administration, valuation, and accounting functions, together with investor servicing. ‘Alternative asset classes’ broadly refers to the use of a range of vehicle types or structures (including fund-of-funds structures) required to support investment into private equity assets, real estate, or hedge derivatives.

Alternative investment back-office operational characteristics

Translating the characteristics of multiple alternative asset classes into the requirements of a back-office technology solution, which is capable of supporting their individual operational requirements, is challenging. Any such technology solution needs to seamlessly, yet effectively, provide at least the following functionality:

• Support for complex derivatives; including short positions, futures, forwards, options, swaps, and the many sub-types that follow
• High volume of activity; e.g. hedge funds conducting price arbitrage opportunities, exchange traded assets, or investor trading activity
• Traditionally labor intensive manual activities such as company secretarial administration
• Regulatory compliance in multiple jurisdictions
• Support for a range of structure types (companies, trusts, partnerships, foundations, etc.)
• Integration with multiple legacy or corporate systems
• Integration with multiple home-grown or excel “systems”
• Support for multiple GAAPs
• Multi-level consolidations (including support for the full range of structures)
• A wide range of investor servicing functionality including to manage: commitments, calls, subscription queuing, performance fees, complex waterfall distributions, investor reporting
• The full range of traditional fund servicing functionality including to manage; valuations, accounting, multiple intra-fund currencies, compliance, and financial statement reporting

Current solutions

Across all asset classes (including traditional retail), there are many systems on the market with widely varying characteristics in terms of: cost, asset class focus, investor servicing focus, entity servicing focus, client-base, flexibility, usability –  the list goes on.

In terms of asset class functionality, Figure 1 illustrates the principle distinctions between today’s back office systems. Overall, they currently tend to focus on one particular sector of asset class market with little or no overlap to other sectors.

Figure 1: Today's systems landscape by asset class functionality.

From a functionality perspective, Figure 2 illustrates the main differences between today’s back office systems, showing a focus on value-chain functionality associated with either the fund administration/valuation of entities or the servicing of investors.

Figure 2: Today's systems landscape by value-chain functionality.

Solution options – technical

So where does that leave firms needing solutions across multiple asset classes? Broadly speaking, there are two obvious (theoretical) scenarios:

• Multiple individual back office solutions for every combination of asset class/value-chain'
• A single “magic bullet” back office solution that meets all needs

However, neither extreme is satisfactory because:

• Multiple individual back office systems translates into numerous challenges in terms of:
• Costs
• Vendor support/relationships
• Upgrades
• Interfaces
• Inter-operability
• A single ‘magic bullet’ back office system simply does not exist!

In reality, multi-asset class managers typically adopt a best-fit, pragmatic approach involving a low number of credible core systems. Some of these may be integrated, some may not, with typically numerous additional manual processes held together by the ubiquitous excel “glue”.

The challenge therefore remains for the industry to step up and become better at producing a system, or at a maximum a pair of complimentary integrated systems, that cover the entire space as a single out-of-the-box solution.

Solution options – other key ingredients

Apart from the absence of a single “magic bullet” solution in the alternatives space, the other bad news for multi-asset class managers is that there is also a long list of other key ingredients that a credible supplier needs to be able to support (in an ideal world). These can be summarized as follows below.

Vendor substance:

• Vendors need to prove their financial strength and outlook, so managers know they will be around over the likely life-time of their systems (minimum 5+ years)
• They need to have a presence in locations relevant to their clients
• They need to have relevant resources available to meet support/development needs (rather than relying on outsourced solutions)

Client base:

• There needs to be an established client base of similar users, nobody wants to be the “guinea pig”

Technology:

• The technology needs to support a system environment were users can be located around the world
• The nature of the solution needs to be based on an “n-tier” architecture to ensure robust scalability, without unsolvable technology bottlenecks
• The development and database tools need to be contemporary, i.e. not themselves in danger of obsolescence

Implementation:

• There needs to be a proven track-record of successful implementations

Flexibility:

• Any successful system needs to be capable of adapting to changing market conditions and regulatory needs. Being the perfect system for “today” is no longer good enough.

Usability:

• Usability for users is a top priority when selecting a system so that a wide-range of user types are supported
• A successful system needs to be intuitive, requiring minimum formal training or use of extensive help manuals

Integration:

• Possible integration with the myriad of other commonly used systems is essential in the modern era. Any credible solution therefore needs to have a proven integration capability with commonly used infrastructure associated with the industry, such as, SWIFT messaging, Dealing (of various types), Pricing, Email, Calendar, etc.
• Integration using an “open” application programming interface (API) is also a must-have for building 2-way interfaces to other specialist/niche platforms

Workflow:

• To boost efficiency, a powerful, generic, and flexible business process modelling workflow is required to address any remaining automatable processes that are not delivered out-of-the-box

Reporting:

• Out-of-the-box reports that meet all major standards, particularly in relation to financial statements which are typically challenging for system vendors to fully automate in the alternative investments space
• Querying tools capable of operating in a user-friendly manner by accessing, filtering, and summarizing all of the data in the underlying database(s)

Security:

• Robust, logical, and role-demarcated controls are essential across any effective system in terms of access to functions as well as in controlling access to encrypted data. Such controls are required in particular to satisfy the needs of the most enthusiastic internal auditor or industry security standard(s)

Costs: 

• Finally, there are a number of consequential and inter-related components to the cost of a system that need to be understood to ensure the total cost of ownership is in line with the business case for any system
• Each cost components of the system needs to be identified, and then modelled by asset class, business unit, volumes, and timeframe, etc. The cost components include for example, the software license structure, software license levels, annual maintenance charges, implementation costs, development costs, and configuration costs

Conclusion

We are clearly some way from achieving any form of nirvana for managers requiring systems that support multiple alternative asset classes in the fund/investor administration space. That does not mean however that we should not all be continuing to strive for systems that are ever-closer to perfection.

In practice, this means that managers should be reviewing their legacy systems and demanding more from vendors in the alternative space, in particular by building robust business cases that clearly demonstrate that the substantial investment required is worth the inevitable significant effort. System vendors should also be taking a strategic, rather than reactionary, approach to their system development roadmaps. By planning further ahead firms can capitalize on the inevitable new market that will arise as the industry continues to consolidate in line with the blurring of boundaries between asset classes and investor types.