Consolidated asset platform déjà vu: The key to competitiveness for alternative investments?

The investment management industry is going through a metamorphosis for alternative investments similar to that for listed securities at the turn of the century. As consolidated asset platforms are necessary for more effective investment strategy execution, this article explores the challenges faced by investment managers today and how those firms with consolidated platform experience for listed securities are better prepared for managing consolidated alternative asset platforms going forward.

As the millennia was upon us, asset managers were struggling to keep up with due diligence demands, pre-trade compliance and consolidated reporting for equities, fixed income, and money market trades. If firms had comprehensive systems for trading, accounting and analytics, it was for equities – some had separate systems for fixed income and the Holy Grail of a consolidated platform for all listed securities was elusive.

In search of the Holy Grail

As firms began to acquire or build consolidated platforms for all listed securities, their ability to act swiftly for potential trade opportunities with solid understanding of the impact to their asset allocation and consolidated investment scenarios increased their competitiveness in the marketplace.

Fast forward to today as global investment in private investments is growing rapidly and the asset management industry is experiencing déjà vu with firms still seeking a consolidated platform – not just for listed securities now, but for their increasing asset allocation to private investments as well.

Firms increasing diversification with alternative assets as part of their asset allocation pie are facing the same watershed moment experienced with listed securities many years ago. The management of a consolidated view of listed securities in one platform of technology solutions is achievable today, but each alternative asset class is still largely in its own separate solution for many firms.

With an increasingly larger slice of the investment pie allocated to alternative investments, firms are struggling with the challenges of not having consistent, consolidated data.Carol Penhale, CEO, Bedford Park Associates

With an increasingly larger slice of the investment pie allocated to alternative investments, firms are struggling with the challenges of not having consistent, consolidated data for all asset classes for key functions such as compliance, risk, performance and cash positions on a timely enough basis to effectively manage their investment holdings and make informed decisions on potential new acquisitions.

A consolidated platform – also for alternative investments

Once again, the Holy Grail for sophisticated asset managers has become a consolidated platform – however, these days it includes not only the full range of listed securities (equities, fixed income, money market and derivatives) but also the growing complement of alternative investments (private equity, real estate, infrastructure, etc.). Asset classes are being added to the diversification pie faster than operations or technology can keep up with the demand for front, middle and back office needs for portfolio managers.

The need for a daily consolidated portfolio and cash view has become even more crucial for asset managers to manage investment risk with the increased exposure to alternatives. Listed securities offer liquidity, which is one of their strong investment appeals of exchange-traded securities, but private investments do not. Indeed, until recently they were referred to as the ‘illiquid’ part of the investment strategy by many asset managers. In lieu of liquidity, alternatives generally have offered higher rates of return, which is the attractive feature of them given performance by stock markets globally in recent years.

Ensuring sufficient cash flows is critical

Allocating larger sums to longer terms of illiquid alternative investments carries an additional challenge for consolidated portfolio strategies that include listed securities and external cash obligations. For alternative asset managers, there are three little words that require reflection and demand stress testing when making any new investments: negative cash flow. Ensuring cash flows are sufficient for both obligations and capital calls for private investments is critical – especially since private investments, once committed, are more onerous to dispose of for cash flow needs.

The increasing exposure to private investments puts greater pressure on cash flow needs and monitoring on ‘liquid’ portions of the portfolio. As long as the portfolio has a steady infusion of new cash, addressing go forward cash flow obligations is manageable. However, any cessation to the anticipated cash flow becomes an immediate problem – many asset managers will recall the repercussions of the sub-prime crisis of 2008 to their cash flow obligations and investment portfolios.

Determining the cash flow needs/availability on a daily basis to adequately aid expedited turnaround time on investments is increasingly difficult given the complexity of due diligence. Having this function further segmented with the absence of a consolidated platform for all asset classes adds complexity to producing the calculations on a timely basis with a reasonable sense of comfort in the numbers.

Lacking corporately supported tools, many still rely on Excel to cobble together their estimates of cash flows for existing and proposed new investments and asset allocation shifts.Carol Penhale, CEO, Bedford Park Associates

Lacking corporately supported tools, many still rely on Excel to cobble together their estimates of cash flows for existing and proposed new investments and asset allocation shifts. Using Excel as the ‘platform’, coupled with data that is not vetted or (equally a challenge) all the sources of data do not represent the same ‘snapshot in time’, represents a key process for due diligence and operational functions that is flagged in audit reports on an increasing basis.

Worse than not meeting the scrutiny of an audit, assembling the Excel picture is not timely enough for market execution compared to firms who have invested in technology. Those who have a consolidated platform for listed securities know the streamlined abilities they have for those assets. The inability to execute quick turnaround on due diligence for an asset class or the consolidated portfolio makes competitiveness an elusive target. Firms that have achieved a consolidated platform for listed securities see the dangers of the growth of the private side asset allocation without the same effort to reign in these asset classes into a cohesive technology environment.

Due diligence as a competitive differentiator

Accelerated due diligence as a competitive edge has become more acute for alternative investments in recent years, even for savvy seasoned players in the space. The demand for quality private investments far exceeds the supply which creates great challenges for firms with complex diversification of assets to make seasoned investment decisions using Excel on a timely enough basis.

As opposed to listed securities where the playing field is level for execution, private investments are very much about relationships. Many investment management firms struggling with establishing good relationships for quality product are also struggling with turnaround time internally to decide on an opportunity. The inability to assess the portfolio fit, compliance tests, risk tolerance and cash flow implications of a potential investment leave many firms with a difficult decision: they either continually miss out on good investment opportunities to others who can say ‘yes’ faster or they have to say ‘yes’ sooner with less due diligence. The latter scenario introduces risk to the consolidated portfolio and, unless very lucky, takes its toll over time on the asset allocation and investment objectives as a whole.

Boosting support for the CIO

The complexity Chief Investment Officers face with diverse asset classes is increasing, especially with books of business in both listed and alternatives. Often, the due diligence presented to the CIO by managers for each asset class has varying approaches, algorithms for the same calculation, data sources and presentation styles/reports. In addition to the challenge of the CIO being challenged to do an apples-to-apples comparison on the best investments not only for the asset class, but for the consolidated asset allocation strategy as a whole. The time it takes to perform such an exercise is often precious time lost in the execution process, further complicating the competitiveness situation of the firm.

The complexity Chief Investment Officers’ face with diverse asset classes is increasing, especially with books of business in both listed and alternatives.Carol Penhale, CEO, Bedford Park Associates

Apart from competitiveness capabilities, firms have as the result of an absence of a consolidated platform solution, they are also missing out on the enhancements to operations, transparency/drill down capabilities and alleviating frustration of key staff who struggle daily with turnaround time for due diligence for investment decisions.

In addition to these key challenges for operational functions and portfolio managers, CIOs must be wary that the demand, frequency and transparency for both internal reporting and regulatory needs (especially AIFMD) is accelerating. The inability to garner cohesive sets of data across asset classes for reporting on a corporately supported system has become mainstream for listed securities and is coming of age for alternatives as well.

In addition to all the challenges noted above, the CIO must be concerned about cross-asset class exposure for compliance adherence and risk tolerance profiles. This piece of the due diligence puzzle has grown with complexity in recent years, especially since the sub-prime crisis outlined the need to understand the underlying holdings and true exposure an investment opportunity may present.

While the head office of an organization may be in the U.S., if its core operations are in Southeast Asia, geographic, political and currency risk must be taken into consideration. As well, many firms are looking to ensure their risk tolerance is hedged wherever possible, so a private investment in commercial real estate in Germany must be considered against exposure to the same areas in its equities, for fixed income or FX exposure.

These trends will feel like déjà vu for those who worked on listed portfolios in the last 20 years. Those who survived the consolidated platform for listed securities know these trends will continue to plague investment professionals in their ability to seize opportunities for more attractive holdings and portfolio exposure, especially for alternative investments. While there are no silver bullets (yet!) in the industry for all asset classes, those firms that are striving for consolidated platforms that handle public and private assets are on the best path to remaining competitive going forward.