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24 February 2020

The Alternative Route to Growth and Profitability

By Roger Woolman

We’ve hit yet another record – the latest figures from Preqin show global alternatives assets under management surged to $10.3tn in 2019, with the firm predicting AUM of $14tn by 2023.

A large and growing group of committed investors are helping fuel the expansion: Preqin tracked a total of 12,000 institutions with active alternative asset investment programs as of January 2020, up from 11,280 a year before.

Pension funds in particular are upping their exposures to alternative assets such as private equity, hedge funds and real estate on the hunt for more attractive risk-adjusted returns and reliable income streams to meet swelling liabilities. According to a new report from Willis Towers Watson’s Thinking Ahead Institute, alternatives now account for almost a quarter of allocations in the seven largest markets for pension assets (Australia, Canada, Japan, the Netherlands, Switzerland, the UK and US). That’s up from just 6 percent in 1999.

Private assets lead the way
Private equity is receiving the lion’s share of the alternatives allocation flow—something we’re seeing in our own business from conversations with fund managers keen to launch closed-end or hybrid funds, and service providers that need the operational wherewithal to support them (with fund behemoth Vanguard one of the latest to extend its reach into the private equity arena).

Private equity AUM hit a record $4.1tn as of June 2019, according to Preqin, as yield-hungry investors plowed more than $500bn into the sector for the fourth consecutive year. And the growth seems set to continue, with 86 percent of the LPs surveyed by Preqin planning to allocate as much or more capital to private equity in 2020 as they did last year. The industry is on course to add almost a trillion dollars per year for the next five years, Preqin suggests.

Private debt has also hit record levels, reaching $812bn in AUM in June 2019. Assets have grown consistently each year since the financial crisis, as banks retrenched from serving the middle market and private debt funds flocked in to take their place, notes Preqin. The U.S. and parts of the EU have been at the forefront of the trend, and now the Asia-focused private debt market is also gathering momentum, with assets more than doubling between 2014 and 2019.

The pace of fundraising has slowed in the last two years on concerns about the state of the current economic and credit cycle. Yet interest remains high, with 84 percent of the investors surveyed by Preqin planning to commit as much or more capital to private debt this year, and nine-tenths intending to maintain or increase their allocation over the longer term.

Profit from the right infrastructure
There are tremendous opportunities for investment managers and fund administrators to tap into some of these vast allocation currents flowing into private assets in particular, and alternative investments as a whole.

But opportunity can be tough to translate into results. Aside from the obvious investment skill and competence required, firms need a reliable trading, processing and overall operational infrastructure purposely designed to manage with the idiosyncrasies of managing assets like private equity and private debt, and the fund structures that house them.

Accurately allocating profits, losses, expenses and tax implications among every investor over the lifetime of such a fund requires specific administrative expertise and system functionality. That expertise and technology can be bought. Not every (indeed, not many) systems have the built-in functionality though to seamlessly account for and report on the assets.

So what features and capabilities should you look for?

At a minimum an infrastructure that can handle partnership accounting and servicing for both onshore and offshore funds, along with comprehensive instrument coverage to ensure high-quality support for the full range of asset types.

For example, PE and hybrid funds need an integrated investment and investor accounting capability that can provide investors with detailed look-throughs to the underlying assets, and to deliver enhanced transparency into the portfolio constituents and performance.

With a single, end-to-end portfolio investment and investor accounting solution, firms can monitor and control the relationship between each investor’s capital flows and the final investments. It allows you to track your investors across multiple investments, generate accurate fee and distribution waterfall calculations, and provide opt-in/opt-out capabilities where desired. You can also run exposure reporting to show investors exactly where their money is going—a growing imperative, as industry pressure builds for greater transparency and more reporting standardization.

Flexibility, scalability and rapid time-to-market to take advantage of the current wave of investor interest—with the aid, for instance, of technology hosting and outsourcing services—are other considerations.

Are you ready?
Many firms’ existing infrastructures struggle to integrate the investment and investor accounting pieces to deliver look-through capabilities. Without it they will be saddled with manual, offline processes in separate systems or spreadsheets.

Such inefficiencies are neither scalable, cost effective, nor likely to deliver the high-quality servicing that will keep investors happy… the key factors that will determine whether your firm can profit from these powerful industry trends.