Increasingly, the search for alpha is pushing asset managers into the furthest corners of financial markets. New asset classes, new instruments and new geographies are conspiring to place huge pressure on pre-existing operating models as managers struggle to cope with the volume of investment data. Whereas previously the front office operated independently from the middle and back office, all three are converging to handle the data management task.
This, in short, is leading to a new investment management operating model; one that is more integrated, front to back. And is, in turn, being supported by service providers. Fund administrators, who may previously have focused on back office tasks, are now adding middle and front office capabilities to respond more effectively to the multi-asset investment environment. Middle office-focused providers are now diversifying their offerings into the front office. And as SEI states in a new white paper – The Investment Management Operating Model 2.0 – this convergence, within fund management groups and service providers means that “everyone is playing in everyone else’s sandbox”.
Build a better mousetrap
Multi-asset investing is the name of the game today. Think of it as ‘hybridisation’ whereby hedge funds running liquid portfolios are looking further across the illiquidity spectrum to generate additional yield, private equity managers are adding a satellite ring of liquid positions around their core allocations, real estate managers are combining REITs with unlisted real estate holdings etc.
This could, in theory, signal the beginning of the end for ‘pure play’ investment managers.
“From a strategy perspective, the pre-existing arbitrary lines and borders are breaking down,” says Ross Ellis (pictured), Vice President and Managing Director of the Knowledge Partnership in the Investment Manager Services division at SEI. “A private equity manager, for instance, while having a core expertise in that asset class or specific strategy, doesn’t need to hermetically seal themselves off. They might look at the market and decide they like parts of what the equity long/short or macro managers are doing and attempt to meld them into their own strategy, thereby building a potentially better product.
“Just as we are imploring traditional asset managers to look outside their four walls for inspiration, the same applies to alternative asset managers, in terms of how they structure their products. There will always be a place for pure-play strategy expertise. But what I think we will see is more of a willingness among managers to explore further afield, to look at fresh or non-traditional areas for inspiration and ideas to make a better solution for their investors.”
Thanks to the huge developments in technology, and the wider support that they get from their service providers, investment managers have evolved to become solutions-driven specialists as opposed to strategy-driven specialists.
As SEI’s white paper points out, the front office has led the charge in terms of technology investment “and taken on a growing share of risk management functions that historically resided in the middle office as an ex-post process”. The front office is far more focused on pre-trade risk analysis, exposure analysis, and pricing. In other words, ex-ante risk has become a critical function, as opposed to merely ex post risk. Indeed, the AIFM Directive and upcoming MiFID II regulation place huge emphasis on pre-trade transparency.
In that sense, converging roles from the front office to back have also been a direct response to regulation as much as a need to diversify into multi-asset investment specialists.
Front office push
By breaking down walls between the front, middle and back offices, Ellis says that the hedge fund industry has moved from monthly snapshots of portfolios to weekly and daily, with the ultimate goal of providing near real-time investment data to a variety of consumers. While the private equity side of things is still set on the quarterly valuation cycle, through better data management and architecture, portfolio insight occurs far more frequently.
In reality, most investors come from the long-only space. They have a certain understanding of what transparency is and as they become more sophisticated, and technology improves, they are winning the power struggle, as it were. If they allocate to a private fund, they need to be able to analyse it in the same way as they do their long-only investments, in order to achieve an aggregate overview of the portfolio.
“As investment managers move out of their style boxes, they need to look internally at how they collect and manage additional data in order to effectively run broader scope portfolios. At the same time as they are asking that question internally, they also need to know how to present sufficient, and appropriate, transparency to investors and regulators.
“In some respects, therefore, the front office is forcing the back office to change because in order for them to create the solutions they want to, they need better infrastructure,” comments Ellis.
Too much transparency…?
Some investors no longer differentiate between public and private equity. They have an equity bucket, with a continuum from liquid to illiquid and they want to know what their exposures are in certain sectors or geographies. They don’t think about having a 20% private equity bucket, it’s just an equity bucket full stop. They are going to demand this same level of transparency across all investments – private credit and public credit, listed RE and unlisted RE etc.
If that trend continues, this, says Ellis, will undoubtedly lead to self-selection:
“Some managers will not give very much away of their secret sauce because the more they give away, the less alpha they potentially could generate. It’s going to harm themselves to give out too much transparency. That works if you are a top-tier, multi-billion dollar manager. It doesn’t work if you are a mid-market manager struggling to break through the USD150 million barrier with average performance.
“Even the biggest managers, however, understand that they have to provide something. The world has changed. It’s no longer a wink and a handshake. If an allocator is willing to put down USD100 million, they will expect a certain level of transparency, no matter who the manager is. And the more sophisticated managers understand and appreciate that a well-informed investor is a better investor. ”
Evolving the operational model to support greater data management capabilities, and transparency prowess, could actually work to the advantage of smaller managers. In order to compete, they could make it a strategic focus to tell investors that they will offer more transparency. And in turn make it easier for people to invest in their strategy because they will be able to do more cross-asset class portfolio analysis.
“Instead of struggling to work out how their strategy might fit into an investor’s portfolio, the manager could say, ‘I’ll give you all the transparency you need to make it as easy for you as possible to understand correlations and monitor on an ongoing basis’,” suggests Ellis.
Service provider convergence
This convergence trend is happening within the service provider community as much as it is the investment manager community. Middle office providers have begun expanding vertically into the front office. By leveraging their strong data and staffing resources, these providers have been able to quickly introduce data-enabled services, often as Data-as-a-Service (DaaS).
This is crucial in supporting their clients’ front office teams as they grapple with larger, more complex volumes of market and investment data. The last thing a fund manager wants is to be hamstrung by operations. In the old silo-based world of operations, that is precisely what would happen; a particular best-of-breed IT system might have worked at the time, but it wasn’t designed to give the end-user the sort of information they need for wider portfolio management or order management requirements.
“With the likes of data-rich companies like Amazon and Google and new digital entrants, there is so much available technology for asset managers and asset servicers that it is breaking the shackles of what is now possible. There are plenty of new entrants to the market that do not have broad name recognition but may have extraordinary technology to support enhanced technology, reporting, portfolio management etc. They are there to support and enable swifter portfolio management decisions and remove potential roadblocks,” states Ellis.
Examples of this include software vendors such as Narrative Science and Arria, which use proprietary AI to analyze investment data and turn it into commentary for client, regulatory and internal reports.
This is potentially groundbreaking for front and middle office teams as they will have even greater ability to manage data effectively and use AI technology and Robotic Process Automation (RPA) to automate key operational tasks.
According to SEI’s white paper, the cloud-based web services of Amazon, Microsoft, Google and IBM are already cutting into the market share of traditional service providers: “Their entry may well be only the beginning of their disruption of the Software-as-a-Service (SaaS) and DaaS landscapes in asset management.”
“Traditional silos, legacy technologies, and indeed maintenance of the status quo no longer work in today’s asset management industry. The good thing is that there’s no shortage of partners and technologies out there that can help. Done right, managers can turn this ‘problem’ into a competitive advantage,” suggests Ellis.
As the paper itself concludes, “asset managers who underinvest in their operational infrastructure or adopt a wait-and-see approach risk far more than a regulatory breach...they are likely to miss a rare chance to truly differentiate themselves from their competitors and capitalise on an exciting opportunity to lay the foundation for sustainable future growth.”