Alternatives: Digitise or jeopardise
Alternative investment managers face a stark choice as digitisation increases
- Technology will deliver solutions in alternatives, not just cost reductions
- Alternatives are becoming more client centric, and technology will be key
- Boundaries between public and private markets are eroding
- New client segments are emerging, including defined-contribution pensions and millennials
As in long-only investing, so in alternatives, data is the lifeblood. Digitisation is thus emerging as the new ‘heartland’ technology, with the potential to penetrate every activity in its value chain – as reported in IPE, July 2017.
Previous waves in information technology mostly automated routine, manual processes to reduce costs. The current wave, on the other hand, seeks to deliver end-to-end solutions, creating more joined-up businesses powered by speed, connectivity, insights, transparency, personalisation and disintermediation.
These attributes are conducive to strong operating leverage via:
• Competitive information advantages from machine learning;
• Friction-free client experience from innovative intuitive engagement;
• Lower costs and competitive fee structures from more productive staff;
• Operational excellence that rises to meet more stringent due-diligence demands.
Unsurprisingly, on a 10-year view, current alternatives business models face digital disruption, according to 63% of respondents to a global survey conducted this year by KPMG and CREATE-Research for the report ‘Alternative investments 3.0: Digitise or jeopardise’.* The report highlights fresh winds of change driving alternatives investing into the third phase of its evolution (see figure).
Prior to the 2000s, the alternatives landscape was dominated by home-grown, autonomous lifestyle businesses run along craft lines. In the last decade, the search for uncorrelated absolute returns intensified, following the success of iconic investors such as the Harvard and Yale Foundations. The new wall of money from institutional investors ushered the industry into its second phase, where economies of scale became a fresh imperative.
The front office retained its craft nature but the approach became more product-centric, while routine activities elsewhere in the business were increasingly automated or outsourced via a new horizontal integration.
Now the industry is transitioning to its third phase – centred on the customer - where more and more activity is digitised to create operating efficiencies and improve customer experience, with an emphasis on strategic partnerships that leverage best-of-breed external service providers and fintechs.
The latest phase redefines the industry’s craft heritage via a new human–machine interface that combines the best of both. It also seeks to create new opportunity sets by widening the scope of the business. Above all, it reflects the transition from being product-led to becoming a customer demand-led industry.
There are several indications suggesting that alternatives investing may be starting this transition. First, the favourable tailwinds from quantitative easing are receding, as central banks retreat. Market-led growth in assets will be in the rear-view mirror. In the ensuing low-return environment, organic growth will top the agenda.
Second, cost pressures are likely to intensify. The return differential between private and public markets will continue to erode. Fees and charges will emerge as a key differentiator. Already under strain, the 2-and-20 fee structure will become the exception rather than the rule. It will become the preserve of those able to deliver excess returns consistently. Alpha will become an even bigger zero sum game, as markets become more efficient. The needle is already getting smaller while the haystack is getting bigger.
Entering hitherto under-served client segments has become vital: all the more so, as defined benefit pension plans worldwide are advancing into their run-off phase with ageing membership.
The new client segments are likely to be insurance companies, defined contribution pension plans, high-net-worth investors and millennials – the so-called ‘internet generation’ – engaged in virtual teamwork at hyper speed in social media.
Millennials do not know a world without technology. They will also be the main beneficiaries of the biggest wealth inheritance in human history, as the wealthy post-war baby boomers pass on. The sums involved are estimated at $30trn (€25.4trn) in the US alone, according to CNBC; and just as much in the rest of the world. They will emerge as a substantial investor group in the next decade.
Plugged in like no other generation, millennials want live investment information that can be displayed in ways that bring data to life, unlike dry factsheets. Uncorrelated absolute returns will remain in great demand.
It will be at the centre of a digital brand, alongside two key elements of client experience that are now common in e-commerce:
• 24/7 digital customised, natural, seamless, intuitive and user-friendly service, based on interactive tools and mobile capability; and
• Pre-emptive insights, like human telepathy, that anticipate client needs and offer solutions to problems even before they arise.
Operating leverage will become vital. Without it, alternatives managers will find it hard to expand their footprints in new client segments and geographies. In the past, as managers ramped up their AUM, the craft nature of the business often delivered a perverse outcome: a rising cost-income ratio from the diseconomies of scale inherent in all people-centred businesses.
By any measure, the industry has been highly profitable. But its members face a stark choice as it enters the third phase: they must either embrace the revolution sweeping through their societies or risk becoming its unwitting victim.
Amin Rajan is CEO of CREATE-Research and member of The 300 Club. Anthony Cowell is a partner at KPMG
*Available at: www.create-research.co.uk