The Digital Transformation of Alternatives Can't Wait

The growth of the alternatives market shows no sign of slowing, but alternatives investors need to invest in digital transformation to help them stay ahead of the game. Gus Harris, Head of AD Data & Analytics and member of the Group Executive Board at Alter Domus, explores the key considerations for investors planning on upgrading their systems. 

These are exciting times in the alternatives marketplace. With total assets exceeding $10 trillion and projected annual growth rates of about 10% (according to Preqin’s 2021 Global Alternatives Report), the market for alternatives is projected to exceed $17 trillion within five years. But this growth has inevitably led to growing pains, particularly around the issues of data transparency and access to portfolio information.

As Preqin explained, the top five technology-related challenges for alternatives investors all come down to managing vast streams of data to facilitate portfolio insights and decision-making. In other words, they expect technology to offer them greater transparency, efficiency and access to underlying investment data to improve investment performance. As the appetite for alternatives continues to grow, addressing this market need will be essential to support a healthy alternatives marketplace. 

Vendors have stepped up admirably to help investors get a better understanding of their portfolios by offering services to normalise disparate data points, map them into consistent formats, identify the key information among the vast sea of available data, and ultimately deliver insightful reports and tools to alternatives investors. But even so, much more remains to be done, particularly when compared to the developments made in other financial markets. 

The 'Do It Yourself' Urge Remains Strong 
Anyone who has embarked on a home improvement project will know there comes a point when choosing to ‘Do It Yourself’ can become less of a cost saving and more of a liability. Yet many alternatives investors still find themselves stuck performing the gruelling tasks of collecting, normalising, databasing and reporting on their portfolios.

Unfortunately, Excel spreadsheets and other in-house applications are simply not designed for the level of sophisticated analysis, consistency and control required – never mind the ability to share this data safely and securely. As alternatives make up a larger share of portfolios, investors must be prepared to abandon their DIY principles and embrace more durable, robust and reliable systems. But how can they make the transition as painless as possible.

Starting the Upgrade Journey
Before any internal systems upgrade is sought, investors would benefit from imagining their ideal data and analytics solution. Even if those questions cannot be answered immediately, any system must be flexible enough to accommodate future enhancements as new capabilities and expanded data become available.

A key part of the selection process is to identify current shortfalls, as well as studying data and analytics solutions developed outside the alternatives marketplace. Looking at the systems used for mainstream asset classes can give alternatives investors an insight into what may be possible.

True Look-Through
For example, comprehensive analysis of an alternatives portfolio, especially one with a fund of funds component, will require aggregating the ‘look-through’ holdings to unique identifiers and companies. The challenge here is to match underlying holdings to unique entities, with only limited available information. This exercise becomes even more arduous with real estate holdings, where exposure to lessees (tenants) needs to be considered.

Even so, identifying common holdings on a look-through basis may not provide the full story in understanding an investor’s true financial exposure to a unique portfolio company. Not all exposures are equal. Leverage in underlying funds, for example, could amplify the impact on an investor’s exposure to a unique underlying entity, as would the entity’s credit risk or maturity profile. These additional dimensions could deliver significant insight into the true exposure to a unique entity.

Trying to quantify this risk level is not an easy exercise, but automation may go a long way in identifying common holdings. Therefore, investors must consider the information they need to collect so this capability could be readily incorporated into their platform.

Identifying and Extracting Key Data
Investor demand for ‘more data’ is heard loud and clear. In some cases, the data is available, but contained in unstructured formats. Investors may want to take stock of what is already at their disposal and how that data could deliver the insights they need, assuming it could be used in the decision-making process.

Accessing this data may be costly, and the cost-benefit of data processing needs to be carefully assessed. However, now is the time for market participants to find ways to streamline the process of delivering vital data, as well as identifying what additional data will prove just as essential in the future.

Enriching 'Market Data'
More sophisticated investors have recognised that supplementing existing data with that provided by third-party vendors – in areas such as market pricing, credit ratings, economic data and forecasting, financial statements and commercial property information – can significantly enhance their understanding of their own alternatives portfolios.

Additionally, significant insight can also be gained from ‘market data’ that helps analyse market trends. But integrating such data is not as easy as it sounds. A ‘mapping’ exercise is often necessary to ensure the market data is properly matched to the alternatives portfolio holdings. The extent of this exercise will vary depending on the characteristics of the underlying holdings, as well as the data structure of the third-party provider. How that data is imported could also pose some challenges, depending on the technology delivery mechanisms used by vendors.

Connecting the Dots 
Investors may be surprised by how much insight can be gained from triangulating across private equity, private debt and real estate portfolios to analyse trends across their portfolio holdings. For example, a private debt portfolio with improving credit risk trends and increased prepayments could be a leading indicator of the direction that a private equity or real estate portfolio may go.

Conversely, high valuations in an equity portfolio when credit trends appear to be deteriorating in a private debt portfolio could raise questions around ‘which market is giving us the correct signals.’ Triangulating this data with information from public markets could provide even greater insights. Automation and smart analytics would be invaluable in building these capabilities.

'Future-Proofing' The Tech Stack 
None of the above capabilities will be possible without a smart investment in technology that balances cost considerations with processing power. Flexibility is the key. For example, systems will need to scale up and down efficiently; data storage capacity needs to be extensive; connections to third-parties will make it easier to integrate additional data and services; and modularised applications can ensure the platform can evolve over time. The most effective platforms will let users efficiently take what they need, when they need it – for example, taking data cuts to build analytic models and reports.

Outside of those considerations, the basics can’t be ignored. Sensitive and complex data demands high security. Disaster recovery, system health monitoring and performance tracking tools will also be essential.

Where to Next?
In boardrooms across the world, alternatives investors are sketching out their expanded data and analytical needs as they gear up to increase their allocations to alternatives. The range of topics discussed here is just the beginning, but for the alternatives market to realise its full potential, investors and vendors must start imagining the world they want to see, and prepare for it – wholeheartedly – now.