Alternatives Up Their Game

George Sullivan, global head of State Street’s Alternative Investment Solutions group, on the impact of the changing regulatory dynamics on alternative fund managers.
By Soapbox

The alternatives industry has always centered on performance — and this remains true today. However, the current environment also brings increased regulation and sophisticated institutional investors, as they rely more heavily on alternatives to generate returns.

What do these dynamics mean for alternative fund managers? That’s what State Street set out to learn when we commissioned a study among nearly 400 alternative fund managers globally. We wanted to know what alternative fund managers are concerned about and how they’re planning to get ahead in this fast-moving environment. We’ve identified five key areas where they should be focusing.

1. Performance and Risk

Our survey shows that over half of alternative fund managers think generating performance will be among the greatest challenges for their business over the next five years. They have made significant changes since 2008 and plan to make more. Twenty-nine percent of survey respondents say they plan to add new investment strategies with in-house resources over the next five years, while 25% said they have been doing this since 2008.

While the need for performance is nothing new, institutional investors are more knowledgeable and involved with the search for performance than ever. They are also more focused on risk. As a result of their concern in these areas, alternative fund managers are required to be more transparent.

According to managers in our survey, investor demands for greater transparency around risks and performance is the biggest driver of change in the sector. Not surprisingly, when asked what operational changes they had made since 2008, the largest proportion said they are reporting more information on investment exposures, risk and performance to investors — and more frequently.

2. Regulation

The alternatives industry is in the eye of the regulatory storm. Alternative asset managers need to deal with a complicated patchwork of national and international regulations as well as the interplay between these regulations. In the European Union alone there are almost 60 regulatory initiatives in the European Union (EU) that have an impact, either directly or indirectly on asset managers.

Alternative fund managers based in the US rate Dodd-Frank as their biggest regulatory challenge with nearly two-thirds (64%) citing the private fund registrations and Form PF provisions of Dodd-Frank as negatively impacting their business. AIFMD is cited by 20% of managers as their leading challenge; among Asian respondents, FATCA leads the list of regulatory concerns.

Managers who want to get ahead will seek to understand regulatory requirements, gain expert advice and build stronger internal infrastructure. Although the cost and operational burden to regulate can be cumbersome, there is a silver lining. This new era of regulation is creating opportunities by providing transparency and a consistent standard for the alternative fund sector.

3. Data and Analytics

One of the areas where alternative fund managers can truly differentiate themselves is in data and analytics. Investors’ demands for increased transparency and the vastly increased issues around regulatory reporting are changing the way managers think about data. Some managers have proprietary technologies to analyze their investment portfolios. But these tools are difficult to design to meet the needs of both regulators and investors. Fund managers need the right IT systems and data strategies to meet reporting requirements and provide meaningful insight to investors — efficiently and effectively.

4. Operational Excellence

While 86% of alternative fund managers feel their costs will increase over the next five years; of those, 75% do not expect that it will constrain their growth potential.

There is no doubt that industry dynamics are raising the bar for operational efficiency. Institutional investors want alternative managers to have institutional-quality back-office operations and a solid operational and investment infrastructure to manage their money. At the same time, managers are seeking to strike the right balance with cost structures by keeping alpha-generating costs as fixed, and operational costs as variable, by leveraging service partners where possible. Outsourcing risk and reporting functions also allows staff to focus on their areas of greatest competency.

5. Raising Capital

The appetite of institutional investors is strong — and so is competition. Eighty-two percent of alternative fund managers surveyed say that fundraising will be among their greatest challenges over the next five years. While investors are gravitating to larger fund managers who can offer institutional-quality practices, the managers that have the best ability to demonstrate performance value versus costs will continue to succeed.

A New Standard

The industry’s continued transformation is a reality, but several factors remain uncertain. The bottom line is that managers will need to be flexible and willing to continue to evolve to keep up with changing dynamics.