Despite a decade-long bull market in public markets, notwithstanding the more recent coronavirus-crash, investor demand for alternatives has remained high in the private markets, including private equity, private credit, real estate, royalties, infrastructure and natural resources. Success, of course, attracts competition. Beyond the enhanced yield that private market alternatives seek to deliver, sustained fee and margin compression in more liquid, public market strategies has also led to more than a few traditional managers pursuing a barbell product platform anchored by low-margin passives and high-margin alternatives. Add to this a flurry of new entrants, including a migration of hedge funds into the sector, and there’s clearly a risk of overcrowding.
Moreover, the increased competition has driven asset prices higher across fewer quality deals, collectively diminishing industry returns. And, with so much dry powder now sitting on the shelf, portfolio companies can continue to tap the private markets for subsequent rounds of funding, without the need to subject themselves to the management, regulatory overhead and reporting rigors associated with an IPO, for example. This, of course, also extends the duration of exit strategies for investors.
Despite these potential headwinds, investor interest has largely continued unabated. Beyond the traditional LP investor base, consisting of institutions, endowments, sovereign wealth funds and high-net worth individuals, the emergence of Private Equity Investment Trusts (PEITs), for example, now offers accessibility and liquidity to retail investors, too. The model is similar to the Real Estate Investment Trusts (REITs) that preceded them, and represents a sizable opportunity for the industry, but also comes with additional regulatory, reporting and scale requirements, as would be expected from a retail product.
So, how are alternative GPs handling these challenges, and opportunities? The short answer is: it’s too early to tell. It’s no secret that many such managers have historically been very document-heavy, and have relied on gut instincts, spreadsheets and email-centric processes within their investment functions. And there’s often been little incentive to shore up client servicing functions, as relationships and performance have historically been sufficient to maintain investor commitments amongst LPs. But as the industry expands, as deal sourcing becomes more data-driven, and as the demographics and expectations of investors evolve, it seems unlikely that the same cloistered approach will continue to dominate.
Beyond just the world of investment management, consider the transformations underway in nearly every other industry. Digital, in particular, has redefined the landscape across most sectors, with data, analytics and client experience at the forefront. Within financial services, quant shops have been all-in on the application of data and new technologies, like machine learning, to drive systematic investment strategies. Perhaps the greatest impact of digital in the sector, to date, has been in payments, but the pace and sophistication in other domains – robos in investment management; retail and commercial lending platforms; branchless digital banks; new factoring services; online insurance channels; blockchain and distributed ledger technology; and electronic markets, to name a few – is tangible, significant, and growing.
The impact of a generational transfer of wealth, too, isn’t only applicable to investors in retail segments, including high net worth individuals and families, but also to those who make investment and allocation decisions in the workplace on behalf of institutions, SWFs and endowments. Millenial and later generations are digital natives who value a seamless, interactive, informative and tailored experience that also facilitates self-service. But older generations, too, have adapted digital lives, as they increasingly research, consume, socialize and transact online. Collectively, these individuals increasingly demand that the digital experience in their professional lives mirrors that in their personal lives.
Further, such digital channels allow for a bilateral flow of information and intelligence: not only can compelling content be delivered to clients and prospects in an interactive medium, but data gathered about their interests can better inform product management and manufacturing functions, enabling a virtuous feedback loop.
Additionally, an increased interest in socially conscious investments has led to greater investor focus on environmental, social and governance (ESG) practices. Here, too, the private markets must adapt. While methodologies for scoring and monitoring ESG attributes in the public markets are themselves still evolving, the capabilities remain largely embryonic in the private markets. Nonetheless, it’s clear that managers unable to cater to this requirement, meaningfully incorporating it into their client servicing, investment selection and investment governance processes, will be at a distinct disadvantage.
Participants in the public markets have begun to adapt more robust data and analytic capabilities, particularly in their investment processes, albeit with varying levels of sophistication and maturity. And while the application of data and data science in public markets may seem more achievable, given the shear volume, velocity, variety and veracity of available data sets, plenty of opportunities exist for private market participants to similarly exploit these capabilities.
For example, the use of artificial intelligence (AI) can generate new insights across multifarious data sets that may simply be too large, active or disperse for a human analyst to comprehend in a reasonable period of time. These insights need not be specific to a particular company, whether public or private, but may reveal critical information about the likelihood of potential investment success, or even how to best position or guide an existing portfolio company or property. Consider how demographic intelligence, macroeconomic activity, regional employment, consumer practices and patterns, geospacial observations, shipping data, manufacturing practices and news, amongst the many other sources of data, can be leveraged to better inform investment decisions in both public and private markets.
Of course, as with any company that seeks to apply data-driven methodologies to either, or both of their distribution and manufacturing functions, alternative managers must commit to investing in these capabilities. You can’t go from zero to AI! This requires leadership, vision, talent, capital, execution and dedication. It further requires achievable objectives and a plan that results in a coherent data strategy, framework and operating model.
The adoption of digital is ultimately a business strategy; not a technology strategy, or a purely operational set of processes. CEOs that recognize this will rightly drive related discussions and decisions in their respective executive committees and boardrooms. They will also be well-served by positioning their technology, data and/or digital leaders as direct lieutenants, rather than as layered under more operationally-focused functions.
With the challenge to source quality deals, and the ability to maintain healthy returns increasingly at risk due to an influx of new entrants and additional capital in the sector, forward-thinking alternative managers will need to consider their end-to-end digital capabilities to maintain an edge. Areas, such as investment selection, investment governance, and client servicing will all benefit from a contemporary digital and data strategy. Beyond simply nice to have, I believe this will become existential for participants in the sector. Those that actively, if not aggressively pursue such capabilities will be well-positioned for the future, while those that cling to legacy practices are apt to become the next casualties of the digital age.
