Over recent years investment managers have put systems in place that comply with the European Alternative Investment Fund Managers Directive (AIFMD). Now, a second wave of organizational reforms is underway as they adapt their processes to place ever-increasing amounts of institutional capital more efficiently across a wide range of jurisdictions and sub-asset classes, says Kai Braun, alternatives advisory leader for Europe at professional services firm EY.
PERE: What is driving the need for greater efficiency among fund managers?
Kai Braun: Because of continued low interest rates the big institutional investors are increasing their allocations to alternatives including real estate. That means asset managers need to develop their capacity to raise bigger funds, sometimes several at once, with assets located across a number of different European countries. Meanwhile, more traditional fund managers that have previously concentrated on stocks and bonds, as well as hedge fund managers, are also going into these areas, so they need new operating models to enable them to do so efficiently.
In a nutshell, more cash is being allocated to alternatives and a broader spectrum of alternatives is being managed by a greater variety of investment managers. That is coupled with the fact that the environment has been more regulated for a few years now, and managers that initially saw regulation as a burden are now turning their attention to how to operate in a more efficient way in the new environment. Meanwhile, margins are being squeezed and driving performance is becoming more difficult because higher asset values make it harder to achieve a good rate of return. All of those factors make it essential that managers have the right operating model in place.
PERE: How are managers adapting to the need to work across national borders?
KB: A lot of the larger players have offices in several European jurisdictions and they are increasingly aiming to align those platforms on a European level. One reason for that is the simple desire for efficiency – they want to do things the same way across their organization – but they also want to work as one European manager with an international brand. Being aligned means ensuring regulatory and tax compliance across national boundaries, while ensuring things such as that all underlying special purpose vehicles are properly structured and managed over their lifetimes. Those challenges have been around for a long time, but they are now high on managers’ agendas.
There is also an issue around regulatory uncertainty. In each jurisdiction each regulator may have a slightly different view on AIFMD. Meanwhile, in some countries there are pre-existing local rules. If you align on a European level to a European standard then your processes should all be the same, but where there are regulatory differences between countries you need to add an extra loop within your process to capture those.
In addition, fund managers are increasingly operating across a number of different sub-asset classes: they might be investing in private equity, real estate and real estate debt at the same time. That requires them to take a view of operational efficiency that includes each of the sub-asset classes and the way that processes play out across the different aspects of the business, for example in valuation, so that people in different parts of the company have access to the same level of information.
PERE: Why is it so important to get operational processes right?
KB: Where something in a process doesn’t work, so that it requires costly and sometimes exhausting intervention by human beings, then you have an organizational pain point. One classic example of a pain point is where a fund receives lots of invoices and the manager needs to be able to identify to which entity those should be allocated – at the fund level, to the SPV or to the operating company or property. Tasks like that can be processed in a semi-automated way so that when an invoice is received by any entity within the structure there are well-defined allocation rules and certain payment instructions are triggered automatically that only need to be validated.
Automation and improved IT can help to tackle problems, but the prerequisite is to first have the right process in place. To really understand how things should be done you can apply the ‘RACI’ matrix to determine who is responsible, who is accountable, who is consulted and who is informed. That focus on process is even more important in international businesses where you need to achieve alignment.
You can have organizational pain points as well as process-driven ones. Pain points created by the way the organization is set up might require reorganization – for example, you might want to centralize certain functions within a single European jurisdiction.
PERE: Is improved technology the answer?
KB: The prerequisite for bringing in new IT and technology solutions is that they need to be based on the right operating models organization-wise as well as process-wise, because by carrying out IT changes in an area that is broken already you are wasting money and resources. There are two types of major IT enablers managers are looking at now. The first is enterprise resource planning for IT packages, which are front-middle-back office systems that allow the manager to run their business in a fairly standardized way and to move away from using things like Excel spreadsheets and sending around emails. Those packages allow for proper process and workflow management, so you can see who is carrying out certain tasks or approving them. That can help an organization improve the way in which its people are complying with processes.
The other is smart technology solutions like robotic process automation and artificial intelligence, and we increasingly see those coming into real estate. Sometimes a manager has to read through hundreds of pages of contracts out of which they are maybe looking to gather 200 data points. That process can be automated nowadays. Some payments can be automated too. Sometimes those systems need to be built and more managers are now hiring chief information officers from other industries and bringing them into the real estate and private equity world to build out their IT environments.
Big data is being used more extensively, too, but it requires a single source of truth. At the moment, managers often have three different values for the same data point because that data comes out of three different systems. Managers and service providers are now working to make sure when they build a data lake, all the data are correct. Then it can be used much more extensively going forward for actual management tasks like valuation, and not just for back and middle office operations.
People are always talking about disrupters of various kinds – distributed ledger technology disrupting depository banks and so on – and there is a fear of disruptors. However, none of them are really disrupting businesses; in fact, they are business-enhancing. They are not creating something totally new, but they are creating something better. The managers tackling these issues today will have a competitive advantage tomorrow.
Of course, the question remains of how long the market will continue to grow, but right now funds are raising tremendous amounts of money in lots of sub-asset classes, so managers need to make sure they can cope with that volume of capital. Having the right organization and IT systems is a prerequisite for survival and for success in this market.
This article was sponsored by EY. It appeared in the Fund Services and Technology special supplement that accompanied the September 2018 issue of PERE magazine