Propelling Diversified Public-Private Strategies in the Era of Financial Convergence

Uncertainty is still the biggest influencer in US markets in 2024, with causes ranging from the upcoming election to macroeconomics, to geopolitics. And while the Federal Reserve has now cut rates for the first time since 2020, which will undoubtedly have an effect, some asset classes are experiencing continued expansion – such as hedge funds, cryptocurrency - which has almost doubled its market capitalization in one year - and private markets, where experts project continued growth in the Americas and Europe. Investment management firms continue to see alternative investing, including the private markets, as attractive high yield opportunities.

Most investors expect to increase their private market deployments, while almost nine in 10 believe that private markets will continue to outperform their public market equivalents in the long term. Further, the high correlation of stocks-bonds amplifies the call for specialty investments that are not so intertwined with the overarching markets. However, what worked well in the last two decades may not be optimum in the next decade, as the era of low rates has evaporated. This presents a need for investors ramping up private markets activity to do so intelligently.

Diversified investment strategies spanning both the public and private markets will persist, but with this continued convergence of public-private asset classes comes a challenge. Alternative investments such as private credit bring significant data and operational demands that differ from those encountered in public markets, and asset managers will need to be prepared to manage these effectively if they are to continue to drive ROI in private markets as the space evolves.

Private market managers’ pain points

The complicated structures of alternative strategies can perplex even seasoned investors. Diversified portfolios that include, for example, cryptocurrency, infrastructure, and private debt present some thorny workflow challenges for managers as well since the operational infrastructure to manage investment lifecycles is an industry ecosystem “work-in-progress.” For example, the customized nature of private credit investments, like the popular direct lending, often mandates advanced systems functionality to accommodate adjustments to loan structures and repayment schedules, like paydowns, custom coupon calculations, and rollovers. In this space, the added complexity of loans necessitates more comprehensive due diligence, and a shorter timeframe to perform that due diligence. Diverse data points from direct lending, mezzanine, distressed, and venture debt present obstacles to precisely track and measure performance and attribution. Multi-strategy private credit portfolios can challenge seasoned portfolio managers and analysts in performance and attribution, thanks to this variety of credit strategies, the risk/return spectrum, and the varying performance measures and metrics.

Investment varieties are increasing, and entity and investment structures are becoming more complex, compounding headaches in record keeping, accounting, and reporting. Firms must install systems that connect middle- and back-office data and operations, so they can frequently measure fund performance, synthesize attribution, and conduct meaningful analyses.

Private + public convergence paradigm

As Goldman Sachs observed, “Recently, we've seen a trend of more companies strategically leveraging both public and private capital markets to secure funding.” The asset managers that have merged onto the private markets expressway have encountered vexing operational and data management bumps in the road, trying a variety of models to achieve consolidation. They sometimes lack the proper data tools to meet the demands of different teams using the same data across risk, compliance, operations, trading, and third parties. Each new data source presents a problem that takes time to solve, with regards to integrating and aggregating datasets.

In private equity, private credit, infrastructure, and cryptocurrency, funds structures are more complex, investment horizons are longer, and valuations are calculated differently. Throw in several related partners, loan agents, vendors, fund administrators and managers, and it is easy to see the investment data management challenge. To take command of investment data, firms engaging in public and private markets should reimagine capital allocation structure and operating models, including detailed modeling of private holdings. Only a single golden thread of data that enables the aggregation of holdings, performance, cash flows, risk analytics, and reporting can generate alpha from intricate, modern investment structures.

Position to compete in a new financial landscape

It is fair to say that fund managers and institutional asset managers are aware of the data infrastructure problem that diversification presents in trying to transform raw data into actionable, trustworthy information. As EY wrote, a primary goal in the financial services industry is, “Developing a coherent enterprise-wide data architecture, underpinned by a clear data strategy, strong data governance and robust data management.” Those firms and fund managers who can excel in deploying the best integrated data architecture while purging data anomalies like duplicates, errors, and missing data are best positioned to generate comprehensive performance data and reporting, enabling them to demonstrate their expertise in the private markets space to attract and build trust with investors.

Gaining data transparency in an opaque asset class

Firms seeking to diversify and stride along with the evolving financial environment cannot afford to conduct operations with stodgy workflows and disparate investment data. They seek the capability to harmonize unlimited volumes of investment reference data, global transactional data, lifecycle events, and offer a holistic view of public and private assets for position management and investment P&L. If firms can use technology to achieve fully transparent audit trails for inherently opaque asset classes, they can differentiate themselves with smoother collaboration, powerful analytics, and real-time investment strategies adjustments – in sum, they can leverage the value of their mountains of data to drive growth.

Operational efficiency across functions

Firms are gravitating toward multi-asset, blended strategy, multi-currency, and cross-border activities. Cleanly consolidated data is a prerequisite to maximum workflow efficiency. Flip side, manual or fragmented workflows and cobbled together accounting, reconciliation, and risk management systems will render outstanding data management futile. Firms would be unable to execute nuanced tactics, unable to optimize multi-asset collateral allocation. They would be unable to support position and cash management, profit and loss generation, and portfolio accounting.

With optimized operations and modernized data management, they can leverage automation of complex management and incentive fee calculations, standardize the investment lifecycle, reduce operational overhead, and automate reporting for client, regulatory, and management.

Firms seek growth in all dimensions

In many ways, institutional investors now operate in uncharted territory under the backdrop of a morphing financial system. Digital technology is simultaneously the problem and solution. It is rapidly introducing new instruments and markets but also serving up solutions that boil down the intricacies. Not only must firms gain control over their current operations with technology, but they must also be able to onboard new asset classes and strategies as they will inevitably emerge. To do so seamlessly, they need to unify the front-, middle-, and back-offices with a golden thread of data for more intelligent enterprise-wide decision making. They must be agile in adapting to regulatory changes, deglobalization, war, and, of course, new disruptive technologies. The firms that can extract clarity from uncertainty using technology stand to better the competition and sustain growth.

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David Nable is Managing Director at Arcesium

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The views expressed in this article are those of the author and do not necessarily reflect the views of AlphaWeek or its publisher, The Sortino Group