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Moving the Needle on Alternatives Digitization
As asset owners have increased their allocations to alternative assets, many have been challenged in aggregating an accurate picture of their portfolios. New technology solutions can change that experience.
By Raphaelle Granger, Lead Product Manager - Alternative Asset Services, Northern Trust, and
Vincent Molino, Head of Operational Risk Management Solutions, Northern Trust
Alternative asset investing is a key focus for institutional investors, driven by their desire to diversify their portfolios, achieve a premium on investment returns, and manage risk. In what has traditionally been a more operationally manual asset class, new technologies are moving the needle in the effort to make alternative assets easier to manage and administer for institutional investors of all types and sizes.
This migration to alternative portfolio allocations continues to gain momentum. One survey of global asset owners found the average portfolio now allocates 26% of assets to alternative investment strategies, up from 24% in 2019. Additionally, 40% plan to increase their allocations to alternatives assets over the next three to five years.1
With a greater commitment to alternative investment strategies comes an elevated process for servicing these complex assets, buoyed by the need to understand the performance, risk and liquidity of such holdings. However, emerging technologies are evolving at a fast pace which can improve the asset servicing experience, facilitating a revolution in alternative asset digitization.
Asset owners can face challenges when there is a need to incorporate a detailed and accurate view of alternative investments into their portfolios. With little standardization in alternative markets, a variety of reporting formats used by portfolio managers include key investment data accessed across a number of files, usually transmitted over email or through portals. Asset owners and asset service providers are often left to manually piece together a view of an alternative investment portfolio’s composition and performance.
Due to a general lack of readily available, plug-and-play technology, automation of such records is not typically available to most asset owners. As a result, resources are diverted in the form of many hours of manual work to accurately compile information of alternative investments, where such resources could be better utilized through maximizing time with higher-value strategic tasks.
However, emerging technology applications such as artificial intelligence and blockchain are transforming the world of alternative asset servicing by streamlining processes in both asset owner and asset servicer operations. Capabilities of these technologies range from improved investment research management, to enhanced administrative workflows related to accounting, performance reporting, liquidity analysis and risk oversight.
The combination of emerging technologies has the potential to revolutionize the methods of alternative investment data management, from both the perspective of asset owners and asset servicers.
- Artificial intelligence (AI) – In general, AI offers various prospects in the servicing of alternative assets, with particular regard to increased efficiency, decreased risk of errors and potential lowered operating costs. AI’s applications for alternative asset servicing have come a long way from early rule-based template documents which required repetitive reprogramming as a document’s structure changed. While today’s AI capabilities will not completely eliminate the need for specialized knowledge in data normalization, it can allow for higher quality data and reduce the need for human intervention. Two key subsets of emerging AI technologies are showing promise for alternative asset servicing, especially when used in combination.
- Natural language processing – Asset owners gain insight into the performance of alternative assets – particularly private market investments – through holdings statements from investment managers. Without the assistance of technology, asset owners and asset servicers are left to manually review numerous statements in order to compile a complete picture of investment performance. Recent developments in natural language processing, and other subsets of AI such as optical character recognition and visual relationship detection, are enabling systems to translate human language and extract specific data found within scores of documents. These processes simply require human supervision, and not constant administration.
- Machine learning – Machine learning is a subset of artificial intelligence that allows a program to continuously adapt its recognition abilities based on real data. With a variety of uses across many asset owner challenges, machine learning can achieve refined capabilities in document extraction and data recognition. As asset owners and asset servicers exchange documents, machine learning algorithms become increasingly accurate, automating the exchange of information. Additionally, with increased interest in ESG investing, asset owners can pursue ESG initiatives with the support of machine learning that provides transparency into whether an investment manager is investing in holdings that meet or violate ESG standards.
- Blockchain – Blockchain is an emerging technology that can be used to automate and record transactions from multiple parties in a single decentralized ledger. Specifically, distributed ledger technology provides real-time transparency to all parties of a transaction, including an investment manager and investors, allowing regulatory access when required. It offers “a single source of truth” that cannot be changed by any one party, providing greater data certainty and security.2 This is especially beneficial in complex private markets, which can require significant effort to reconcile evolving fund data. As the intensity of governance and oversight increases for investors with the growth in alternatives, a technology like blockchain can ease asset owners’ growing data needs in order to gain visibility into their private investments. Distributed ledger technologies also have the potential to open alternative asset classes to other institutional investors, such as defined contribution plans, increasing both access and liquidity.
- Cloud computing – Cloud infrastructure allows for faster and more efficient development of solutions which leverage the technologies described above. Its influence comes largely thanks to affordable, easier access to fintech offerings and greater prevalence of open-source technology that wasn’t as accessible just a few years ago. For those asset owners who determine to do so, third-party applications can be utilized which are ready-made with platforms and solutions that require little to no additional development. Solutions requiring vast amounts of real-time data are especially suited to cloud-based systems, increasing the ability of asset owners to derive better views into their portfolios. When coupled with alternative asset services in the cloud, the ability to build complex investment models and analyze alternative investments in a visually rich fashion is increasingly achievable. Although a cloud-powered fintech solution on its own can’t fully deliver on an asset owners’ needs without also pairing technology with industry knowledge and guidance, the combination of technology and service provides an edge that investors would be unable to gain with a tech-only or service-only solution.
As asset owners commit to increased alternative asset allocations, their portfolio management and administration needs will grow in complexity. Therefore the opportunities that emerging technologies provide in both investment opportunities and operational efficiencies will likely become complex as well.
When looking ahead at how these technologies will continue making change, blockchain technology may hold the most promise for true industry transformation. Blockchain is already improving how securities are settled and cleared. As an example, in recent weeks, a blockchain infrastructure provider had managed to complete same day settlement T+0 with two large global brokerage houses.3 Going forward, tokenization of alternative investments will increasingly change how assets are issued and traded. Using the power of distributed ledger technologies, tokenization provides enhanced transparency, greater liquidity, and faster settlement.
In the future, we expect to see increased access to alternatives through the issuance of tokens that digitally represent physical assets like real estate, infrastructure, and natural resources. The ability of digital asset tokens to provide fractional ownership of assets that now require large investment outlays is also expected to provide greater access to alternatives like hedge funds, private equity, and venture capital.
In a broad context, these technologies promise to enact significant change on the alternative asset servicing space. Understanding the capabilities and options available, in current and emerging technologies, will provide the tools needed to better serve the requirements of managing diverse portfolios.
1 Pensions & Investments, “More asset owners worldwide turning to alternatives – CoreData survey”, September 1 2020.
2 Northern Trust, “Northern Trust and IBM Pioneer Use of Blockchain Technology to Help Transform Private Equity Administration”, February 22 2017.
3 Forbes, “Same-Day Stock Settlements Are Here: Using Paxos Blockchain, Credit Suisse And Nomura Instinet Hit T + Zero”, April 6 2021.
November 12, 2020
While investors are still evaluating the impact of the current crisis in an uncertain environment, the pandemic has created the opportunity to accelerate data and technology trends in servicing alternative assets. Having a comprehensive strategy, underpinned by advanced technology and better data solutions, will be crucial to thriving in the post-COVID future.