Northern Trust defines a new era in alternative investment transparency

Like many of us, Northern Trust’s Kimberly Evans remembers going to a big industry conference prior to the pandemic lockdown. She recalls that recession was on many attendees’ minds and lips.

Private equity managers were concerned that they would need to scale back fundraising and there were implications for underlying portfolio investments that would need to be pared back too. But nothing was priced at a discount, and so many wondered how they would glean real lasting returns going into 2020.

But as 2020 unfolded, expectations shifted as quickly as everyone hops on a Zoom call these days. The second half of the year saw an unexpected fundraising boom that showed the true resiliency in the private markets’ realm, according to Evans, executive vice president of Northern Trust Alternative Fund Services and North America head of Private Capital Fund Services.

“The large asset managers are getting larger and are not facing the fundraising challenges previously expected. Additionally, many are oversubscribed on new launches, especially when there is a double bottom line or impact element to the fund’s structure,” she added.  

Evans reports that in her practice they are seeing new firms launch and even a return to venture capital strategies. Over the last two years that Evans been working within the North American business, the firm has pretty much doubled in size and there has been growing complexity with the structure of the funds, such as having parallel entities that have access to EMEA or APAC investors. The volumes of capital calls and distributions have literally quadrupled over that same time period, she said.

The money is flowing in, but she described mounting pressure to create the transparency investors have long demanded. The new inflows, new funds and potentially massive new demand stemming from this past summer’s U.S. Department of Labor action allowing for retail investor access to private markets are all working together to form a call to action to the industry at large.

“This is leading to the greatest amount of transparency that we have ever seen in private markets,” Evans said. “The pandemic has forced GPs and service providers to respond. As the pandemic has sped up digitization of sales, meetings and markets, it also sped up the realization that there is this stale notion that investor transparency could be an afterthought for private market firms looking to expand their client base.”

Institutional investors are making sure that increased allocations are aligned with the purpose of their investment methodology. Eager to look deeper, they wish to find what is creating the return in those investments rather than the figures on exposure alone, according to Evans. Investors are digging deeper to know who is behind the company and what diligence informed the investment, for instance.

The need for increased transparency was always there and is now part of a broad movement that also includes ESG initiatives in order to ensure an investment is fully aligned to an investor’s mission and purpose. “There’s an insatiable interest that wasn’t there before,” she added.

Northern Trust’s recently released white paper, “From Pressure Comes Diamonds: How industry forces will give way to a new level of maturity for alternative assets,” outlines the expanding role technology has to play in the key areas of concern to GPs, including first and foremost that need for greater insight into a manager’s investment process and operations.

With the DOL letter issued last June, officials have been considering how to respond to greater retail interest. Previously, managers had to incorporate principles centered on governance in EMEA. Regulators now need to know how smaller investors will be protected, according to the report.

“The GPs will take the candy, but they will pay for it in transparency, governance and oversight,” commented Evans. “The transparency is a level or two different than just understanding the basic investments.”

While some GPs will remain cautious over giving away the secret sauce, they will be forced to respond. Northern Trust, Evans said, is working with clients to find ways to do it right.

Fintech vendors have already descended on this opportunity, due to a lack of well-defined standard reporting and analytics practices within the private capital industry. Specifically, data portability and asset class comparability within portfolios can become a significant challenge for LPs. Tech-providers reliance on artificial intelligence and machine learning to pull the data from GP statements helps these managers meet the investors’ needs, and the report also highlights the opportunity the GPs must face to better anticipate their investors’ needs.

“Ultimately, investors are seeking the kind of investment experience we’re all accustomed to as consumers — rather than relying on quarterly or monthly statements per individual fund, they want to be able to log in to a digital platform and quickly see a real-time view of their portfolio of alternative investments, as well as perform their own analysis within the same tool,” the report states. “In addition, they seek more standardized, consumable and combinable reporting to help them paint a clearer picture of their entire portfolios, liquid and alternative investments alike. As a result, managers face the opportunity to anticipate these LP needs and equip their back-office operations with robust investor-facing technology that meets these needs.”

At Northern Trust, the team has been eyeing distributed ledger technology (DLT) dependent on blockchain. The technology provides a more complete picture of how the GP manages capital and how that fits in with their larger portfolio and investment strategy. For managers, DLT/blockchain offers an opportunity for managers to achieve the levels of transparency and data insights prized by LPs.

Northern Trust launched the industry first commercial use of blockchain in Guernsey in 2017 and the bank holds patents for its private-equity targeted blockchain solution to guide certain fund administration elements, such as the capital call process. Officials say that managers may also seek out a technology partner with cloud-based capabilities that in turn streamline the onboarding process in comparison to building a custom tool. The technology covers not only the management of a fund, such as cash and securities movement across banks but also communications with investors. An API library, according to Northern Trust allows managers a way to easily move data from one source to another with very little need for bespoke programming.

In 2019, Broadridge Financial Solutions took up Northern Trust’s DLT solution in a bid to commercialize it. According to Evans, there are a number of clients going live on the Broadridge platform that in turn is scaling up to serve other GPs and even fund administrators as an industry tool to help standardize and simplify the very manual and archaic process of keeping track of fund assets.

For Evans and her team, it is very much about being ready to solve the GPs problems before they surface. She said that the retail infrastructure for private equity is only starting to be built. The DOL ruling sets the stage to focus though on the infrastructure necessary for retail investments.

“We are already seeing the need for it among existing clients, but we are not there yet,” she said of the private equity expansion into retail.

Perhaps it is akin to the old adage, “if you build it, they will come.”

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