The Evolution of Limited Partners in Alternative Investments

Alternatives as an asset class continue to be attractive, especially with Limited Partners. This is a trend Hugues Chabanis of SimCorp expects to become even more pronounced in 2018.

Last year, SimCorp wrote an article for the 2017 Outlook, Feasting on Alternatives, which highlighted the favorability of alternatives as an asset class prompting asset managers to implement simplified IT systemarchitectures with cross-asset IBOR and ABOR capabilities. Hugues Chabanis, Product Manager Alternative Investments at SimCorp, sticks to this opinion even for 2018:

Alternative Investments continue to be attractive, with Limited Partners (LPs)– meaning partners whose liability is limited by the extent of their share ownership – maturing in their understanding of the asset class, improving strategies to achieve higher returns atacceptable levels of risk, and using technology to effectively manage alternative portfolios. With the rise of technology and its broader application for LPs, there is a natural inclination to request more and more data from General Partners (GPs)- partners with unlimited liability – particularly forunderlying portfolio performance data in the form of investment, financial and non-financial Key Performance Indicators (KPIs).

The Need of Transparency
The premise of big data is not specific to alternative investments, but in many ways its application is. Alternatives are generally long-term and lock investors in for upwards of 10-12 years, while legally defining those who have investment making powers (GPs) and those who don't (LPs). As long as the GP adheres to the terms of the Limited Partnership Agreement regarding investment decisions, LPs cannot use vastamounts of analytics to influence or quickly rebalance portfolios in the way they can with traditional asset classes. If they do not like the decisions and performance of a manager, they can sell the position on the secondary market, decline to invest in the next fund or both. So why do LPs increasingly request more data from their GPs?

The larger reason is increasing regulatory pressure for greater transparency. In North America specifically, public pension funds are evaluating their alternative portfolios due to regulations requiring the disclosure of detailed fund and portfolio data, which could become publicly available through the Freedom of Information Act (FOIA). In the UK, the Financial Conduct Authority has plans to unveil a framework to increase transparency for public pension fund investments including alternative asset classes by the end of 2017. Dutch pension funds will be required to provide fee transparency, and many worry that the complex nature of alternative fee structures will only make comparison difficult and misrepresentation inevitable, especially when an economy struggles. Further, Europe has been grappling with the implications of AIFMD the past few years.

Broadly speaking, transparency is a good thing, but it can be overwhelming for a GP and can strain relationships at a time when the asset class is most attractive. At the same time, it comes at a cost to both GPs and LPs who need to consider financial and operational costs, data security, the potential effects of valuation and exit disclosures, competing organizations and standards, the complexity of the data required, evolving investment structures, and risks to competitiveness within the market.

GPs are generally accommodating, but Hugues Chabanis continues to see many struggle with data management and stakeholder requests, and continually plays catch-up when it comes to investor requests for portfolio performance or look-through data. Despite being a topic of discussion for a decade now, there remains no generally accepted standardization of reported look-through data with LPs asking for different information in different formats. This burden is felt most by GPs who struggle to implement data management systems to meet the requirements. With the constant increase in regulatory requirements, and many not yet having the solutions needed to handle this efficiently, this pressure on GPs will continue in 2018.

Lack of Standardization
Many organizations have long tried to bring asset-class specific standardization to the market, such as ILPA, OPERA, NCREIF, NAREIT, MSCI IPD, SBAI, IPEV amongst many others. But these attempts have yet to be wholly adopted, and while this certainly is the direction the industry needs to head, we need to gain a better understanding of how LPs use underlying portfolio data before being able to collaboratively agree what the standards should be.

LPs use underlying portfolio data for internal and external reporting requirements (e.g. regulatory) and even more importantly, for visibility into risk and exposure so they can hedge effectively. The volume of practical data to do this is surprisingly low. As a simple example, all this can be done by tracking and aggregating a schedule of investments, financial KPIs and non-financial KPIs such as ESG data (e.g. number of employees). Yet, some initiatives and investors demand vast amounts of very detailed look-through data, the use of which is debatable and has unforeseen consequences that exacerbate the lack of standardization.