investments-3-7-18.pngCapital has been flowing into the alternative investment industry over the past few years, with some experts predicting that money invested in private funds will reach as much as $20 trillion by 2020. Preqin, which collects data on the alternative investment industry, recently published a study stating that there are as many as 17,000 private funds open for investment.

Strong returns and opportunities for diversification have attracted high net worth and institutional investors, who can invest in exponentially larger quantities than the average investor. Though these investors come with a greater ability to deploy capital, their size and influence translate into greater expectations and hurdles to meet in order to invest.

The word that best sums-up these growing expectations and hurdles is “transparency,” and this word has become a lightning rod when it comes to alternative investments like hedge, private equity and venture funds, along with special purpose vehicles and real estate.

As alternative assets have become a more common avenue for investment, transparency has grown in importance for investors. A 2017 study titled “Alts Transparency: Finding the Right Balance” by the Economist Intelligence Unit highlights this growth. Sixty-three percent of respondents listed “degree of transparency” as “very important” for alternative investments, which was ahead of all other considerations. Another statistic showed that the importance of transparency as a key issue for private fund managers has increased almost six-fold since the 2008 financial crisis.

Breaking this down further, the issue of transparency can be separated into two different types: (1) information about the fund, and (2) information about investors’ holdings within that fund. The first type deals with greater transparency of the overall performance of the fund, which includes the underlying assets in which that fund is invested and how risk is assessed and managed. The second type deals with greater transparency relating to investor-level performance. This includes metrics like investors’ allocation and return, and how fees are calculated.

There are a few reasons why the industry has struggled to deliver this type of information:

Complexity of Private Funds
There are key differences in reporting metrics between the various types of private funds. Performance metrics shown to an investor in a more liquid fund, such as a hedge fund, should be different than those reported for less liquid vehicles, such as private equity funds. Adding to the complexity, investments in alternatives can come in the form of limited partnerships, co-investments and direct holdings.

Outdated Technologies That Trap Data
Many of the widely used technologies for portfolio and investor-level accounting were created several years ago and because they lack Application Programming Interfaces, or APIs, they cannot integrate with each other or with other systems. This effectively traps the data contained within these systems, thereby restricting its usefulness and portability. This in turn has curtailed the ability to provide transparency to investors, as it restricts or prevents the necessary type of analysis, aggregation and modern presentation of data.

Lack of Leadership and Reporting Standardization
There is a lack of uniform reporting standards within the alternative investment industry. Although an increase in regulation along with the presence of organizations like the Institutional Limited Partners Assn. have helped advance standards in private equity, there is no current reporting standard across all types of private funds. Additionally, the party that should be responsible for delivering on transparency is unclear.

Despite these hurdles, the alternative investment industry must evolve and adapt. I would argue there are two key steps the industry must take to be able to deliver on investor demands for transparency and keep new capital flowing into private funds:

Move Towards True Digital Reporting
As it stands today, much of the industry reports performance information via static documents like PDFs, but this method traps data and inhibits interaction. By embracing new technology, the industry can move toward the type of dynamic, digital presentation of data that is experienced in brokerage and personal banking accounts. For example, cloud-based technology offerings can be integrated with accounting systems to liberate the data contained within for purposes of data mining, analysis and presentation.

Fund Administrators Must Take a Stronger Leadership Role
Fund administrators are best positioned to deliver on transparency needs given their role as independent third parties. They typically subscribe to the accounting systems that house this data and therefore have access to or create much of the analysis and reporting that is needed to deliver on transparency demands.

Helping their fund manager clients with transparency is good business for fund administrators, as it improves their overall quality of service to clients. All indications point to another banner year for alternative investments in 2018. However, investor demand for transparency will only continue to grow as alternative assets become more commonplace. The industry must modernize and adapt in order to stay ahead of the curve in the race for assets.

Chris Andraca