The Role of Technology in Managing Alternative InvestmentsThe Role of Technology in Managing Alternative Investments

Four reasons why advisors are embracing the key role alternative investments can play in client portfolios.

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In recent years, advisors and their clients have been embracing the important role alternative investments can play in those clients’ portfolios. Because they tend to have low correlation to traditional asset classes such as equities and fixed income, they may be a beneficial way to add diversification to a portfolio while potentially enhancing returns. “The current environment has provided a tailwind for increased exposure to alternative investments,” says Tim Loughrey, Head of Client Success at Canoe Intelligence. 

There are four key reasons, Loughrey says. First, advisors are increasingly turning to alternatives to balance the lower expected returns of traditional asset classes like  stocks and bonds. This is particularly acute with the low yields offered by fixed income and the arguably stretched valuations within the equity markets. Additionally, in recent years, robo advisors have helped commoditize investing, so advisors are actively taking steps to differentiate themselves by offering more sophisticated investment solutions. Also, clients are increasingly aware of available investment options and demand more from their advisors. Consider Newport Beach, California-based Corient Capital Partners. “The clients that we serve—families and institutional portfolios—require the ability to handle a level of complexity that’s not present in retail portfolios, including alternative,” says Joe Kolker, Corient’s director of operations. Finally, the application of easy-to-use technology to support alternative investing has helped democratize access to these investments. 

No matter a firm’s size, alternatives may present advisors with operational challenges, including complex document collection workflows, difficulty managing unstructured data, and additional cost pressures. Advisors appear to be increasingly looking to automated technologies to more effectively manage these operational challenges.

Recently, WealthManagement.com and Informa Engage surveyed financial advisors on behalf of Canoe Intelligence to gain a better idea of how advisors are using alternative investments, how they manage reporting, and the challenges they face.

Nearly half of advisors surveyed say due diligence is their greatest challenge when managing alternative investments.

Nearly half of respondents (49%) reported that managing due diligence was their most pressing challenge around incorporating alternative investments into client portfolios. Wealth management firms typically have manager research and monitoring teams strictly focused on researching alternatives managers and strategies. “The challenge is that’s a huge cost,” says Loughrey. “Only the largest wealth management firms have the scale to employ dedicated due diligence teams.” Smaller firms often rely on third-party research, he says.

One in three (30%) advisors reported access to alternative funds and investment products as a pressing issue. “Access to funds has long been a challenge,” says Loughrey. Alternative funds may be capped with finite allocations available. What’s more, alternatives aren’t necessarily custodied like a mutual fund or ETF, so wealth management firms need access to these investments via specialized platforms or direct contact with an alternative investment manager.

Respondents gave equal weight (roughly 20%) to data reconciliation and validation to ensure quality control, reducing the cost of manual work, document management, storage and access.

On average, most firms dedicate two staff members and 10 hours or more per week to alternatives management.

More than half (54%) of respondents spend at least 10 hours a week managing documents for alternative investments, while 46% spend less than 10 hours a week. The time that firms spend managing alternatives tends to be spread evenly over three tasks: document collection, data extraction and reconciliation, and data delivery into accounting and reporting tools.

As noted previously, when it comes to time and effort spent managing alternatives, smaller firms may shoulder a bigger burden relative to bigger operations that have large, dedicated teams, says Loughrey. “The amount of time it takes to manage alternatives is outsized to their place in most client portfolios, so it becomes a front-and-center operational challenge for these firms.”

Most respondents (66%) have at least two people on staff who are involved with client reporting or managing alternative investment workflow. Larger firms with AUM of $1 billion or more are more likely to have 10 or more people on staff devoted to these tasks.

Almost half of advisors manually manage data associated with alternatives—but most plan to move to automated service.

Nearly half of respondents (47%) manually manage the data and documents related to alternative investing in-house. “In many cases, when an advisor makes an allocation to an alternative, they’re signing up for a labor intensive, manual process,” says Loughrey. Advisors typically must retrieve the data from PDFs supplied by the alternative investment and upload it manually into a wealth management reporting tool for analysis before relaying information to clients and making informed investment decisions on their asset allocation.

Despite the relative burden of manual alternative data management, nearly half of respondents report having manual processes. Only a third (37%) use technology platforms, while one in five (21%) turn to third-party service providers. That said, most respondents (58%) who currently rely on manual processes anticipate switching to an automated technology platform or outsourcing the work to a service provider.

The move away from a manual process was a matter of scale, says Kolker. “As your firm grows, you can add more analysts to handle manual data entry and audits, but you quickly run into problems of high staff turnovers and training new hires to make sure you have enough staff. You are also making a commitment to infrastructure that makes it hard to change to new tools,” he says. “We knew that as we continued to grow, we needed a solution that could deliver scale and automation so we could become increasingly efficient.”

Four out of five advisors fear that outsourcing alternatives management could result in lack of transparency and control.

Outsourcing data management provides advisors little capacity to manage alternatives in-house with one potential solution. Yet, while time- and resource-strapped firms may benefit in some ways from outsourcing to a third party, there are still some challenges, according to eight in 10 respondents.

“Firms generally want control and ownership of their data so they have oversight, they’re informed, and they can easily share information with clients,” Loughrey says. Yet advisors at times appear to have a hard time achieving these goals: Nearly one in five respondents (18%) reported a lack of control or access to documents when outsourcing. And about a third said that timeliness of reporting, data transparency, data quality and accuracy, and rising or unreasonable costs were an issue.

While about 40% of respondents have made the move to automated technology to manage data, another 44% are considering the shift, especially among larger firms.

On average, four in 10 respondents (41%) use automated technology to manage alternatives document and data workflows. Advisors who currently use technology in alternatives management are most likely to use performance reporting (68%) and portfolio management technologies (64%). Fewer use technology for document collection and management (39%), internal systems (32%) and data management (32%). 

Nearly half (46%) of respondents use a proprietary system for performance reporting. Perhaps due to greater access to resources and scale, larger advisors are more likely to have a proprietary system, including 49% of those with $1 billion to $5 billion in AUM and 58% of those with $5 billion or more in AUM

In addition, 44% of advisors are considering making a move to automated systems. While larger firms tend to have more resources to devote to managing processes manually, advisors with $1 billion or more in AUM are more likely to use automated technology. And the more assets they hold under management, the more likely this use becomes. While 47% of advisors with $1 billion to $5 billion in AUM are likely to use automated technology, that number rises 55% for advisors with $5 billion dollars or more in AUM.

Of the 15% of respondents who said they had no plans to switch to automated technologies, about one in five were firms with less than $10 billion in AUM, despite a potential relative lack of in-house resources.  Only one in 10 advisors with $10 billion to $25 billion in AUM have no plans to switch, and that number falls to just 6% of advisors with $25 billion or more.

“We didn’t want to be in the business of handling data constantly,” says Kolker. The firm, a Canoe customer, needed an automated solution that extracts data from PDF documents, unifies the data treatment and reduces the number of times analysts have to touch the data. “Canoe is a huge time saver,” says Kolker. “It takes multiple steps off our hands, making the whole process more efficient.”

When considering ideal solutions for automated technologies, other advisors are looking for a comprehensive and turnkey solution that’s easy-to-use, and automatically gathers documents and data from various sources and uploads it into existing portfolio and reporting platforms.

“Overall on a relative basis, advisors are dealing with a lot of operational pressures,” says Loughrey. “To increase efficiency, differentiate themselves, and combat fee compression,      advisors must adopt scalable technologies that integrate with each other. Without a streamlined dataflow, advisors may not only experience diminishing returns, but also be unable to compete with larger wealth management firms.”