Over the past several years, rapid developments in the global economic environment have pushed asset management to the forefront of social and economic change. An important part of this change – the need for increased and sustainable long-term investment returns – has propelled the alternative asset classes to centre stage. To help alternative asset managers plan for the future, we have considered the likely changes in the alternative asset management industry landscape over the coming years and identified six key business imperatives for alternative asset managers. We have then examined how managers can implement and prosper from each of these six imperatives. Alternative asset management 2020 Fast forward to centre stage

Report

www.pwc.com/alts2020 2 PwC Alternative Asset Management 2020 3 PwC Alternative Asset Management 2020

Contents

Introduction 4

Executive summary 6

The alternative asset management 10 landscape in 2020

Here’s how 12

Conclusion 34

Contacts 35 4 PwC Alternative Asset Management 2020

Introduction

Over the past several years, rapid developments in the global economic environment have pushed asset management to the forefront of social and economic change. The need for increased and sustainable long-term investment returns are an important part of this change and has propelled alternative asset management to centre stage.

Alternative firms, with their emphasis on investment outcomes rather than products, and specialisation rather than commoditisation, will increasingly attract investors seeking customisation, diversification and genuine long-term alpha. At the same time, alternatives will increasingly occupy a prominent allocation in the world’s economies, both established and emerging. Fast-forwarding to 2020, alternatives will have a centre stage role to play in the investment universe and in the global economy.

Between now and 2020, alternative assets are expected to grow to $13.6tn in our base case scenario and to $15.3tn in our high case scenario. High performance of capital markets driven by accommodative monetary policies and stable GDP growth would push alternatives towards the high case scenario. However, the possible rise of interest rates in the US and Europe, coupled with a normal correction in the capital markets, would support the base case.

Figure 1: Alternative assets in USD tn

= CAGR 16 15.3 13.6 14 8.1% 9.9% 5.0 12 6.9% 4.6 28.5% 10 7.9 2.9 8 26.5% 6.6% 6.9% 2.5 2.9 6 5.3 17.0% 9.5% 8.9% 2.0 1.4 4 37.9% 6.3% 8.8% 2.5 6.5 7.4 0.8 2 1.0 3.6 0.5 2.5 0 1.0 2004 2007 2013 2020 2020 (Base case) (High case) n Private Equity n Real Assets n Hedge Funds & FoHF Source: PwC Market Research Centre analysis based on Prequin, HFR and Lipper data. 5 PwC Alternative Asset Management 2020

From now until 2020, the The diversity of the alternatives alternative asset management industry may mean that measuring industry will experience a period business unit and product of transformation as firms look profitability is not practical for all to calibrate their businesses and firms, but firms will need to be operations as they move to centre increasingly systematic and granular stage. The principal focus for many in their analysis of opportunity firms will shift to creating a broader versus cost. This shift will not come asset class and product mix and easily to all firms in the sector, some opening new distribution channels. of which pride themselves as being While some firms still strive to artisanal. become more institutionalised, the leading firms will work to build But the majority, by 2020, will see industrial-strength operational the virtues of becoming fitter for platforms. They will meet this growth, agility and profitability. challenge by revamping their business and infrastructure to be more agile and scalable, with a high degree of efficiency and operating leverage.

Neither regulation nor investor expectations are, of course, a ‘done deal’. Both will still have a major impact and produce some significant challenges as well as opportunities in the years to 2020. But leading alternative firms will, in the coming years, shift focus and invest more time and resources on business strategy, organisational design and data-informed decision-making. Unfocused approaches to all will be increasingly rare. 6 PwC Alternative Asset Management 2020

Executive summary

Choose your channels Alternative firms by 2020 will adopt world-class ideas and practices from the broader financial services industry and from traditional asset managers. They will develop more sophisticated market strategies, more focused distribution channels and better recognised brands. Most alternative firms will work out exactly which investor channel or channels they want to target and develop relevant strategies and products. Some will focus more systematically on sovereign investors, pension funds, other sophisticated institutions and private wealth markets. Others will target emerging markets, and still others will pursue the potentially huge asset flows through liquid alternative products. A small number of mega-managers in the alternatives space will operate across all major geographies, channels and strategies. Build, buy or borrow Greater segmentation of investors will, in turn, drive greater segmentation of the managers themselves. Deciding which segment of the market to inhabit will require alternative firms to more consciously evaluate what they are as an organisation and where they want to be. They will typically aspire to be one of the following types: diversified alternative firms, specialty firms or multi-strategy firms. All these models exist today; the difference is that firms will by 2020 explicitly choose a growth strategy in order to remain competitive. To develop the chosen business model, firms will pursue one or more of three growth strategies: building, buying or borrowing. Builders grow by building out their internal organisations, leveraging and developing their existing capabilities and investment talent. Buyers expand their alternative capabilities across asset classes and strategies by acquiring talent, track record and scale overnight. Borrowers partner with other institutions, including asset managers, wealth managers, private banks and funds-of-funds, to expand their investment capabilities and take advantage of broadened distribution channels. These ‘borrowing’ relationships include, but are not limited to, distribution arrangements, joint ventures and sub- advisory relationships. 7 PwC Alternative Asset Management 2020

More functions like compliance, tax and investor servicing into ones that standardisation, are more technology-enabled, more customisation scalable and integrated within the The polarisation of the alternatives overall operating environment. industry into standardised and To do this, larger firms will build customised solutions, already in more resource bandwidth with in evidence in 2015, becomes change agents who will drive even more marked by 2020. process improvement while core This shift responds to three key teams continue to drive day-to- investor demands. The first is the day operations. Firms will also ongoing demand by the largest seek to better control operational institutional investors for made- risk, systematically identifying, to-order products, providing prioritising and managing greater customisation and strategic operational risks to target areas of alignment. The second is demand potential vulnerability. for next-generation commingled funds that are more focused on The right resources outcomes. The third is demand in the right places for liquid alternative funds in By 2020, the shift to data-informed standardised formats as some decision-making will lead to institutional investors, as well as the improved organisational designs mass affluent and newly wealthy, that can better deliver the right seek easy access to alternative resources to the right places. Design strategies. elements that will be adopted by alternative firms include: From institutional centres of excellence to leverage quality to industrial expertise; dedicated teams to focus strength on underserved areas; sourcing strategies to reduce costs for high- Owners, investors and regulators volume, repeatable processes; and will broaden their expectations from location strategies to bolster a firm’s ‘institutional quality’ to ‘industrial presence in a particular jurisdiction strength’. They will expect or to reduce cost. alternative firms to operate in a way that goes beyond the prerequisite Many alternative firms will also quality standards to operate even make more effective use of right- more effectively and offer a broader sourcing strategies. In some cases, range of capabilities. Having they will shift to using outsource institutionalised their businesses, providers or utility-like platforms alternative firms will seek the higher where key skills or geographic standard of ‘industrial strength’. coverage can be provided more cost- effectively, externally. In other cases, Firms will revamp their operations alternative firms will continue to use in a cost-effective way that is not in-house support functions to take disruptive to their day-to-day advantage of operating leverage business. This includes embedding benefits. Successful right-sourcing more data-informed decision- efforts are accompanied by more making to estimate the impact systematic and efficient internal of business mix changes and oversight to bridge the gap between process improvement on costs and external service providers and revenues. They will then implement internal resources. these process improvements, eliminating operating inefficiencies by automating and outsourcing processes. Firms will look to transform labour-intensive 8 PwC Alternative Asset Management 2020

It’s not only about The result will be a data-centric, Analytics enable the data self-service environment in which alternative firms time is spent on the analysis and to better measure Data and data-centricity are key reporting of data, rather than on the business imperatives in 2015. the strength of manipulation of data. The resulting By 2020, the focus of leading analytics enable alternative firms to their operational alternative firms will have largely better measure the strength of their processes and moved on. They will have laid the operational processes and enhance enhance key necessary ‘plumbing’, and accessing key functional areas such as tax, functional areas data across their organisations will compliance, reporting and investor such as tax, be as natural as turning on a tap. servicing. The model will also help To do this, they will adopt data compliance, plug the current drain on resources standard protocols allowing all parts in the manual and non-standardised reporting and of the organisation to exchange areas of portfolio monitoring, investor servicing. information, creating a self-service operational due diligence and model. These protocols will also investor onboarding. speed information exchange with key counterparties and service providers.

the focus of leading alternative firms will have largely moved on. They will have laid the necessary ‘plumbing’, and accessing data across their organisations will be as natural as turning on a tap. 9 PwC Alternative Asset Management 2020 10 PwC Alternative Asset Management 2020

The alternative asset management landscape in 2020

The asset management landscape is undergoing radical change. This change was set out in a paper PwC published in early 2014 – Asset Management 2020: A Brave New World.1 The paper captures the global trends impacting the industry in the coming years and identifies the consequences of these trends. The key predictions it makes are outlined below and supplemented with a brief analysis of the potential impact on the alternative asset management sector:

• Asset management moves centre-stage. Changing demographics and markets will thrust asset management to centre-stage. First, regulation will continue to hinder banks: for alternatives this furthers significant opportunities such as catalyst hires from banks and the opportunity to Public pension fund turns to further step into the funding gap. Second, as the world ages, retirement and healthcare will become critical issues that asset management can alternatives solve: capital preservation and alpha generation will be key. Third, By 2020, there will be a fundamental shift asset managers will dominate the capital raising required to support towards alternatives by many sovereign and public pension funds. This is the growing urbanisation and cross-border trade: growing asset classes continuation of a trend that first gained in infrastructure and real estate play into alternatives firms’ areas of traction in the US and then globally. In expertise. Fourth, asset managers will be at the centre of efforts by April 2015, for instance, the world’s largest sovereign investors to invest and diversify their huge pools of assets: pension fund, the $1.1tn Government alternative firms are ideally positioned to partner with them. Pension Investment Fund (GPIF) of Japan announced a new strategic asset mix in a • Huge rise in assets and shift in investor base. Alternative assets are bid to achieve higher returns and address expected to grow between now and 2020 to reach more than $13.6tn the needs of an ageing population. in our base-case scenario and $15.3tn in our high-case scenario. Assets Significantly, GPIF’s new mandate allows under management in the SAAAME (South America, Asia, Africa and for a 5% allocation to alternatives, the Middle East) economies are set to grow faster than in the developed representing a significant opportunity for world as these economies mature. This growth will be evidenced by the alternative firms. And it will not end there. Three smaller funds managing about projected emergence of 21 new sovereign investors, the vast majority of $250bn – the Promotion and Mutual Aid which will originate from SAAAME. Corporation for Private Schools of Japan, the Pension Fund Association for Local • Growth in assets will be driven principally by three key trends: a Government Officials, and the Federation government-incentivised shift to individual retirement plans; the increase of National Public Service Personnel of high-net-worth-individuals from emerging populations; and the Mutual Aid Associations – plan to adopt a growth of sovereign investors. This creates the need for more tailored, mix similar to GPIF. outcome-based alternative products that provide capital preservation, By 2020, it is expected that global pension but provide upside opportunities. fund assets will have reached $56.6tn, with alternative assets expected to play a considerably larger role in their asset allocation mix. Source: Adoption of New Policy Mix (GPIF) October 31, 2014 gpif.go.jpou

1 www.pwc.com/AM2020 11 PwC Alternative Asset Management 2020

Figure 2: Number of sovereign investors by region alternatives firms, so distribution alliances will be critical for 146 alternatives firms. 160 North Africa 125 2 140 18 • Alternatives become 2 Sub-Saharan Africa 120 11 16 mainstream. The term 13 Latin America 100 24 ‘alternative’, already strained to 20 80 Europe reflect a mix of different strategies, 25 24 60 Middle East products and firms, becomes 25 40 24 further flexed. The growth of North America 20 liquid alternative products, either 31 36 Asia-Pacific 0 in the form of mutual funds 2015 2020 or UCITS, continues to create Source: PwC Market Research Centre analysis based on sovereign investors’ financial information, Sovereign greater integration between Wealth Center, Prequin IFSWF, The Natural Resource Governace Institute and the Columbia Center on Sustainable Investment data. alternative and traditional asset management. By 2020, alternative asset management will become Figure 3: Pension fund assets in USD tn synonymous with ‘active asset management’ and, increasingly, 6.2% 60 ‘multi-asset class solutions’.

50 • New breed of global managers. 4.0% 40 Traditional managers leverage 11.3% their existing platforms, 30 56.6 distribution capabilities and brands to develop full-service, 20 37.1 29.4 multi-asset class alternative 10 21.3 businesses. A few of today’s largest 0 diversified alternative firms will 2004 2007 2013 2020 become mega-managers in their Sources: PwC Market Research Centre = CAGR own right, establishing a presence analysis based on City UK and Towers Watson in all the key geographies and investor segments. The largest • Pressures on the asset alternative firms will continue management industry. their growth trajectory and Alongside rising assets, there diversification through product, will continue to be increased asset class and distribution regulatory requirements, rising expansion, fuelled by build, buy costs and pressure to reduce fees. and borrow strategies. Specialist Alternative firms do not escape firms will seek ‘best-of-breed’ this pressure and will seek to status by producing sustained respond proactively. performance, while certain emerging firms will fight for shelf • Distribution is redrawn – space. regional and global platforms dominate. New markets and • Asset management enters the untapped investor types will twenty-first century. By 2020, open up if alternative firms can technology and data-informed develop the products and access decision-making will become the distribution channels to tap mission critical to drive investor them. By the early 2020s, four engagement, data analytics, distinct regional fund distribution operational and cost efficiency, blocks will have been formed and regulatory and tax reporting. allowing products to be sold pan- Data management and investment regionally. These are: north Asia, in technology have not always south Asia, Latin America and been a top priority for alternative Europe. However, these blocks firms – this will change. benefit traditional firms more than 12 PwC Alternative Asset Management 2020

Here’s how

So what do these huge future shifts in the industry mean for alternative firms and how they operate in the years to 2020 and beyond?

The key business imperatives for alternative firms in 2020 will be: • Choose your channels • Build, buy or borrow • More standardisation, more customisation • From institutional quality to industrial strength • The right resources in the right places • It’s not only about the data

The rest of this section looks at each of these key imperatives in turn and examines how managers of alternative strategies can implement and prosper from them. 13 PwC Alternative Asset Management 2020

with global operations, firms already Choose your accustomed to registered products channels and firms willing to step up to the increased requirements. World-class asset management organisations may serve many The shift in global economic different markets, but they have one power from developed regions to thing in common: they understand developing regions drives continued the different market segments and focus on sovereign investors, tailor their products to each market’s fast-growing institutions and the unique specifications. emerging middle classes in new markets. These groups of investors Alternative firms will spend a bigger will increasingly seek branded portion of their time and resources multi-capability firms. A number over the coming years figuring out of alternative firms exist in this how to access the discrete pools category in 2015, while others will of wealth that will exist by 2020 aspire to join them in the 2020s and how to tailor their products to through various growth strategies. each pool’s unique specifications. While marketing and distribution The sovereign investor challenges are not unique to the channel alternatives sector, the solutions probably are. This is because By 2020, sovereign investor assets the distribution landscape for are projected to grow by 6.2% to hit alternatives has been historically $15.3tn. difficult to navigate. In 2015, few Geographically and economically alternative firms possess brands diverse sovereign investors will that are well-recognised, well- require a highly bespoke approach understood and global. In the lead- due, in large part, to their different up to the 2020s, leading alternative economic objectives. Sovereign firms will have determined exactly investors, comprising sovereign which investor channels they want wealth funds, public pension reserve to target and will have developed funds (PPRF)2 and other large strategies for each channel. pension funds, will continue to seek high levels of transparency. They Here’s how: will also seek high standards of By the early 2020s, few alternative governance, reporting and economic firms will still take a scattergun alignment with alternative firms. approach to distribution. Many firms will devote more resources to Sovereign investors will also deciding which investor channels seek more in-house control and they want to play in, how profitable transparency over their assets. They each of those channels are and are transitioning from a model of how to optimise their chosen hiring external asset managers channels. These decisions will to talent insourcing, and are respond to the natural strengths hiring experts across asset classes, and goals of firms, but also to industries and geographies. Where their views on the likely future they interact with alternative firms, behaviour and needs of investors. sovereign investors are consolidating Decisions will also respond to relationships and seeking innovative views on regulatory challenges ways to align both parties’ economic and opportunities that different interests. channels and markets present. Regulation brings cost burdens, but it also offers distribution 2 Source: “Sovereign Wealth and Pension Fund opportunities, particularly for firms Issues” by Adrian Blundell-Wignall, Yu-Wei Hu and Juan Yermo,2008 14 PwC Alternative Asset Management 2020

Here’s how: Sovereign investors By 2020, there will be more require a direct sovereign investor participation and individualistic in alternatives with the largest approach to earn increases in allocations likely to their business. be private equity, real estate and infrastructure. Sovereign investors pay a great deal of attention to past performance, regardless of the size Figure 4: Sovereign investors’ assets in USD tn of the asset management firm, so distribution to sovereign investors is not limited to mega-alternative asset 18 6.2% 15.3 firms. If long-term performance is 16 outstanding, firms of any size can 14 9.8% 11.3 secure mandates. 12 6.4 Sovereign investors require a direct 10 and individualistic approach to 4.6 8 5.5 4.2 4.3 earn their business. Alternative 3.5 3.3 6 3.0 asset firms need to thoroughly 2.8 2.7 4 2.2 8.9 understand these non-homogeneous 6.1 6.3 6.7 4.8 5.2 institutions, their individual needs 2 4.1 4.0 4.4 3.3 and objectives, and develop long- 0 2007 2008 2009 2010 2011 2012 2013 2014 2015 2020 term relationships with them.

n SWF n PPRF Source: SWF Institute & PwC Market Research Centre

Alternatives and sovereign investors: a perfect fit? Sovereign investors usually have one of three economic objectives: capital maximisation, stabilisation and economic development. Sovereign investors with capital maximisation objectives • Sear ch for higher alpha and diversification • Alter natives to reach 14% of portfolios in 2020 • Private equity allocations by 2020 are expected to increase to 38% of alternative portfolios (36% in 2015) • Real estate is expected to increase to 41% of alternative portfolios (from 38% in 2015) • Hedge fund allocations and derivatives are projected to decline respectively to 6% (from 10% in 2015) and 2% (from 3% in 2015) • Ageing populations and slower economic growth will encourage PPRFs to seek more yield and more alternatives exposure • PPRFs will have a more limited risk appetite than sovereign wealth funds due to their explicit pension liabilities Sovereign investors with economic development objectives • Naturally favour infrastructure and private equity investments • Alter natives are expected to account for 29% of sovereign investors’ portfolios in 2020 with 79% of that allocation being in private equity and infrastructure Sovereign investors with stabilisation objectives • Shorter investment time horizons • T ypical asset allocation is highly liquid assets like money market instruments and government bonds • Risk appetite is low, so less likely to shift to alternatives Source: PwC SWF2020 and The taxonomy of Sovereign Investment Funds - Richard Boxshall: PwC Market Research Centre analysis based on available recent financial information 15 PwC Alternative Asset Management 2020

Sovereign investors increasingly Figure 5: Completed co-investments deals by sovereign investors alongside firms seek to consolidate their manager by year relationships and seek bespoke solutions based on their economic 63 70 objectives. Instead of simply 45 42 40 41 allocating large pools of capital to 60 35 many alternative firms to manage 50 29 on a discretionary basis, they 26 increasingly prefer to enter into 21 40 fewer (and broader) strategic 10 relationships. On the one hand, 30 these strategic relationships involve sovereign investors taking stakes in 20 the alternative firms themselves. 10 On the other hand, alternative firms have become more adept at 0 // creating innovative co-investment 2006 2007 2008 2009 2010 2011 2012 2013 2014 2020 and financing arrangements, joint Source: PwC Market Research Centre analysis Including all deals across Asia-Pacific ventures, partnerships, advisory based on Sovereign Wealth Center data Europe, Middle East and North Africa, North relationships and dedicated funds America, Oceana and sub-Saharan Africa that allow sovereign investors to meet their objectives by investing in less traditional and difficult-to- manage assets.

As a result, the number of co- investment deals between sovereign investors and alternative firms has risen steadily over the last decade, from an annual average of 21 co-investment deals between 2006-2009, to an annual average of 40 deals between 2010 and 2014.3 The co-investment trend will continue over the coming years, with co-investments expected to reach 63 during 2020.

3 Source: Sovereign Wealth Centre 16 PwC Alternative Asset Management 2020

Emerging markets channels Here’s how: Latin American and Asian investors, With private wealth growth in and particularly institutional and emerging markets outpacing high-net-worth investors from developed markets, wealth China, represent a significant, and management becomes an area of in some cases largely untapped explicit focus and differentiation for opportunity for alternative some alternative firms. They create firms. Other Asian markets will bespoke products to match specific present opportunities, but none customer needs in specific emerging will continue to dominate the markets. First mover advantage is focus like China, given its greater critical. concentration of high-net-worth The internationalisation of the individuals (HNWIs). Asia-Pacific’s share Chinese currency and Beijing’s of high-net-worth In 2012, almost 24% of the high- continuous reduction of investment net-worth assets and 34% of mass barriers will provide opportunities assets will increase for alternative asset management 4 affluent assets around the globe to 29% by 2020 are in Asia-Pacific. It is expected firms by 2020. Among changes and mass affluent that Asia-Pacific’s share of high-net- likely to have significance for both assets will increase worth assets will increase to 29% the China and Hong Kong markets to 43% by 20204 and mass affluent assets by 2020, several are already in will increase to 43%, much of that evidence: increase originating from China. • The launch by a foreign entity As Latin American (LatAm) of the first Qualified Domestic countries look for alternative Limited Partnership (QDLP) investments to domestic bonds, hedge fund. alternative firms have an • The establishment of Shanghai- opportunity to create different Hong Kong Stock Connect. products that can attract HNWIs and sovereign investors. There is • The launch of duty-free zones an appetite by investors to invest by two Chinese provinces to in projects in LatAm which will encourage the establishment of contribute to the development of the financial services firms across the region and produce above-market respective provinces. returns. • The Mainland-Hong Kong Mutual Recognition of Funds (MRF) initiative.

The Chinese regulatory authorities will become more knowledgeable about different fund structures leading to a fine-tuning of their technical expertise. A positive feedback loop will slowly form, giving impetus to the alternatives industry in mainland China.

4 PwC analysis, with past data based on Credit Suisse’s Global Wealth Report 17 PwC Alternative Asset Management 2020

Some international firms on the Figure 6: High net worth individuals assets in USD tn other hand will focus on developing relationships with mainland Chinese = CAGR investment banks, partnering with 90 76.9 them to gain access to Chinese 80 4.9% HNWIs. Regardless of which 0.9% 1.9 0.3 70 9.7% strategy they pursue, international 22.6 60 52.4 asset managers will face competition 50.1 from domestic firms. With their 50 20.9% -0.4% 0.9 6.0% knowledge and access to local 37.9 9.3 12.7 40 22.5% 7.7% 9.0% 21.6 markets, they will start to compete 7.3 8.4% 6.3% 7.5% with international firms. Domestic 30 19.2 17.0 14.3 10.2% -2.5% 3.4% Chinese asset managers, like 20 their international counterparts, 9.4% 1.0% 4.4% 30.6 10 20.7 21.7 will also focus on creating global 15.8 brands and on selling their funds 0 2004 2007 2012 2020 to international investors in Europe n North America n Europe n Asia-Pacific n Latin America n Africa and the US. Source: PwC Market Research Centre analysis based on Credit Suisse data In LatAm, distribution channels are concentrated among a few firms and are likely to be controlled by Figure 7: Mass affluent assets in USD tn the biggest banks well beyond = CAGR 2020. In Brazil, for example, the 120 asset management industry is 6.8% 100.4 concentrated among a few big firms 100 1.3% 4.5 0.9 with the top ten asset managers 9.9% responsible for 88% of assets under 80 5 management in the country. 20.9% -0.4% 10.1% 59.5 43.3 To enhance the distribution of 60 55.8 alternative products within the 22.5% 1.4 7.7% 2.1 10.1% 42.1 15.1 region, alternative firms will 40 0.8 8.4% 6.3% 20.5 9.8% 11.9 31.6 consider alliances with local asset 10.2% -2.5% 4.2% managers and distributors. 25.8 22.8 20 19.3 9.4% 1.0% 4.9% 20.1 10.0 13.0 13.7 By 2020, firms that have successfully 0 integrated emerging market 2004 2007 2012 2020 regulatory requirements into a n North America n Europe n Asia-Pacific n Latin America n Africa global compliance framework will Source: PwC Market Research Centre analysis based on Credit Suisse data. have a competitive advantage. These firms will have achieved more consistent, efficient global compliance controls, resulting in cost savings and reduced regulatory risk exposure.

5 Source: Associação Brasileira das Entidades dos Mercados Financeiro e de Capitais (ANBIMA) 18 PwC Alternative Asset Management 2020

The retail channel cases, traditional firms will build or buy turnkey platforms to attract For some alternative firms, the alternative portfolio management emergence of liquid alternatives talent. In other cases, they will is an enabler, while for others it leverage their established brands is a disrupter. Broadly speaking, and distribution capabilities traditional fund managers will to effectively borrow portfolio dominate retail alternatives in the management talent from alternative 2020s, as this group understands firms through sub-advisory and registered products and controls other relationships. retail-focused platforms. Liquid alternatives pose a number The first wave of liquid alternatives of risks, as well as opportunities. (1.0) has been largely targeted at Both alternative and traditional the institutional space. The second firms will carefully weigh whether wave (2.0) will increasingly focus they are really committed to on the retail space, including the marketing alternative products fast-growing defined contribution to retail investors. In particular, pensions fund market. Traditional they consider whether the core asset managers with their alternative strategy can be adapted For some established distribution capabilities to a registered product and whether and trusted brands will dominate alternative firms, the firm has the necessary portfolio 2.0, although a number of management, operational and the emergence of predominantly alternative firms marketing skills to offer a profitable liquid alternatives will also develop retail capabilities. and compliant liquid alternatives is an enabler, while fund. for others it is a Here’s how: Traditional and alternative firms disrupter. Given the nature of the liquid that decide to follow the retail route alternatives market and growth may have to devise a business plan potential, the question for many that is starkly different to their traditional managers is how to enter Given the unique usual modus operandi. In the light the market. On the other hand, portfolio liquidity of the attention from regulators, given the unique portfolio liquidity needs and different asset management firms should needs and different (lower) fees, the (lower) fees, enter this new line of business questions for alternative firms are if well-prepared from a compliance the questions and how to participate. for alternative and organisational standpoint. This managers are Liquid alternatives is the epitome includes: of convergence between retail if and how to • training products, which are dominated by participate. traditional firms, and alternative • assessing customer suitability products, which are dominated by alternative firms. It therefore • marketing and education represents the potential for a • building out compliance and classic alliance of distributor and surveillance, and manufacturer. In a fragmented market where traditional firms • robust liquidity risk management. and alternative firms do not yet see each other as peers, they will need to figure out how to coexist and even work together. In some 19 PwC Alternative Asset Management 2020

Liquid alternatives: from trickle to torrent According to Morningstar, liquid alternatives assets have recorded a CAGR of 50% between 2008 to 2014, from USD 27 billion in 2008 to USD 304 billion in 2014. The number of funds grew by 226% during the same period from 482 to 1,569 funds. PwC estimates the demand for liquid alternative mutual funds to surge from $260bn at the end of 2013 to around $664bn by 2020. In addition, while assets in European hedge funds have grown by 13% a year since 2008, alternative UCITS – the European equivalent of US alternative mutual funds – have grown by more than 30% a year over the same period.

Source: Morningstar Alternative Investments Observer 2009/2015 20 PwC Alternative Asset Management 2020

selected and differentiated strategies. Build, buy or borrow Their rationale is that focusing on a set of core competencies provides Differentiation, relationships and the best basis for outperformance, branding will become major planks of and that investors are willing to pay business strategy in the alternatives for superior investment capabilities sector. Over the next few years, firms in selected areas. They will primarily will make major decisions about their target the largest institutional business models, explicitly choosing allocators globally, offering bespoke the kind of business they seek to and heavily customised solutions. be and developing their business by building, buying or borrowing Multi-strategy firms. In the capabilities. middle of these two extremes are a large number of multi-strategy Structurally, the alternatives market firms. These firms concentrate on in 2020 will be more clearly focused generating strong returns and low on three key business models: volatility through strong investment Diversified alternative firms. teams and dynamic asset allocation. These large firms play across They invest in leveraging the multi- multiple alternative asset classes and strategy structure to expand into products, including hedge funds, new, often tangential, investment private equity, credit, real estate, strategies, creating a repeatable mezzanine and infrastructure. They model (e.g. a credit manager moving target predominantly institutional into direct lending). They believe investors looking for an investment that growing AUM significantly will partner with a diversified offering require offering different strategies and experience across asset classes. within the same asset class. They These diversified firms leverage have the resources, capabilities and synergies across the group by cross- credibility to deliver competitive selling to clients and sharing ideas, performance in other styles. Their insights and capabilities. They stretch current operating platform is flexible their brand and capabilities across enough to accommodate such a alternative asset classes, seeking strategy. to add value through a portfolio approach that materially exceeds the Here’s how: sum of its parts. Alternative firms have often functioned as manufacturers, Becoming a diversified alternative sponsors and/or distributors of firm may be an obvious choice for their own products, and some will many large traditional asset managers stay that way. But in the lead up as they continue to push aggressively to 2020 and beyond, these roles into the alternative space, assembling evolve. Alternative firms looking multi-asset class businesses from to access key investor channels within their ranks and filling gaps will increasingly sell their products where needed. It is also a strategy through distributors or other that the largest alternative firms intermediaries. Multi-strategy and will continue to pursue in search of diversified alternatives firms will growth. access specialised alternative asset Specialty firms. There will still be management capabilities in order strong competition among specialist to broaden their asset class, strategy firms, which will devote their and/or products offerings. resources to becoming best-in-class Regardless of which business model (e.g. a dedicated hedge fund, private each firm adopts, they will pursue equity or real estate firm keeping to one or more of three possible growth their core competency). These firms strategies: building, buying or create very strong core competencies borrowing. to become the leading player in 21 PwC Alternative Asset Management 2020

The builders will look inwardly for Figure 8: US alternative asset management deal volume by subsector growth, leveraging their existing capabilities and investment talent to 45 create repeatable models, in the belief 40 that their current platform is flexible 8 enough to accommodate change 35 13 6 and growth. They become adept at 30 14 identifying, recruiting and developing 25 14 talent and make doing so a strategic 8 12 20 10 11 focus and competency. They also 34 15 create talent mobility programmes, 30 30 10 21 as practised by many successful 19 18 17 15 16 traditional investment firms. 5 0 The buyers will primarily comprise 2006 2007 2008 2009 2010 2011 2012 2013 2014 managers who are looking to n Hedge fund and CLOs n Private equity and venture capital expand their alternative capabilities Source: Thomson Reuters, SNL and PwC analysis across asset classes and strategies by acquiring talent, track record and scale overnight. As discussed Figure 9: Acquisitions of US alternative asset managers by foreign buyers in PwC’s Asset Management M&A 17 trends paper,6 alternative asset management deals will dominate the 10 M&A market. And this deal flow will 2 not be solely US domestic activity, as 8 10 of the 35 deals in 2014 involved 2 6 non-US buyers looking outside 2 their home territories for attractive 1 4 3 2 8 Number of deals 5 acquisition targets. 2 6 3 2 4 6 3 Large traditional firms will build out 2 4 1 1 their alternative platforms, while - large alternative firms will buy to fill 2006 2007 2008 2009 2010 2011 2012 2013 2014 capability gaps. Some will opt for a decentralised network of dispersed n Foreign buyers’ deals (Volume undisclosed) n Foreign buyers’ deals (Volume disclosed) alternative asset management Source: Thomson Reuters, SNL and PwC analysis capabilities such as the multi- boutique model. Others will seek an For them, teaming up with a larger integrated model. Still others will manager or a distributor can help follow a mixed model. Regardless of them access the necessary resources, which business scale and experience to reach new The borrowers believe that they model each firm investor channels. Traditional can best achieve their growth adopts, they will strategy by ‘partnering’ with other firms will continue to manufacture institutions including other asset and distribute their own products, pursue one or more managers, wealth managers, but they will increasingly decide of three possible private banks and fund-of-funds, to buy or borrow the capabilities growth strategies: to expand their capabilities and of dedicated alternatives firms. building, buying or Diversified alternative firms and distribution channels. These borrowing. relationships will take many forms multi-strategy firms will also decide including distribution arrangements, on a combination of build, buy and joint ventures and sub-advisory borrow strategies to expand their relationships. capabilities.

Specialty firms need to consider whether to allow their differentiated capabilities to be bought or borrowed by larger firms looking to supplement 6 Asset Management M&A Insights: In pursuit of growth – their asset class or strategy offerings. PwC April 2015 22 PwC Alternative Asset Management 2020

By 2020, alternative firms will More effectively decide which approach, standardisation, or approaches, to take and then focus their resources into developing more customisation the appropriate strategies, products Firms will increasingly evaluate and operations. their product development strategies in the years leading up Here’s how: to 2020 in accordance with their Customised solutions are By 2020, overall business objectives. New standard products will only be launched alternative asset after an established product The most sophisticated institutional management firms development process that considers investors in 2020 will have more will effectively strategic fit, the marginal costs and complex structures and objectives decide which ongoing legal, tax, operational and and demand highly customised approach, or compliance issues. alternative solutions. approaches, to Alternative asset management firms In a 2014 report,7 more than half take and then focus by 2020 will respond to three key of the 220 hedge fund investors their resources investor demands for products: surveyed said they planned to grow into developing allocations via customised mandates, • The ongoing demand by the the appropriate compared to only 6% who made the largest institutional investors same assertion in 2013. strategies, products (e.g. sovereign investors) for and operations. made-to-order products with Rather than merely gaining greater customisation. exposure to specific asset classes, institutional investors will • Next-generation commingled increasingly seek outcome-based funds that are focused on investment solutions that seek to outcomes. deliver target returns or predefined cash flows over various durations. • Demand for the creation and servicing of liquid alternative Investors’ decisions will also be funds for institutional investors driven by environmental and social and retail investors including considerations. For example, in investors in developed markets a recent survey, 71% of limited and the newly wealthy in partners interviewed said they emerging markets seeking would decline to participate in a alternative strategies. fundraising, or would turn down a co-investment opportunity As a result of these demands, where environmental, social and alternative firms will be pulled governance (ESG) risk issues were in different directions. On the present. In addition, 18% of those one hand, they must show their interviewed also noted that they had commitment to finding bespoke withdrawn from an investment or solutions for their largest, most withheld capital on ESG grounds. strategic institutional investors. As noted in the survey, 97% of On the other hand, they must limited partners interviewed adapt commingled funds to serve believed that responsible investment the changing demands of both will increase in importance over institutional and private wealth the next few years. It is expected investors. At the same time, they that the amount of investors who must position themselves to attract will continue to require socially the potentially huge (and stable) responsible investing as part of side asset flows from permanent capital letter arrangements will increase vehicles and the world’s mass and, in response, managers will have 7 Waiting to Exhale – Barclays Strategic Consulting, 2014 affluent. to adopt policies and practices to 8 PwC Bridging the Gap: Aligning the Responsible Investment 8 interests of Limited Partners and General Partners, May 2015 accommodate these requirements. 23 PwC Alternative Asset Management 2020

Partnership models evolve Figure 10: As per the Financial Stability Board (FSB), shadow banking assets accounted for 25% of the global financial assets in 2013*. By 2020 do you think The shift from standardised that shadow banking assets will be: products to customised solutions drives more interaction between asset managers and their clients. 0% 0% 16% 66% 18% Asset managers effectively partner with institutional investors to address bespoke needs. These new relationships will bring with them even greater alignment of interest in terms of economics, transparency, service and risk management.

55% or more of 45% to less than 35% to less than 25% to less than less than 25% of In the case of the largest and most global financial 55% of global 45% of global 35% of global global financial sophisticated institutional investors, assets financial assets financial assets financial assets assets the discussion of co-investing and fees will by 2020 have evolved into Source: PwC Capital Markets 2020. Base: 261 Capital Markets Surveyed firms a discussion of economic sharing to *At approximately USD 70 trillion up from USD 26 trillion a decade earlier. align interests. This takes the form of vertically integrated structural Filling the funding gap and economic relationships to facilitate economic and risk-sharing In 2020 and beyond, alternative rather than the contractual fee for firms continue to move into areas services model. Additionally, hedge traditionally dominated by banks, funds seek greater alignment of such as lending, securitisation interests by trading fee levels against and financing. This provides In the case of the AUM and liquidity. Alternative opportunities for next-generation firms launch more permanent commingled funds that focus more largest and most capital vehicles, such as business closely on outcomes. The greater sophisticated development companies (BDCs), range of assets and the more diverse institutional Real Estate Investment Trusts income streams allow the creation of investors, the (REITs) and public vehicles, to a number of outcome ‘buckets’ that discussion of assure a more stable capital base. each meet the needs of a different co-investing and investor type. Regulation and tax fees has by 2020 The funding gap will present evolved into a Regulation and tax are also part of considerable new opportunities. discussion of customised alternative solutions. For In its 2014 Global Banking example, as a consequence of asset economic sharing Monitoring report, the Financial to align interests. management inhabiting the space Stability Board (FSB) noted that once occupied by banks, regulators shadow banking assets accounted and tax authorities are being forced for 25% of total global financial to address certain new investment assets. The FSB also pointed out activities (e.g. direct lending) which that some of the most rapid growth traditionally had been conducted (18%) among non-bank financial by non-investment entities such intermediaries engaged in shadow as banks. In these jurisdictions, banking activities was from appropriate tax structures, risk investment funds. In addition, a appetites and reporting must be report9 showed that a large majority considered. (82%) of capital markets industry executives expect shadow banking For all investor types, alignment assets to grow by 2020, with some with global tax rules will be a major of that growth coming from hedge consideration, given the increasing and private equity funds. In China, cross-border nature of investors and where shadow banking – also investments. known as the ‘private trust’ sector 9 Capital Markets 2020 – PwC 2015 24 PwC Alternative Asset Management 2020

– has grown to represent 20% of Both alternative and traditional all banking transactions by 2014, firms must carefully prepare before shadow banking is also likely to launching liquid alternative funds grow rapidly by 2020, despite new aimed at retail investors, in order regulatory measures. to capitalise on opportunities while minimising reputational risk. To The shift by asset management this end, they typically conduct a firms to fill the funding gap will be number of pre-launch assessments: encouraged by some governments and also by sophisticated • Preliminary vetting: The types Some alternative institutional investors who seek of alternative products that are firms create access to strategies and the in demand and the investor partnerships illiquidity risk premium, which channels to target. with banks are not always available to other • Regulatory ‘buy-in’: Firms discuss investors. and the largest new products with regulators in advance. institutional Ongoing government deficits investors, provide opportunities to invest in • New product approval: Includes providing infrastructure and other projects approval from key stakeholders integrated traditionally done through public such as operations, risk programmes. As well as creating management and compliance, expertise in commingled funds, some alternative senior management and the managing new firms create partnerships with board of directors. Regulators asset classes and banks and the largest institutional expect to see evidence of this building products investors, providing integrated process. As alternative products that often have expertise in managing new asset are new for the retail segment, limited liquidity classes and building products which they require greater due often have limited liquidity but offer diligence by the new products’ but offer steady steady income flows. This kind of committee, which should focus income flows. partnership alleviates the pressure on reputational, regulatory and on banks’ balance sheets, while legal risks including valuation harnessing their expertise. practices and reporting capabilities. Creation and servicing of • Technology and operations: retail funds Operations are agile and By 2020, the asset management adaptable to accept new industry will have invested heavily products and assess new service in the development of retail- requirements. oriented products and business models to support the demand for liquid alternatives, meaning the number of sponsors of these products will expand considerably from 2015 levels. Traditional asset management firms, who have already begun to expand their alternatives product sets in 2015, will be in a race with alternative firms to provide multi-asset solutions that include alternative strategies. 25 PwC Alternative Asset Management 2020

Figure 11: Attributes of institutional quality and industrial strength

Reporting Agility

Operational due Scale diligence

Risk Security Institutional Industrial Quality strength

Talent Efficiency Regulation Automation

Measurement Operations

Source: PwC

Owners, investors and regulators From institutional will raise their expectations beyond Asking the tough questions quality to industrial the standard of ‘institutional The key question many managers will strength quality’. Having institutionalised ask themselves is: Can I be a top-quartile their businesses, alternative firms investment performer and a top-quartile Successful companies in the will seek the higher standard of profit performer too? In other words, the strategy must be a strong performer but, in manufacturing sector can readily ‘industrial strength’. the final analysis, profit and compensation adapt to product changes and the Global regulators too will require depend on collecting fees and managing level of production. In a rapidly varying and ever-increasing degrees costs. This, in turn, will largely depend on the evolving environment, they are effectiveness of the manager’s infrastructure of risk management, stress-testing able to regularly overhaul their and operations. and transition planning. Oversight operations and retool their factories. of the firm’s risk management They do this cost-efficiently and function will remain particularly without disruption to operations. acute, with an emphasis on Owners, investors Alternative firms Likewise, alternative asset independence from portfolio and regulators increasingly management. management firms need to be will raise their recognise that adaptable to changes in their To match these expectations and expectations incremental change product mix and the demands get to the next level – whether on their operations. From now beyond the won’t necessarily in terms of profitability, growth until 2020 and beyond, they will standard of move the needle. or diversification – alternative consider how they can revamp their ‘institutional In some cases, firms increasingly recognise operations to provide customised that incremental change won’t quality’. Having transformational solutions to institutional clients, necessarily move the needle. In institutionalised change is required. support new asset classes, products some cases, transformational their businesses, and investors, and keep pace with change is required. alternative firms regulatory and tax requirements. They will seek to do all this in a cost- will seek the effective way that is not disruptive higher standard to their day-to-day business and of ‘industrial in a way that focuses resolutely on strength’. profitability. 26 PwC Alternative Asset Management 2020

Fees will continue to come under comprised of available operational Managing pressure as firms enter different capabilities, such as the operating operational markets and offer different – and, model, in-house competencies, the capabilities will sometimes, lower fee or lower degree of automation and service margin – products. So an increase providers. By overlaying the capability require equal parts in AUM will likely not result profile on the complexity profile, art and science. in a corresponding increase in it will be possible to see if and how profitability. Pressure on margins changes to the complexity profile can reinforces the need for firms to build be proactively managed. The overlap agile, scalable and economically of the two profiles determines the viable infrastructure. agility of the alternative firm.

An agile operating model Firms will utilise more data-driven decision-making tools, including Management company executives modelling of headcount, variable costs will expect their support functions and margins, to create these profiles. The search for agility to be agile and scalable with a high They will combine the measurable, degree of efficiency and operating objective data these tools provide with Viraj Patel, the head of operations for ALT their own experience and judgement Asset Management LLC, an alternative firm leverage. to make more strategic decisions has a problem. 40 Act LLC, a large traditional firm has taken a significant stake in ALT Asset Here’s how: about the operational direction of Management LLC with the goal of launching their business. Many alternative firms in 2020 a liquid alternative strategy which is in huge demand by 40 Act LLC investors. will have moved beyond a reactive Process improvement approach to a more proactive and Viraj tells his CEO Barbara Wassner: “I don’t know if we can handle all that growth right data-informed operational strategy. An agile operating model requires now.” After 2009, Viraj had overseen a 10% Managing operational capabilities firms to streamline operations more reduction in staff numbers and his operations will require equal parts art and aggressively, automate processes team is still stretched years later. science. Decisions that have been and delete inefficiencies. “Well Viraj, it sounds like we need to hire some made primarily based on experience new people,” said Barbara. “Let me know and gut will be informed by specific, Here’s how: what you need. But bear in mind we have to objective data. In PwC’s Global be efficient – we are only getting 100bps on Data & Analytics Survey 2014: Big To do this, firms build in more these funds.” Decisions, 94% of respondents resource bandwidth with change Viraj didn’t simply want to hire a bunch of new representing companies across a agents who can drive process people, he wanted to create a strategy that number of industries, said that improvement while others continue could dynamically react to changing needs. senior management believe they to drive the day-to-day operations. He wants to make operations more agile and are prepared to make their next big scalable. But how to do it? He didn’t have a Value-enhancing opportunities will decision but just 38% relied on data sense of ALT’s unique ‘complexity profile’ and include: and analytics to do so. how that would change with its growth over • Im proving the ability to identify the coming years. Equally, he was not entirely An agile operating model places a and measure cost reduction sure how much more he could get out of his opportunities. in-house resources and how to best access greater emphasis on an objective external expertise, because ALT had never understanding of an alternative • Creating greater automated thought about its unique ‘capability profile’. manager’s unique operational cross-functional workflow, both “Enough is enough,” Viraj said to himself. “No demands and aligning it with their internally and with key service more ad hoc decisions, we’re going to get specific operational capabilities. More providers. more scientific.” He immediately started to specifically, firms will increasingly • Instituting straight-through- write a memo to Barbara, on the necessity of define their own ‘complexity profile’, building more agility into ALT’s operations. processing related to the extraction which is shaped by the external and and transformation of data. internal inputs that drive complexity in their businesses. These inputs • Designing automated include operational demand drivers environments for routine and such as the mix of asset classes, fund repeatable processes. and fee structures, transactional • Identifying and segregating volume, regulatory requirements, high-volume, low-risk processes, investor demands, reporting and in order to outsource or move to so on. They will then overlay the lower cost locations. complexity profile with a ‘capability profile’. The capability profile is 27 PwC Alternative Asset Management 2020

• Reassessing the organisational design across key areas to Getting to grips with complexity and capabilities ensure there is the right balance A day in the life of a functional manager in 2020 will be very different from today. of vertical (fund/entity) Dashboard reporting allows them to monitor, measure and manage operations in a vs. horizontal (functional) proactive manner. Predictive models allow them to better understand how changes in orientation. operational demand drivers relating to new products, new strategies, new distribution channels and volume of transactions will impact their complexity profile and inform • Bifurcating roles where strategic planning. A more data-informed understanding of operational demands operational demands and unique and operational costs allows managers to better understand the marginal costs of skill sets highlight the need to do launching and managing different products. As a result, senior management will better so. Examples include separating understand the capability profile of their support functions and functional managers the reporting function from the are better able to quantify the return on investments needed to create operating accounting group and separating leverage, efficiency and scalability. investor servicing from investor relations. • Enhancing management insight Figure 12: From institutional quality to industrial strength into the costs, profitability and capital required to operate, or Current state Future state invest in new business segments, Limited ability to quantify operational Data-driven decision-making tools geographies or products. investment needs • Using data analytics tools to identify and understand No standard operating metrics More standard operating metrics operational, tax or compliance Proactive responses to business Reactive to business mix changes anomalies and make decisions mix changes based on them. Inconsistent performance and More standard measures of performance profitability metrics and profitability Controlling operational risk Process automation and elimination of High degree of manual processing low value add on work Alternative firms in the 2020s have undertaken systematic Suboptimal use of sourcing and Better use of sourcing and reassessments to identify, prioritise staffing strategies staffing strategies “We understand why we’re different and and manage their key business and “We’re different” operational risks, and to enhance can manage it” the effectiveness of their operations. Source: PwC The results of these risk assessments will provide a clearer picture of operational risks and allow management to focus on issues that Alternative firms to build dynamic compliance functions really matter. The main ways alternative firms will build more dynamic compliance activities are: • Building and enhancing controls and processes around their regulatory reporting Here’s how: as they do for other critical business activities. This requires greater collaboration between those with the subject matter expertise (compliance and legal) and those Improvement initiatives are with reporting and analytical skills and control mindset (fund accounting). targeted first at functions under • Investing in broader compliance resources with interdisciplinary skills extending high operational pressure and beyond legal and compliance into analytics, reporting and technology. consuming a high percentage of fee • Pushing certain routine compliance activities into business units. income. Targeted initiatives allow • Rationalising and reconciling the myriad reporting requirements. firms to identify stress points in their operations, such as immature • Developing a flexible data strategy to allow for centralised data capture either in- house or via outsourced solutions. IT applications, key person dependency, and ad hoc processes • Creating more systematic compliance programmes and checklists including automated record retention and filing, reminders and summary of information for supporting the end-to-end lifecycle. proper review. There will be a reduced reliance on • Shifting from a ‘rules-based’ approach to compliance to a ‘principles-based’ spreadsheets, manual processes and approach for more consistent controls on a global basis. individuals with a high degree of • Investing in local expertise and creating local processes as alternative firms target institutional knowledge. investors from less saturated markets and adapt to new regulatory requirements. 28 PwC Alternative Asset Management 2020

The right resources, Here’s how: The key organisational design in the right places elements that will be adopted Organisational redesign and by alternative firms in 2020 and sourcing decisions are often beyond include: approached merely as exercises to • Transaction centres. Some large reduce costs. In fact, they are much firms will shift middle and back more than that. These decisions offices to offshore transaction will increasingly reflect an analysis centres that support ‘business- of the resources needed to remain agnostic’ activities. The activities competitive and drive both quality best served by these centres are and profitability for the longer term. routine, repeatable transactions Put simply, it is about planning to (e.g. cash reconciliations, loan make sure an organisation has the administration, asset custody and right resources, in the right places, security master maintenance). at the right time. These centres function as high- There is no universal blueprint volume processing centres, for organisational design. Each driving scale by reducing costs alternative firm has its own DNA per unit, facilitating capacity and must develop its own approach, increases. Other firms may although common concepts and decide to operate near-shore design elements permeate many operational hubs to support some organisations. or all of the above organisational components. Key variables alternative firms will address by 2020 to inform • Centres of excellence. By organisational design include the contrast, centres of excellence volume and type of transactions, focus on higher value activities the complexity of the asset classes than would be supported by a and investment strategies, the transaction centre. For example, predictability of the activity and the a transaction centre may perform nature of the distribution channels. cash reconciliations while the Other considerations include the centre of excellence is responsible regulatory and tax environments for processing, account set-up in which the firm is operating, and maintenance. The ethos of the availability of talent and the these centres is ‘practise makes proximity needed to the investment perfect’. They ensure that firms process. avoid multiple handoffs, are better able to handle peak/valley As a result of the measurement problems, and can build deep and analysis of these and other expertise to use across the firm. variables, by 2020 we see a range of These centres can be organised by organisational changes across the function (horizontal orientation) alternatives spectrum. or business/segment (vertical orientation). For example, a Each alternative functional model may process all firm has its the capital activity for a private own DNA and equity, real estate and a hedge must develop its fund while a business/segment own approach, model would handle the end-to- although common end servicing for each fund type. concepts and design elements permeate many organisations. 29 PwC Alternative Asset Management 2020

• Hybrid models. Some firms purely at reducing costs. This leads will opt for a combination of to underinvestment in operations, The emergence of financial functional and business-aligned resulting in infrastructure that is market utilities models. This may lead to the inflexible and unable to scale for In response to new regulation, by 2020, creation of business segments by complexity, regulatory requirements incumbent and emergent financial market strategy or fund type, overseen and growth. utilities (FMUs) will have expanded across by the fund CFO/controller. And, the capital markets value chain and will play these may be functional teams, an increasing role with alternative firms. Here’s how: These FMUs will expand from those that which support multiple business Alternative firms by 2020 will are mandated in the capital markets (e.g. segments, strategies or funds. make more effective use of right- trading, clearing and settlement activities) sourcing strategies, using third- to those that facilitate and lower the cost • Dedicated teams. Firms and operational burden of processes such party administrators, other business increasingly build stand-alone as investor onboarding and other investor teams to support underserved process outsourcing firms, and data and documentation challenges. Many, areas such as new fund launches other vendors to create variable if not most, of these emerging utilities will be and client onboarding, driving costing models and buy in key skills. owned by different consortiums of financial process and technology best Right-sourcing is the process by institutions, existing FMUs and financial technology players. The FMUs and the entities practices and integrating between which an asset management firm determines how to most efficiently that own them will themselves pursue growth multiple stakeholders. through build or buy strategies to complement and effectively provide back- and core offerings and create new service models • Substance. The ongoing impact middle-office services. for alternative firms. of regulation and tax will also Source: PwC Capital Markets 2020, will it change for good? drive organisational change. By 2020, a number of new Maintaining an adequate level solutions will take hold to increase of local activity and genuine standardisation, enhance control substance in key jurisdictions is and promote transparency for a growing focus of managers in alternative firms and the broader addressing tax and regulatory capital markets. These include developments. AIFMD, for financial market utilities (FMUs), instance, may lead non-EU emerging and nascent technologies, alternative firms, particularly and utility-like platforms in areas those based in the US, to create such as Know Your Customer, new AIFM entities in Europe anti-money laundering, and other or to transform an existing risk and regulatory requirements. marketing and research unit into By 2020, we will also see a an AIFM. These new entities must number of specialised operations have substance for operations, and technology carve-outs run regulatory and risk management as separate companies, and in matters. combination with one another, to provide specialised services Holistic view of sourcing to multiple players across the alternatives industry. Sourcing has long been a key driver of profitability in other industries, In a growth environment, recruiting and a way to improve operating and retaining talent is a key issue. leverage and access specific skills Anticipating talent shortages in and information. Hedge fund growing areas like operations, tax firms, in particular, have embraced and compliance, alternative firms the outsourcing of non-core will make right-sourcing in these key activities. But some firms leading areas a strategic focus. up to the 2020s will recognise the Most hedge fund and hybrid fund importance of a broader sourcing asset management firms outsource strategy for their operations. The at least one back-office function to a challenge for alternative firms third-party service provider in 2015. when assessing their operations is to avoid implementing one- dimensional initiatives aimed 30 PwC Alternative Asset Management 2020

The use of third-party Key performance indicators are key administrators will by 2020 be more to sourcing common for private equity firms Alternative managers will learn to leverage too. Today, alternative firms select detailed service level agreements (SLAs) administrators primarily based internally and externally to manage key on service levels, capabilities and processes, controls and responsiveness. pricing. Cultural fit, best-of-breed They will establish a framework that defines technology, reputation and brand, services and key performance indicators stability and ability to scale will (KPIs) to systematically measure quality and timeliness. become more important factors in the administrator selection process by 2020. The ability of administrators to leverage their scale to invest heavily in technology and innovation will become a compelling part of their value proposition.

Location, location, location

The location of investment talent has long been the primary driver around firm location decisions. The location Simply stated, the back office has of investment been tethered to the front office. talent has long But, by 2020, this close proximity been the primary of the back office to the front office driver around will not be a given. Other factors firm location such as regulatory and tax matters, the availability of talent and cost decisions... will become more important inputs other factors such into the decisions about where as regulatory resources are strategically located. and tax matters, Already today, alternative firms the availability are creating hubs in Hong Kong, of talent and Singapore, Ireland, Luxembourg and cost will become the Netherlands, which are being used to both invest and combine more important substance in a tax-efficient manner. inputs into the At the same time, consideration is decision about also being given to the regulatory where resources implications of legislation such as are strategically AIFMD and, in the future, the Asia located. funds passport. By 2020, therefore, organisational design will be a decision based on satisfying not just the preference and goals of the front office, but the needs of the middle and back office too. 31 PwC Alternative Asset Management 2020

It’s not only about Data dashboards hand Tax impact the data control to compliance modelling will A day in the life of a compliance be a critical Data centricity is a key business analyst in 2020 will be very issue in 2015. By 2020, the different from today. Instead differentiator for discussion will have advanced. of spending the day gathering alternative asset Leading firms have created a single information, manually wading managers. through ‘false positives’ and ‘golden’ source of data, which is responding to the latest fire entirely trusted and feeds multiple drill, compliance analysts will applications. Making a change start each day reviewing key in a single source flows to every risk and compliance metrics application. Firms move to a data- presented in dashboard format. centric, self-service environment in Where statistics show activity which time is spent on the analysis away from ‘expected’ or out of the ordinary, they will be able to of data and resulting decision- immediately drill down into the making, rather than on its extraction information. They will be able and manipulation. For those firms to tag the data with comments, that are prepared, the discussion have their own analysis logged about data moves on to one that is for later reports, initiate a case or focused on actionable data and data- indicate the matter resolved. informed decision-making.

Technology in 2020 will no longer • Cybersecurity. Firms will have be seen as a processor, but as an built more robust defences opportunity driver that leverages against cyber attackers who may capabilities and data to provide increasingly target alternative advantages across the organisation. asset managers, given their high- Key non-investment activities that profile clients and the ‘richness’ will be significantly enhanced by of data. technology improvements include: • Operational due diligence. • Tax. Alternative firms view taxes Technology helps transform as a key operational risk. When one of the biggest drains on launching new products, asset resources for alternative firms The role of the tax middle office managers in 2020 will carry and their clients – the manual Successful implementation of a technology- out full assessments of after-tax and non-standardised nature of enabled tax environment depends on the performance and tax risk. Firms operational due diligence and related information exchange. maintenance of appropriate source data. will seek access to real-time data Properly establishing the key data needs on taxes and use analytics to throughout the organisation requires tax to inform their decision-making. Here’s how: have a voice in the organisation’s middle office. By 2020, the role of the tax middle CFOs and tax directors will Tax provide more tax transparency office emerges to parallel the customary role of the middle office. Drawing on tax, to owners and investors on a real Firms expect to be able to view accounting and operational resources and skill time basis. their tax positions and tax scenarios sets, it serves as a ‘go-between’ for the front across their entire portfolio and back office. • Compliance. Technology will on a single dashboard. The The role of the tax middle office will be to enhance compliance platforms overwhelming trend will be to move ensure that the growing tax data needs of by enhancing data-gathering the tax process to a technology- an alternative asset management firm are techniques and using dashboards enabled environment that captured and available. The tax middle office will drive data-related synergies by capturing to convert the analyst’s role from centralises and connects existing and tracking key attributes around deal and clearing exceptions to that of technologies to tax-sensitised a forensic investigator and an investment structures to facilitate tax analysis, databases. The use of a central tax planning, compliance and forecasting. By analytics expert. data hub will be the centerpiece of doing so, it links the front-office transactional the tax technology eco-system for tax planning and the back-office tax alternative firms, enabling investors compliance in an integrated year-round to get more information and greater process. 32 PwC Alternative Asset Management 2020

detail faster. Meanwhile, tax Many technology platforms of Analytics averts danger professionals have more time and alternative firms in 2020 can Ann Jones, the chief compliance officer for data available to focus on strategic gather, integrate and draw insights ALT Asset Management LLC is pulling up the tax planning initiatives that could from a wide variety of information performance analytics screen for all of ALT’s positively impact funds’ after-tax sources, both inside and outside funds. She notices the system has flagged performance and the performance the firms. Reporting will be a key a warning next to ALT’s flagship fund. ALT’s of the firm overall. focus: although most alternative compliance tools profile their performance firms recognise that reporting against policy rules and external benchmarks. Technology tools also allow This fund had outperformed the benchmark requirements are mushrooming, over the last month by 250 bps. Over the last alternative firms and investors for many firms, tax and regulatory 5 years, according to her screen, the fund to monitor tax services at their reporting is not at the required level typically has been in a range of plus or minus service providers and understand in 2015. 100 bps. workflow in real time. Tax The compliance tool presented Ann with the departments no longer have to Further, the technology deployed opportunity to ‘approve’ the warning flag or raise queries by phone or email, but can flex to adapt to new demands deem further investigation necessary. She are provided with a dashboard to and new sources. Internal decided to investigate. The tool automatically follow, for example, the progress of information resides in many, established a work item, logged Ann’s response and passed it to Zhang Wei withholding tax reclamation. unrelated forms. Some of the for investigation. Based on the alert, the information is structured such Alternative firms, via their service tool prepared a standard set of screens as order, execution, position and and reports for Zhang’s review as well as providers, can perform scenario balance data. Other sources will providing him with the functionality to drill testing in real time to assess the contain unstructured information, into details as necessary. One of the standard tax-sensitivity of buying and selling such as research reports, expert screens given the variance to benchmark assets for a particular investor. Tax network memorandum, phone was the performance contribution analysis, impact modelling will be a critical highlighting the sources of performance with a records, emails and instant differentiator for alternative firms. comparison to the benchmark. messages. Compliance technology solutions connect the dots. Zhang immediately notes that for the month Compliance of June the outsized performance is due to one single investment, in XYZ Corp. The Technology support for compliance Cybersecurity technology compliance officer requests the XYZ screen processes in 2015 can fairly be for ALT, identifying who owns it personally, Historical underinvestment in this who has traded it personally or for the fund, described as an unwieldy mix of important area is redressed by 2020. and which analyst covers it. For every person point solutions that have evolved Most firms are highly aware of who has ‘touched’ XYZ, he requests the on shoestring budgets. Each point security issues and have instituted individual employee relationship screens, solution is designed to address a sophisticated data protection drilling down into their knowledge and particular regulatory requirement. activities. This includes searching social media policies. It is usually developed and deployed sites to search for relationships to anyone at XYZ. He then has the natural language on its own, and infrequently First, leadership sets the tone. processor run a scan of the taped broker integrated with other compliance Alternative firms recognise the conversations for the last two months for solutions. business risks beyond portfolio any discussion of XYZ. “Hmmm,” he says to performance and market risk. himself. The analyst covering XYZ is a social Pressuring this landscape further, Investors are more educated about media contact of the head of R&D at XYZ. regulators have improved the emerging operational and security This needs further investigation… technology used to survey market risks and hold management activity as well as the processes accountable for dealing with them. and technology used to conduct their periodic exams. The asset Second, alternative firms know management industry is just their ecosystem better. They know beginning to come to grips with that protecting the firm’s revenue the fact that regulators have more streams, business processes, sophisticated technology than internal information technology, they do. intellectual property and client data goes far beyond physical walls. Firms seek to better understand the flows of all data between their firm and investors and third parties, which may include custodians, administrators, lawyers, 33 PwC Alternative Asset Management 2020

accountants, banks and data warehouse facilities. Firms update third-party due diligence criteria to include cybersecurity.

Third, traditional business continuity and disaster recovery plans are expanded to include the latest threats, scenarios and proper responses.

Technology for operational due diligence

By 2020, technology will have streamlined the operational due diligence process. Many manual processes are bypassed by a more bilateral technology-enabled process that avoids the need to re-key data and facilitates comparisons across alternative asset management firms.

Greater standardisation combined with digitised operational due diligence information and processes will be used to enhance transparency and facilitate information exchange, analysis and benchmarking.

By 2020, technology will have streamlined the operational due diligence process. Many manual processes are bypassed by a more bilateral technology-enabled process which avoids the need to rekey data and facilitates comparisons across alternative asset management firms. 34 PwC Alternative Asset Management 2020

Conclusion

Alternative asset management will undergo a transformation in the years to 2020 and beyond as it adjusts to a new operating and economic environment and moves towards centre stage.

The industry is highly fragmented today with great variation in strategic outlook and operating efficiency among the many firms that comprise the sector. This variation will narrow as the industry becomes more segmented. Those firms who are looking not just for growth but for sustainable growth, will develop more sophisticated market strategies while pursuing a chosen growth strategy that will allow them to acquire the necessary talent and capabilities needed. At the same time, they will have a clear strategy and create robust organisations to exploit the opportunities that will emerge in the coming years. They will, as they have today, still manage highly disparate strategies that leverage unique skillsets. But operationally they will start to look more homogenous as a group as they seek to create ‘industrial strength’ in their operations and processes.

Greater homogeneity will not mean that alternative firms will lose their edge. On the contrary, increasing standardisation and repeatability of key operational processes will confer durability and should lead to higher profitability in the years ahead.

Durability and profitability will be essential credentials for any alternative firm which has ambitions to follow – or lead – the industry to the centre stage of the investment landscape. 35 PwC Alternative Asset Management 2020

Contacts

Editorial Board Contacts for business From institutional Mike Greenstein imperatives quality to industrial Partner, US & Global Alternatives Leader Choose your channels strength PwC (US) Sovereign Investors Mike VanDemark +1 646 471 3070 Oscar Teunissen Partner, US Asset Management Technology [email protected] Partner, Global Sovereign Investors Leader Olwyn Alexander Tax Leader PwC (US) Partner, EMEA Alternatives Leader PwC (US) +1 646 471 8859 PwC (Ireland) +1 646 471 3223 [email protected] +353 (0) 1 7928719 [email protected] The right resources in [email protected] Retail Carlyon Knight-Evans David Brown the right places Partner, Asia-Pacific Alternatives Leader Partner, Asset Management Tim Mueller PwC (Hong Kong) PwC (UK) Partner, US Alternatives Advisory Leader +852 2289 2711 [email protected] PwC (US) [email protected] +44 (0) 7725 704549 +1 646 471 5516 Rob Mellor Peter Finnerty [email protected] Partner, Global Asset Management Partner, US Mutual Funds Leader Tim Wright 2020 Leader PwC (US) Partner, Asset Management +1 617 530 4566 PwC (UK) PwC (UK) [email protected] +44 (0) 20 7804 1385 +44 (0) 20 7212 4427 [email protected] Jose-Benjamin Longree [email protected] Partner, Global Fund Distribution Leader John Siciliano PwC (Luxembourg) Managing Director & Asset Management It’s not only about +352 49 48 48 2033 the data Global Strategy Lead [email protected] PwC (US) Technology Emerging Markets +1 646 471 5170 Julien Courbe Justin Ong [email protected] Partner, US Asset Management Advisory Partner, Asia Asset Management Leader Leader Michael Spellacy PwC (Singapore) PwC (US) Partner, Wealth Management +65 62363708 +1 646 471 4771 PwC (US) [email protected] [email protected] +1 646 471 2076 Joao Santos [email protected] Partner, Brazil Asset Management Leader Tax Andrew Thorne PwC (Brazil) Rob Mellor Partner, Asset Management +55 11 3674 2224 Partner, Global Asset Management 2020 PwC (US) [email protected] Leader +1 617 530 7606 PwC (UK) [email protected] Build, buy or borrow +44 (0) 20 780 41385 [email protected] Dariush Yazdani Sam Yildirim Partner, Asset Management Partner, Asset Management Deals Leader Will Taggart PwC (Luxembourg) PwC (US) Partner, Global Asset Management Tax +352 49 48 48 2191 +1 646 471 2169 Leader [email protected] [email protected] PwC (US) +1 646 471 2780 More standardisation, [email protected] more customisation Florence Yip John Siciliano Partner, Asia Asset Management Tax Managing Director & Asset Management Leader Global Strategy Lead PwC (Hong Kong) PwC (US) +852 2289 1833 +1 646 471 5170 [email protected] [email protected] www.pwc.com/assetmanagement

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