Investors’ quest for scalability

Costs in alternatives are coming increasingly into focus, as investors and regulators up the pressure.

The alternative investments space has been “skyrocketing” over the last 12-15 years, both in terms of fundraising and capital deployment, says Deloitte Luxembourg’s Arnaud Bon. “It has reached levels never seen before, with an approach which has among those managers been extremely entrepreneurial and business-focused, [in terms of] putting capital to work.”

It’s a conscious approach to investing, part of a wider trend also in the increased demand for ESG. Despite an uncertain economic outlook, there’s a realisation that to continue such growth, certain shifts have to happen when it comes to costs, operations and scalability.

Bon says there has been an acceleration into this topic lately, in part due to the economic slowdown. Managers are realising “while [they] are a little less busy with investment capital deployment right now, [they’re] going to have more resources, time and bandwidth to actually consolidate or reinforce the operational backbone so that when things get back to normal or better… it has gained a high level of priority.”

The cost pressure is coming from two sides, Bon argues: investors and regulators.

For investors, “It’s more a matter of transparency… They’re all going to have different levels of management fees–per class, strategy, geographies, they’re going to be pretty much standard. But the devil in the details is whatever comes on top of that,” e.g., the fees charged by a manager to operate a fund, or by a third-party, etc. Very often, it’s operational costs that are creating those additional charges. The partner adds that essentially the middle and backoffice activities are under pressure from operating costs, but the key focus for the industry today is what he calls the “holy quest for scalability: making sure that the additional euro or dollar raised and invested does not translate proportionally in terms of operating costs.”

Drilling down further into action items, process efficiency is one area that can be questioned. “The industry is overall very manual, process based, [which] has to do with the nature of the asset,” Bon explains, adding that while DLT is promising for listed securities, it’s not the same in the alternatives space. And what’s missing for automation is standardisation, given the various sub-strategies, geographies, markets, etc.

And with alternatives opening up more to sophisticated retail investors, new considerations are underway with regards to costs and charges. As Bon notes, although the US Securities and Exchange Com­mission tackled similar topics a decade ago, “more recently ESMA [European Securities and Markets Authority] has been asking alternative managers to bring more transparency, more governance around the overall fee, remuneration and cost structure of the product.”