The need for data innovation in alternative investments

This article is sponsored by Mercatus and first appeared in Infrastructure Investor’s North America Report

Q: What are the big opportunities for infrastructure investors in North America?

HP: There is a tsunami of capital being invested in alternative asset classes – $20 trillion by 2020. The ugly duckling has become the swan. The alpha returns race is wide open, which means a global land grab as infrastructure, energy, and real estate merge into Environment, Social and Governance (ESG) impact investing.

We believe, and we have stories to validate, that companies that can successfully connect people, data and processes have a great competitive advantage. And all of us have an opportunity to impact our global footprint and create a more sustainable planet, which is incredibly exciting.

Q: Conversely, what are the biggest operational challenges the asset class faces?

HP: Opportunity always brings risk and we are seeing that manifest itself in a number of ways. First is fee compression – partially driven by millennials – which means investors have to learn to do more with less.

Second is margin pressure as more funds enter the market, increasing competition for the best infrastructure deals. Third is the massive unscalable data complexity being created by diversification and globalisation of assets, funds, and portfolios. We call that a perfect storm that GPs have to navigate. But there’s still one more dynamic at play here. As LPs write larger checks, they are also demanding more transparency, traceability, and real-time analysis. That is yet one more pressure point on already stressed internal teams, and fund managers who are trying to do more with fewer resources as they work with a reduced fee structure.

Q: How can technology be employed to respond to these challenges?

HP: We conducted in-depth global analysis of growth in assets under management and found that growing infrastructure AUM over the last decade has had no gain in productivity. In other words, headcount has grown linearly to scale AUM. With the fee structures diminishing, doubling headcount to double AUM essentially requires fund managers to defy gravity. If you stress existing teams, you increase error and risk exposure. It’s impossible to increase AUM while keeping operational risk in check with current legacy IT infrastructures.

From a process perspective, funds are thinking about raising money, investing money and managing assets as three separate processes. This is compounded by building IT infrastructure around these to support each process – e.g., the investment team working with legacy front-office CRM building a system-of-record for customers; the asset management team using a ledger-based system-of-record for the back-office.

Missing is a system-of-record for projects and assets across the lifecycle of an asset from origination to divestiture. Investors need to connect critical data locked up in bespoke excel finance models, thousands of documents and email conversations, and centralise it to improve investment decisions and gain the upper-hand on operational efficiency across the entire organisation. This is where the right platform technology can play a critical role in building a scalable foundation for growth. Intelligently centralising data allows the organisation to spend time analysing risk and performance, and forward-looking valuation scenarios, instead of focusing on just meeting reporting and compliance requirements.

Q: What are tangible ways in which data, and the technology to harness it, can lead to better infrastructure returns?

HP: Let me give you a few examples. We worked with a company that had acquired a set of wind farm portfolios. The business model was to sell those assets at the perfect time, and, as we know, timing markets isn’t easy. It was taking that company 23 days to run stress test scenarios, such as fluctuation in currency and inflation rates, which has significant effect on the valuation of wind assets. After centralising the data in our platform, we reduced that time from 23 days to 2-3 hours. Having the ability to do real-time scenario analysis enabled them to gain around a 108 basis point-advantage on the value of the asset.

A second company was operating across 11 different asset classes in 35 countries. Each of those regions had its own deal pipeline and was reporting differently. By getting the basic foundation right, dynamically connecting people and data across the enterprise, that company was able to kill deals in the business development phase a lot quicker. Dead deal costs can be very high. Even more meaningful was the digitalisation of their processes, which enabled the business to increase its assets under management fivefold with the same 200 investors globally.

The superior structural cost advantage allowed them to aggressively bid on new asset acquisition, gain market share and improve IRR performance.

Q: What stage is the infrastructure industry in within North America in terms of technology sophistication?

HP: I would say we are in the early innings of true digitalisation. There are early adopters that have sensed the opportunity to create an agile infrastructure, who see how technology can lead to better, faster investment decisions, competitive differentiation, and alpha returns.

But there are also infrastructure managers that are overinvesting. They are creating spaghetti code and then facing the nightmare of trying to untangle it. Throwing money at the problem can sometimes create more data silos when the goal should be simplification and centralisation.

Q: What’s next for the adoption of technology in North American infrastructure? Will we see emerging technologies at work?

HP: There’s no question that speed and accuracy of decision making in the infrastructure world will be a defining differentiator.

This will not happen without the use of technology to process data faster and empower executives with real-time data they can trust to make good financial and investment decisions. Ultimately, technology will reduce deal friction, increase capital velocity, and deliver efficiency on steroids.

It’s happening quickly. The world of infrastructure and alterative assets is ripe for innovation. The opportunity for the US – and for every market – to become better, faster, smarter, more predictive for investors is right around the corner. But it’s so important to get the foundational plumbing right.

Most infrastructure investors are still relying on 30+ year-old technology – e.g., Excel, Powerpoint, email, people and duct-tape – for critical business functions to scale the business. Funds will need to invest in better collaboration tools to streamline workflows. Due diligence and underwriting have to be systematised and the underlying data have to be centralised.

Once that is in place, you have the possibility of introducing new technologies such as machine learning and artificial intelligence. Once you can see behaviours and repetitive patterns, then you can apply machine learning. Once you have documents centralised and connected to financial spreadsheets, you can look at technologies that read those documents automatically, eliminating human eyeballs and mistakes.

Q: In light of technological advancement, what does the future spell for the evolution of the infrastructure industry in North America?

HP: The US, China, India are still relatively early in the infrastructure rebuild, meaning there are multiple decades of land-grab opportunities to come. But competition will be fierce.

The companies that have lean overhead, that are agile in making fast, accurate decisions will secure alpha returns. The markets are big enough to have many winners.