Experts discuss private markets exposure to retail investors, fund costs, the impact of the Sustainable Finance Disclosure Regulation and technology opportunities.
Jorge Fernandez, Ireland investment management leader, KPMG
Furio Pietribiasi, Managing director, Mediolanum
Roger Woolman, Chief revenue officer, Deep Pool Financial Solutions
Funds Europe – Bringing private equity and other private markets investments to retail investors now appears to be a major development and opportunity within the EU funds sector. How realistic does the panel think this ambition is, and what are the operational challenges for the fund administration sector?
Furio Pietribiasi, Mediolanum – From the distributor perspective, there is a growing interest and demand to explore the opportunities offered by alternative investment solutions since they deliver better risk-adjusted returns. This isn't necessarily because of better absolute performance, but it comes from the fact that private assets are usually less volatile. For this reason, even when returns from liquid and illiquid are similar, it's possible to improve the risk-adjusted return for investors. Market volatility is significantly impacting all the market segments, including fixed income, where even most high-quality instruments, like government bonds, have been materially volatile.
That said, it's not simple structuring cross-border solutions for retail markets. The minimum investment for a professional investor is €100,000, while for retail investors, this goes up to €500,000, and the exposure of this investment needs to be limited in the client portfolio. New vehicles specific to local regulatory frameworks allow lower tickets for retail investors in those specific markets. At the same time, the European Long-Term Investment Funds (Eltifs), which would permit distribution across Europe, unfortunately, haven't materialised as a real mainstream opportunity for retail clients.
But for distributors, there are operational challenges we should mention too. For example, one of the complicated mechanisms is capital calls. While there could be solutions to avoid or minimise the impact of capital calls, like fully funded products that switch underlying investments from short-term fixed income securities to private debt or equity investments over the life of the product, they do not necessarily work for every private assets strategy or manager. In other cases, more recently are becoming available also in Europe evergreen funds of funds, which are very diversified with quarterly liquidity windows targeting the wealth management space and are promoted by players like Hamilton Lane or StepStone.
Jorge Fernandez, KPMG – There has been a higher demand and growth in the alternatives at every level over the last ten to 15 years, and it will continue because they are part of the portfolio compositions of any wealth management, high-net-worth individuals, professionals and retail. In certain areas, such as continental Europe, the demand is fund of funds; more of a push than a pull from private banking and wealth management units.
The challenge is strategic. Private equity is highly sophisticated, so even from a suitability perspective, there must be a good analysis from a Markets in Financial Instruments Directive (MiFID), Undertakings for Collective Investments in Transferable Securities Directive (Ucits) and super management companies (ManCo) perspectives to ensure clear expectations match between shareholders and effective product development. In addition, the design of Eltifs shows a mismatch between illiquid long-term assets and short-term demands, which, from an asset and liability management perspective, is problematic.
Around administration, technology is critical. I doubt there is a good technology for commitments carrying waterfalls on an open-ended structure since limited partnerships or reserved alternative investment funds (Raifs) or Ireland's Limited Partnerships Act, 1907, are used. Those are not properly designed to have open-ended in and out because the asset will be long-term and subject to liquidity events. So, all the structure features must be built properly in the design product.
Roger Woolman, Deep Pool Financial Solutions – Traditionally, retail investors accessed the private equity space indirectly through exchange-traded funds (ETFs). We would get an index of publicly traded firms that invested in private equity, but we're now discussing democratising investment and private assets. As a technology firm, we see managers' and administrators' demands to deliver solutions that are retail-like for private equity and alternative funds and investors, so technology plays a central role.
Regarding fund complexities from a back-office perspective, we need to surface solutions in the front office to onboard investors into these alternative investments in a retail manner. That's the client demand that we see currently, and our clients are principally hedge fund and private equity administrators who now need to enable retail-like investor onboarding, reporting and investing. Technology is becoming an enabler for the democratisation of private assets.
"There is a critical convergence at play: when discussing private assets, funds and wealth management, the broker or adviser acting as intermediary is the conduit for wealth management and private assets."
Concerning creating secondary markets through technology, fractional ownership through distributed ledger technology (DLT) will be a part of this. To provide liquidity, from an investment strategy perspective, there needs to be asset-type consideration. It's an exciting time for technology because the market demands parallel technological advancements and innovation. There is a critical convergence at play: when discussing private assets, funds and wealth management, the broker or adviser acting as intermediary is the conduit for wealth management and private assets. Technology is now positioned to occupy this intermediary space.
Fernandez – All big private equity houses in the US have their own wealth management business, creating demand themselves. Blackstone, for example, has its own wealth management line of business. Demand is created by taking a different approach to high-net-worth individuals. I am still determining the extent of real estate here, but many high-net-worth individuals are retail. They may only qualify partially for retail, but the trend is growing.
Structuring and suitability are important, and people need to understand lock-up periods, how quickly these assets are for, when liquidity events happen, how quickly they can get their money back, and what expectations are. These factors should be part of portfolio composition as a family business, family office, high-net-worth individuals, ultra-high-net-worth individuals, etc. But if these factors enter retail asset Ucits, Eltifs or Raifs in Ireland, careful consideration should be provided.
Pietribiasi – Suitability is a very important element, but also diversification is critical, particularly when you have less money to invest. For example, if you consider a retail investor with €100,000, and an amount of €10,000 or €20,000 is placed on a product that is going to last ten years – especially if we are talking about private equity or real estate – one of the big questions is: "Are we sure that the product is suitable?" Compliance suitability is one thing, but meeting client needs is paramount. That's where financial advice and professional financial planning make a material difference. So, if I buy off-the-shelf from a bank, I might meet all my regulatory and product suitability requirements, but it might not necessarily suit the client's needs and expectations. What about if the clients need their money and don't realise they are locked? So, this is a client education issue.
On the other side, if it's the bank managing money for an affluent client, so wealthier than retail, it's the bank that develops the investment solution comprising different underlying investments – some liquid, some illiquid. We are discussing something that is usually well-diversified and constantly managed by professional investors employed by the bank. Conversely, in the case of high-net-worth individuals, there's the possibility of having a professional team of people who select and allocate money on the client's behalf for different funds or products. Even though there might be a similar degree of education among these three types of clients, the smaller client needs are very different from the financial perspective. So, commercial suitability and meeting client needs are extremely important.
That is why we often look at products from a regulatory perspective. However, it's crucial to consider suitability from the client's perspective and their needs. This is where the role and difference of distribution channels prove to have a substantial relevance. Therefore, having a professional financial adviser between the investor and the solution is valuable.
Fernandez – Look at real estate or open-ended funds in the UK two or three years ago. Structurally, there is a mismatch. Having illiquid assets with average life leases of ten years that are also open-ended doesn't work. Many factors need to be considered to ensure the product is structurally sound. The asset, timeframes and portfolio composition must all be understood.
There is a place for private equity in building portfolios, of course. It can be achieved via listed equities, listed Reifs [real estate investment funds], listed vehicles or funds where somebody can consolidate, invest and provide exposure. But it needs to be done most suitably for investors to ensure that we protect them and that they understand what they are investing in.
Funds Europe – The costs of dealing and settling investment funds far outweigh that of securities, so does the panel agree that the funds industry at large has some way to go to equalise fund costs with those of securities, and what might a roadmap look like for the Ireland funds industry to lead the way?
Fernandez – We shouldn't be lumping everything together. Fantastic products and innovations like ETFs and passive products have democratised finance for retail people and investors like us. Of course, I understand people who might say, "Well, it's not only just the total exposure ratio (TER) that you can see in ETFs; it's also the bid-ask and total cost of ownership in the ETF." They have been highly valuable for investors by providing portfolio compositions. The industry has made a more fundamental change in the last five to ten years than in the previous 150 years concerning product development, robo-advisers and technology in the form of DLTs.
We should remember that regulation is fundamental – and it's expensive. You need to scale, and the industry has brought a lot of value for investors in the last five to ten years, but further advancement is needed. Looking back to 2007-10 when the two-and-20 model was central, the demands on investors were far more sophisticated. They got more value for money and put out professional managers to deliver. The passives are putting a lot of pressure on actives, and that's value for money.
Pietribiasi – I believe the assumption that ‘cheaper is better’ for clients is wrong. If investors opt for a do-it-yourself with securities, it might be cheaper: you do it on a platform, but the concern is the selection. Should investors consult meme stocks, as became clear with GameStop in 2021?
A way to destroy value over the long term for investors is to simply buy when a market is going up and sell when the market is going down. Market timing does not generate value in the long term. There is automation in the market, and it democratises the industry, but it comes with risks. Democratising and cheap investments sound great, but having somebody to advise with the necessary resources is vital. Think about ETFs. Suppose you want somebody who tries to do better than the index and makes a specific selection within the market or pursues specific strategies that an index cannot replicate. In that case, you want to rely on somebody's skills and competencies.
The industry has made a more fundamental change in the last five to ten years than in the previous 150 years concerning product development, robo-advisers and technology in the form of DLTs.
When we look at millennials or Generation Z, when we are not talking about a few thousand, their savings increase and their financial needs are complicated; they look for professional advice because they have too much at stake. Before putting any of their savings into investments like GameStop or other fashionable investments with very strong short-term momentum, they must consider their long-term financial stability, especially when they get married, have children, etc.
Woolman – Earlier, we talked about operational challenges as retail funds try to accommodate alternative assets, and conversely, from the other side, alternative funds are trying to operate in a more retail-like manner; the two sides are meeting. Costs, or streamlined commercial offerings, are technology-dependent.
There are cost savings in the digitisation transformation. Streamlined commercial offerings emerge as we revise trading models, platforms and technology. Suppose we drive operating models more towards self-fulfilment rather than necessarily a pure retail investor investing a small amount of capital since it could be an institutional or high-net-worth investor. In that case, we'll see self-fulfilment models joined with back-office systems.
Distributed ledger technology should be part of conversations concerning the streamlining of operating models, such as the reconciliation processes and settlement processes, and so forth, that add stages and transactions into the trading of funds. But, again, being in the technology world, I do see inefficiencies that clients bring to me, and of course, there's a cost implication for those if they impact the ability to scale. The funds world is more complex, and we need to simplify it, whether through revising the processes or using technology.
Fernandez – Passive investing is going through a revolution. There is space for active investing since the actives need the passives and vice versa. Digital assets and DLTs are essential here. The industry needs to move quickly to create a full ecosystem from depos and custodians to settlement. Industry efficiencies can be found here.
Another important point is that we are 100% dependent on banks. Banks are looking at process harmony as much as possible to reduce costs. Integration is one of the biggest challenges for banks. That explains why many solutions are not available through banks, particularly mass-market solutions, since they have technology challenges, taxation challenges and so forth. The technology is there in DLTs. But, if the ecosystem isn't brought together, then no major progress can be made. For example, settling transactions will be challenging if a custodian or a front office is not using, as a DLT example, ethereum.
Funds Europe – The EU's SFDR rules regarding sustainable investment are making a huge impact on fund managers as policymakers attempt to stamp out greenwashing, so what primary effects or changes are the panel seeing within fund administration?
Fernandez – It depends on whether we are talking about fund administration only or, more broadly, across the industry. If broadly, it's fundamental to product design. If it's fund administration, there is less impact. The Sustainable Finance Disclosure Regulation (SFDR) is the end component of a fundamental European revolution. It makes investors ask: "What is our risk appetite?" "What is our strategy as a manager?" "Where are we going to build and distribute products?" "What data will I have, how do I manage that data and how will I comply with SFDR?"
Pietribiasi – Let's consider the European ESG Template (EET) files, where some fields are becoming commercially compulsory. These files have more than 500 linking fields related to different aspects of ESG [environmental, social and governance]. Collecting, maintaining, compiling, and distributing these data is a massive task, but it's an administrative burden that becomes more manageable once the right infrastructure and automation are in place. Fortunately, technology can be helpful in this.
Recently there have been some discussions over the financial scene around dropping Article 9 funds, and the industry seems to happily welcome a possible change in these terms. When more details were added to the first draft of the regulations, complications emerged. Regulator expectations increased, mainly related to higher risks of greenwashing over the market. But we also need to highlight that many cases of greenwashing are not intentional, as this phenomenon often comes from a lack of clarity and interpretations issues.
Of course, it's not the fund label itself that makes a long-term difference; it's the long-term opportunity for investors. The ESG element is independent and doesn't necessarily promise better investment returns. The transition to a more sustainable economy will require trillions of euros yearly for the next ten to 30 years, opening a new renaissance in the investment space because of substantial changes in how people produce, build and move. New one trillion-cap companies will emerge accordingly to the new trends, which will happen much sooner than for companies like Tesla and Amazon. Linked strategies anchored to specific sustainable initiatives and trends will be long-term capital appreciation opportunities for investors. Still, of course, they will also need to be managed appropriately, respecting ESG investment processes.
"New one trillion-cap companies will emerge accordingly to the new trends, which will happen much sooner than for companies like Tesla and Amazon."
Fernandez – ESG should be thought of in something other than a distribution-like way to raise capital. Regulators will go hard on this topic; we see Esma [the European Securities and Markets Authority] and CBI [central bank] in Ireland doing a thematic review now. Mis-selling is also an important topic. Articles 6, 8 or 9 were not meant to be about labelling, but they became labels, and our colleagues in the UK understand that better than we do in the EU.
Backing up data has become an operational challenge. Investors are seriously considering how to align risk management with data, what the data provider will be, what the underpinning ratings are, the transparency, data capture, etc. On top of that, they have to do all of that while complying with SFDR consistently.
When we have SFDR compliance standardisation, things will undoubtedly get easier. However, there are clear outliers, and regulators are targeting them rightly for mis-selling, whether the mis-selling is intentional or not. Risk management procedures and strategy documents should be sought after for those well intentioned.
Woolman – As most know, SFDR is only as good as the data being used. Greenwashing starts from the data source, particularly mislabelling or a compliance issue not being flagged. Some rationalisation and streamlining would help in other areas, like costs. They also have a knock-on effect in providing transparency. Also, data management and models must be optimised, some of which are derived via the technology changes driving retailisation. The digital investor experience may provide a look-through for SFDR compliance. There are data capture needs at the fund or product and investor levels. Essentially, investor preferences must be constantly monitored and checked, not just the fund or product status.
Fernandez – Effectively, you are as good as your data, but when there is a concentration of data providers, data providers become expensive. We have yet to discuss how expensive the data providers are, who pays for the data and how that goes back to the investors. Those are all the challenges the industry faces now, and with all good intentions, it needs to be thought through properly.
Funds Europe – The Irish funds industry has carried out a major study into what the country's funds sector needs to do in order to meet the technology requirements of the future. Findings were published in a report called 'Sector Technology Needs Analysis September 2022'. I'm curious to know what opportunities are opening up for people in the funds industry and graduates and how these people will aid the funds industry to meet client needs.
Fernandez – In Ireland, we can dynamically and quickly determine where and what to invest. I hope Ireland moves from a back-office centre to a middle-office technology centre. For example, we may never get the front-office position that the UK has because we need the ecosystem. We must invest heavily in maths and effectively in chartered financial analysts (CFAs) and financial risk advisers (FRMs).
Being a back office is good, but it carries a risk of commoditisation, and commodities can drop in cost in other jurisdictions. So, we need to be ahead of that, and for that, it needs to embrace technology and evolve into an established middle office. Our colleagues in the UK are financially aggressive and phenomenal competitors. So, it's essential that we think ahead to make inroads, and we must invest, but we need to invest in the right places.
Pietribiasi – When I came to Ireland 25 years ago, fund administration was entirely done in Ireland. Today, only the most sophisticated fund administration processes are handled in Ireland, as other players have built scalability through offshoring in India, Malaysia and Poland. As many know, now Poland has become the back office of Europe, where all the biggest players ended up.
Unfortunately, the cost of living in Ireland is very high. Organisations can only keep such high salaries in the market by focusing on very high-end activities, which require growing sophistication and higher competencies. Moreover, technology is also impacting this, as certain jobs are becoming redundant.
For example, recent research by Goldman Sachs predicts about 300 million jobs being lost due to the adoption of artificial intelligence across the world in the next ten years. Still, the creation of new and better-paid jobs will compensate for this. In addition, there are challenges surrounding the lure of offshore locations. With reference to this, a key element to keep Ireland competitive has been investing heavily in education, as it is fundamental since it can attract innovation and higher-quality jobs.
Fernandez – We are phenomenally privileged to work in this industry in Ireland. We're talking about the natural evolution of moving into value add. We have a great country that can be effectively shaped and quickly.
Woolman – Interestingly, you mentioned that Ireland provides back-office services. My clients are fund administrators worldwide, and there is a number in Dublin, so you might think of them as giving that back-office experience or service. The demands they place on me as a technology provider are becoming more front-office-like regarding tools for raising funds, capital-raising, portals and direct interactions with investors. Some of this starts now to become a value add. It's part of that process streamlining, too.
"Research by Goldman Sachs predicts about 300 million jobs being lost due to the adoption of artificial intelligence across the world in the next ten years."
In the middle office, we still see a lot of outsourcing or a co-mingling of human resources and technology. Still, in terms of that client-facing experience, technology is moving us away from the white-glove approach of the traditional wealth and private markets.
Regarding the referenced study, important concerns are decision-making, operational efficiency and improving client experience, so we see the technology coming into play, particularly in client experience or operational efficiency. When discussing opportunities for people in the funds industry, I think of more than just the technology opportunities because we shouldn't be driven by technology. Instead, we should be driven by a new way of working or a new business model, so we also need people to be educated who will encourage those new ways of working on designing and improving the business models. That creates opportunities too.
The ‘Sector Technology Needs Analysis September 2022’ study mentions technology trends in what people should focus on and where education should be placed, whether Python or Angular, etc. Still, we know that changes take time, and something else will emerge next year and the year afterwards. Interestingly, the business models and business expertise that keep the industry together mostly stay the same over time – they require deep expertise to guide them. That's what Ireland brings to the plate. Ireland doesn't just bring technology; it brings expertise in the funds and asset management industries.
If we want to move out of that back office into the middle and front offices, Ireland must take on more of the industry. Change is guaranteed, whether that be operating models, business processes, or the implementation of new technologies. These changes require an education push across the funds sector in Ireland.
Fernandez – To do that, we must all work with the industry and the Irish government. Our colleagues from the UK are no longer in the EU; we need to get closer to our colleagues in continental Europe. For that, people in our industry in Ireland must learn other European languages. That's an enabler of better business since it allows people to understand better different cultures, how people get things done, etc.
Language education alongside mathematics will be such a skill enabler. We need to invest much more in engineers as well. This should be a strategic plan for Ireland because other domiciles like Singapore, Israel and Switzerland are investing heavily in these areas, with deep pools of talent in India and China we don't have.
We must challenge ourselves to advance our country's position, continuously asking, "What's next?" and "What can we do better than other countries?" Moving to a front office or embracing innovative technology sounds phenomenal, but we must build, which requires Ireland to invest heavily.
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