KPMG, the auditing giant based in the Netherlands, has put out a white paper on the “digitization mandate” in the alternative investment space. It maintains that fund managers who “dawdle” in digitizing their business are acting foolishly, falling behind the expectations of their actual and potential investors.
Consider fees. Preqin research says that 85% of investors saw an improvement (i.e. a lowering) of their hedge fund management fees in 2017, but 64% wanted to see further improvement in 2018. The old 2 + 20 structure (where managers would routinely charge 2% of their assets under management and 20% of profits) is something for the industry’s rear-view mirror. In this respect, managers are going to have to protect their margins not by trying to insist on the old fees, but by cutting their own costs, which in turn requires an increase in the efficiency of their operations, which is what digitization offers.
Benefits to be expected from the embrace of the new technologies, KPMG says, include:
- More efficient end-to-end processes;
- Improved insight into key operations;
- Increased returns; and
- Improved regulatory compliance reporting.
The underlying data for this report includes two recent KPMG surveys: one that polled managers and other senior AI executives from more than 19 countries (the “Transformation Survey”); the other a project co-sponsored with CREATE-Research, involving 125 countries (“Digitize or Jeopardize.”) The authors also relied on Preqin’s information on performance and management fees.
Misconceptions and Taxes
The new white paper contends that there are two big misconceptions that are delaying the transformations: on the one hand, that such a transformation would be “a program conducted by, and undertaken for the benefit of, an organization’s’ information technology team”; on the other hand, that digital transformation is not a strategic imperative. The reverse of each view is the case.
Fortunately, nearly two thirds of the respondents to the Transformation Survey said that their organizations have begun to transform their business models in response to transformations already underway in their marketplace.
Unfortunately, nearly half describe their response to transformation as “ad hoc.” And only 2% see themselves as highly capable of designing customer-centric business and operating models.
The white paper identifies the tax responsibilities of a management as an area “ripe for the introduction of digital labor.” For example, new natural language processing can help extract information out of various tax forms and related papers. Also, regulatory compliance tools assist with federal/state tax forms, reporting for indirect tax, book-to-tax reconciliation, and regulatory documentation. Systems for risk and dispute management can track and analyze disputes, Sarbanes-Oxley, and tax authority inquiries.
The report quotes Jim Suglia, KPMG’s National Practice Leader in Alternative Investments, saying: “Tax is a great example of where digital efforts are paying dividends.”
A Business Case
The report also discusses a business case in which a multinational organization involved in alternatives in real estate, hedge funds, private equity, and infrastructure funds, has “increased its use of digital tools in a number of operational regulatory areas” but in the context of its investment function, it is encountering “pockets of resistance among some of the traditional investment managers.”
Suglia says, “We recognize that some veteran professionals may not be entirely convinced that a machine can find worth investments better than they can.”
The pushback accompanies a sense that the humans are being replaced. KPMG’s white paper doesn’t entirely deny that some will be, through it says that the idea is to use silicon-based technology to work alongside (carbon-based) professionals. Investor demand requires it. Adam DePanfilis, a KPMG director specializing in alternative investment organizations, says “Investors want to see humans maximizing their potential by leveraging every possible tool at their disposal.”
As a matter of the human resources involved, KPMG says that alternative investment firms must “relentlessly pursue computer and data management scientists,” all while demanding “that portfolio managers, risk specialists, and client-service teams have continuous interactions with the tech talent to foster cross-learning opportunities.”
It also advises that management align itself “with fintechs that have shown this industry that they can offer faster, cheaper, and leaner solutions to help organizations grow.” KPMG expects a heightened pace of alt-investment/fintech partnerships in the years to come.