Alternative Investing: Finding the Right Balance on Transparency

The 2008 credit crisis highlighted the risks associated with having large sums of money invested in opaque, illiquid assets. Nine years later, little has changed to improve transparency in…

The 2008 credit crisis highlighted the risks associated with having large sums of money invested in opaque, illiquid assets. Nine years later, little has changed to improve transparency in the alternative investments marketplace. A new survey by Northern Trust and The Economist Intelligence Unit shows that investors rate transparency a top priority, even as asset managers continue to search for a consensus on how best to deliver it. Absent market standards, investors are left to work through bilateral agreements, side letters and other arrangements to meet their transparency needs as best they can.

Based on our experience serving both clients that invest in alternative strategies and clients that manage them, we believe a more focused, industrywide approach to transparency could yield benefits for each group. And we believe better practices are possible if managers and investors work together toward:

  1. A more nuanced conversation about transparency.
  2. A more strategic approach to managing transparency requirements.
  3. A more collaborative partnership between the buy and sell sides.

Taking a more nuanced view of transparency

Ask investors whether they’d like more transparency in their alternatives portfolio, and most will reflexively answer “yes.” But because transparency comes in many flavors, each presenting different opportunities and challenges, achieving “more transparency” is hardly simple. Is the objective deeper insight into holdings? Faster notification of portfolio changes? A better understanding of valuations? Something else?

A good place to begin shaping a more nuanced view of transparency, whether you are an investor or a manager, is to evaluate the different types of transparency and their importance to your organization and stakeholders. Next, consider the tradeoffs you’re willing to make to achieve your transparency goals. If you’re an investor, you might ask:

  • Will I trade performance for transparency, and if so, how much?
  • Am I getting value from transparency? (Do I have the systems and skills to derive meaningful insight from the data I’d be given?)
  • Am I willing to pay more for the operational costs associated with transparency?

Managers needs to ask themselves similar questions:

  • How far will I go to accommodate the requirements of large investors?
  • What are the risks associated with public disclosure of my fund data?
  • Am I willing to walk away from a large investor to protect intellectual capital?

Once investors and managers have considered what they really want and need, and what they are willing to sacrifice for it, they can begin to develop a more realistic transparency framework.

Treating Transparency Strategically

Our experience has been that few organizations treat transparency strategically. We believe those that do reap valuable dividends. For those new to the exercise, we recommend developing a transparency “tool kit” to facilitate decision-making and consistency across the organization. This tool kit should consist of agreed standards, processes and controls to govern how the organization assesses transparency, and how it uses the information it produces. While each firm’s tool kit should reflect their unique requirements, the development process will typically include the following standard steps:

  1. Identify stakeholders. While transparency is critical for risk management, decisions around transparency practices affect a broad cross-section of the organization.
  2. Prioritize types of transparency to ensure the most important are addressed, and to determine where tradeoffs are and are not acceptable.
  3. Rank key questions and build your tool kit. Specific questions on your list will depend on your transparency goals, but universal examples for managers include questions like “What ‘industry standard’ levels of transparency do our peers provide?” and ‘How will we communicate with investors whose transparency needs we cannot meet?” Investors might ask “What’s our minimum acceptable level of transparency?” and “What’s our process for exempting an investment from our standards?”
  4. Establish practices for review. Review your transparency tool kit at least annually to assess changes in market practice, review organizational strategy, and test and confirm controls and procedures.

Forging a partnership between investors and managers

Unlike traditional equities and fixed income, alternative investments are complex, long-term commitments more like joint ventures than transactions. Where investors and managers understand one another and have complementary objectives, alternative investment funds are more likely to succeed. Similarly, if they approach their interactions as a partnership, they may find reaching a consensus on transparency practices easier.

Because we support both investors and managers around the globe, we see the complexity and subtlety on both sides of the transparency discussion. Investors have legitimate data needs for risk management, stress testing and due diligence. But variances in data formats, and the systems and talent requirements needed to normalize and get value out of data, present layers of expense and complexity to taking advantage of transparency. Managers, meanwhile, face challenges relating to the complexity of the data requested and the potential competitive harm that providing more insight into their operations might cause them.

While we don’t presume to know the best way to solve these issues, we do believe the path forward involves reframing the conversation. Rather than talking about transparency within their own camps, investors and managers need to meet and talk in an industry-neutral setting. Participants should include not only senior leadership, but also the people who are actually generating and using the relevant data and who may have the most intimate understanding of the complexities associated with meeting transparency objectives.

Moving toward consensus and better practice

There is no magic bullet that will resolve the challenges around providing the transparency investors want from alternative investments while simultaneously satisfying the privacy and competitive concerns of managers. However, with a more nuanced and strategic approach to the issue, and a more collaborative partnership between investors and managers, we believe the alternatives industry can identify and adopt better transparency practices and create a more vibrant and rewarding market for all who participate in it.


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