The large majority of hedge funds and private equity firms are not reacting quickly enough to digital technologies that are radically reshaping the alternative investment industry, according to a research report by KPMG International and CREATE-Research.
The report “Alternative investments 3.0 – digitize or jeopardize” is based on a global survey of 125 hedge funds and private equity firms and shows that while 98 percent of respondents say “business as usual” is not an option, at least three out of five respondents said they are still at the nascent stage of “awareness raising” with respect to revolutionary technologies that could potentially transform their businesses.
For instance, only the top hedge fund managers are getting close to utilizing machine learning techniques after years of trial by experimentation. Others, however, are making only slow and incremental progress. Many fund managers find it hard to trust innovations that are not yet fully understood, the report finds, noting that “until machine learning is accountable to its users, it will remain the preserve of the early adopters with a strong technology DNA.”
The report identified activities such as portfolio risk management, research and securities selection, alpha generation, deal flows, risk and compliance, and fund accounting as particularly prone to disruption in the front, middle and back office.
“What the internet did to the music business, digitization will do the alternatives industry – it is not a question of if, but when. The big players are well ahead, but the rest face an Everest of a task,” said Anthony Cowell, head of asset management at KPMG in the Cayman Islands, and the report’s co-author.
Less than a third of respondents said they are at the implementation stage for key innovations for both hedge funds and private equity, whereas advanced technologies such as blockchain and robo-advisers have been implemented by 3 percent or fewer.
While the disruption of the industry is not in doubt, with 63 percent of respondents expecting either a full or partial disruption of their business, there are different opinions as to where the disruption will come from.
Fintech companies are already carving out a niche in the industry landscape, by designing tools that are superior to the ones currently used by hedge fund and private equity managers. But only 22 percent of those surveyed expect the disruption to come from these external actors.
Nearly half (44 percent) believe that hedge or private equity funds will collaborate with these external rivals to gain an edge.
In contrast, many of the larger fund managers (34 percent) see the top funds actively drive the technological change to counter any competitive threats.
Factors affecting the pace of innovation
The pace of digital innovation in most businesses is mainly driven by market factors such as growing cost pressures (58 percent), changing investor needs (51 percent), and fees and charges (30 percent), the survey shows.
In addition, the growing social acceptance of digitization and end-investors becoming more demanding (37 percent) and more financially and digitally savvy (36 percent) are important factors.
“Only a minority of firms we surveyed are deploying innovations designed to give them a competitive edge. With growing pressure on costs and the demands of digital-savvy millennials, this will have to change markedly,” noted Al Fichera, global head of alternative investments at KPMG International.
But there are a number of reasons why the adoption of new technologies is lagging in the alternative investment industry.
Survey respondents cited cybersecurity concerns (58 percent), legacy IT systems (43 percent), and high cost (42 percent) as factors delaying the implementation of digital solutions.
Others noted that senior executives were too focused on day-to-day matters (40 percent) or they blamed regulatory issues (39 percent) and a generally low-risk appetite in the corporate culture (31 percent) for the delay.
The report suggests that to accelerate the pace of innovation, firms should collaborate with fintech companies, form strategic partnerships with third-party administrators, improve the human–machine interface to harvest the benefits of machine learning, and broaden their talent pool to upgrade in-house technology capabilities.
“There are no easy options, but to do nothing is the worst. Alternative managers must either embrace the revolution that is sweeping through their industry or risk being sidelined,” said the survey’s co-author, Professor Amin Rajan, CEO of CREATE-Research.