Pitfalls And Strained Reporting In The Democratization Of Alts

As Alts Become Popular In Portfolios, Advisors Should Watch For Common Pitfalls And Find Solutions To Data And Complexity Problems In Reporting Systems

Michael Madden, Contributing Editor & Research Analyst, Wealth Solutions Report

In good times, we often hear the phrase, “That’s a good problem to have.” Of course, the phrase indicates that the problem exists because some other positive condition precipitated it. In the world of alternative investments, good problems are rising.

As alts democratize from the institutional and ultra-high net worth realm to become common in high net worth and mass affluent portfolios through advancements that allow more investors access, problems arise for newer investors who often are not familiar with the drawbacks and complexities of alts.

At the same time, custodial, data and reporting systems struggle to fit these differentiated and less liquid investments into platforms designed for standardized liquid assets.

Joseph Larizza, CEO & President, Mirador

To explore how these problems arise, where advisors need to focus their attention and potential solutions, we reached out to Joseph Larizza, CEO and President of wealthtech firm Mirador, which provides managed services for financial reporting, technology solutions and products for the ultra-high and high net worth wealth management space.

We asked Larizza about the pros and cons of the democratization of alts, issues of transparency in reporting systems and the difficulties of reporting for alts through systems geared toward liquid assets.

WSR: Describe the drivers and trends behind the democratization of alts. Where can advisors find value in this democratization and what pitfalls should they watch for?

Larizza: Many advisors are finding better returns, diversification and risk mitigation through alternative investments. As the current trends indicate, more and more portfolios are holding greater percentages of alternative investments (as high as 30-40% for ultra-high net worth investors). Because of these trending investor preferences, several platforms have emerged to address some investor and advisor needs.

These platforms typically offer reduced minimum investments, streamlined account opening and improved reporting capabilities. However, it is important to be aware of some common pitfalls associated with using alternatives platforms.

First, pay attention to the expenses. Alternatives can still be an expensive asset class compared to other types, particularly when purchased through platforms and funds of funds that entail multiple layers of fees for clients. Moreover, many platforms can’t (and don’t) offer the truly unique and bespoke (i.e., uncorrelated) assets that many are seeking as a hedge against current market conditions.

Alternative assets also require active management. They aren’t a “set it and forget it” option like some other investments because of capital calls and other unexpected requirements, often with short notice.

Lastly, a layer of complexity exists with data tracking and managing alternative assets. For example, an avalanche of data needs to be processed from different sources like custodians, specialized alternatives platforms or directly from fund managers, resulting in nonuniformity and subjectivity in its interpretation.

Being mindful of these considerations can help investors better navigate the realms of alternative investments and all the emerging alternatives platforms more effectively.

WSR: Describe the trends toward transparency in alts reporting. How is this straining legacy reporting systems and what innovations are happening or needed to provide the required transparency?

Larizza: Given the increasing significance of alternatives in portfolios, including these investments in overall reporting has become imperative. Several key challenges arise in this context:

Lack of standard data feeds. As mentioned above, alternatives lack standardized data feeds, making it challenging to consolidate and analyze information.

Data source complexity. Typically, data for alternatives comes from unstructured documents like PDFs, delivered through a number of means including emails, portals and even paper mail. This makes data collection and processing a very complex task that needs extra time and human resources.

Disjointed reporting cycles. Reporting for alternative investments may not align with that of liquid investments. Investment committees need to be careful to ensure the alternative investment values align with the timing of the other investments and benchmarks.

Lack of standardized common terms. It’s common to have multiple terms for the same transaction, making identifying and tracking pertinent information much more challenging. Transaction types are also often buried deep in the documentation instead of being included on the summary page.

Technology-only solutions have limitations. Many technology-only reporting solutions are attempting to use artificial intelligence and machine learning. This type of technology does not have the capabilities to navigate the nuances of alternative asset reporting and can often create more roadblocks and missed opportunities.

Diverse investment formats. Investors looking to add alternatives to their portfolios rarely stick to just one “type.” As a result, many wealth managers must navigate reporting from multiple institutions in multiple formats with multiple different reporting schedules. Technology-only solutions do not have the adequate accuracy to manage reporting properly and still require a lot of extra human oversight and intervention.

While the use of technology in alternative asset reporting has experienced increased momentum, many quirks and absent capabilities still make a solely technology-focused approach inadequate. To be truly transparent, a blended technology-enabled human process works best for navigating the nuances of alternative investment reporting. This both increases efficiency and avoids common technology pitfalls.

WSR: What issues arise when alts data is presented through a reporting system designed for liquid assets, and how can that be improved?

Larizza: Caution must be exercised with custodians’ reporting systems. They often claim to have nonliquid investment information in their data feeds when it’s comingled with liquid investment data. Custodians also often hold alternative investment positions, particularly for “nontaxable” accounts that necessitate data custody. These services typically come with additional fees.

Problems can arise when financial institutions attempt to funnel alternative investment data through reporting/custody systems primarily designed for liquid positions. This can significantly impact reporting, particularly performance metrics in three ways:

First, these systems lack the correct transaction types (e.g., buy/sell) needed for accurate representation, leading to mathematical errors in performance calculations. Next, when the systems do have the right transaction types for illiquid investments (e.g., capital call, distribution or return of capital), it is still not uncommon for them to apply the incorrect transaction type, resulting in calculation errors.

Finally, some systems attempt to unitize alternative investments, even though such investments are not meant to be treated in this manner, causing additional inaccuracies. It is crucial to be aware of these limitations and ensure that reporting systems are appropriately equipped to handle the complexities of nonliquid investments.

Michael Madden, Contributing Editor and Research Analyst at Wealth Solutions Report, can be reached at mmadden@wealthsolutionsreport.com.

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