John Sergides, CEO of MUFG Investor Services

We’re nearly halfway through 2024, and it’s clear that the global alternatives markets are evolving at a rapid pace and will likely appear very different in the immediate future. The takeaway for fund managers and their trusted service providers is straightforward: If you haven’t started adapting to changes in the marketplace, it’s time to get on board or risk being left behind.

What Changed?

In February, KKR released a new survey of more than 75 family office chief investment officers (CIO), who are responsible for more than $3 billion in assets, finding family offices have increased their investments in alternatives to 52% of assets. The survey also found that these CIOs are planning to bolster investments in private credit, infrastructure and private equity.

Institutional investors, the traditional mainstay of global alternatives, are being joined by high net worth and mass-affluent retail investors. These investors could bring an additional $500 billion to $1 trillion in new capital in the coming years, with another $3.9 trillion in unspent alternatives capital waiting to be invested, according to industry reports issued by McKinsey and Bain & Co. As the rate of investment in new technology increases and diversifies, managers and providers will need very different skill sets than previously expected.

Global regulators are stepping up transparency and disclosure requirements for the alternatives markets, and it’s clear that new disclosure regulation and timeliness of reporting have become integral parts of global regulatory schemes.

Additionally, the expanding presence of family offices, retail high net worth investors and new regulations are among many factors creating greater pressure on fund managers to reexamine how they operate. Internal proprietary operating models that were once sufficient to launch funds and manage early growth need to be revisited.

The Need for Updated Systems and Processes

Funds will need updated systems and processes to accommodate new expectations for a range of investment components, including pricing, cost, education, distribution and product suitability.

The alternatives industry faced significant headwinds in 2023. Rising interest rates led to fewer deals and less exits. This caused an accumulation of deals coming to market and delayed distributions. As a result, the threshold for launching a successful fund is higher than ever and the mortality rate of new launches over a three-year period is likely at an all-time low.

Going forward, fund managers will be pressed to move faster with a greater sense of urgency, nimbleness and dynamism to capture the new retail capital. As managers focus on deploying capital, there is an increased need to launch new funds with sufficient reserves, efficient infrastructure and solid organization from the outset.

While private markets are unlikely to ever move at the same pace as the public ecosystem, the days when funds may operate on their own unique time frames are coming to an end. As “evergreen” structures narrow the liquidity spectrum and behave more like publicly traded securities, private markets managers are under increasing pressure to deliver timely, robust reporting, especially in volatile markets.

Private markets investors expect a reward for the relative lack of liquidity, and the demands on alternatives managers have never been more intense. Often, private markets are being accessed by high net worth investors through registered investment advisors who often aggregate client capital or by firms packaging products. As participation by high net worth investors grows, they will expect outsized performance, insightful commentary and a superior service model with visibility into metrics.

How to Adapt to the New Market

Successful fund managers need to tailor new products to better meet retail investor strategies and improve education for investors and their advisors. This new paradigm will help to ensure a clear understanding of product suitability, reasonable rates of return and maintaining positions. When a fund’s performance is stressed, or performance data is not available, clients may want the ability to leave an investment and that process must be clear.

Industry experts have already seen family office managers use their bargaining power to negotiate fees and more beneficial terms to avoid becoming forced sellers or locked into a product. The two-tier system is most evident as industry “goliaths” can resist such pressure, while smaller, emerging managers have little, if any, negotiating power.

Rebuilding technology will enable this work, and managers will be confronted with significant multiyear investments to eliminate outdated systems and build new, automated platforms to manage and process investor data. Creating true “golden source” data will be critical to the future of the alternatives’ ecosystem, especially as managers move toward artificial intelligence solutions to guide investment decisions, develop new products and improve service models.

While some managers are willing to commit funds necessary to modernize technology independently, many more are turning to trusted partners for help. For those funds, it makes sense to hire providers already investing in innovative technology and processes and use their financial resources and people to increase revenue and drive growth. Those managers are developing deeper relationships with their service partners to manage costs and obtain help with back-, middle- and front-office functions, including client onboarding.

As fund managers scale their businesses for the future, they need to identify which functions to outsource and which to keep internal, and when to augment staff by using a partner’s team to work on their platform, or a standard industry system, through their network. The work can range from service partners exploring a complete reengineering of operating models to solving specific issues.

For the largest managers, this also presents a unique opportunity to monetize their own operations via a lift-out or a transaction. Change is a constant in global alternatives, and as our operating models transform, the most successful fund managers and their partners will be those who take the initiative to work together and prepare now rather than wait any longer.

The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.

This article was originally featured in Forbes June 2024.