A prevalence of PDF documentation creates significant data extraction challenges for alternatives-focused wealth managers. But as firms turn to technology, those choosing cheaper generic tools are likely to find that a false economy, explains Mike Muniz, chief revenue officer at Canoe Intelligence, in this exclusive interview.

Rising allocations to alternative investments has been one of the wealth management sector’s biggest themes in the years following the global financial crisis, amid a hunt for yield and improved diversification. This trend has naturally been particularly pronounced in, although certainly not limited to, the UHNW/family office space.

Although greater exposure to alternatives - and a broader range of them - may certainly be beneficial for portfolios, many firms are now really struggling with the operational burden this creates in capturing data for reporting and analysis.

Worse still, those attempting to tackle the issue technologically are often setting themselves up for failure by buying entirely the wrong solution for their needs. According to Mike Muniz of Canoe Intelligence, a growing proportion are evaluating generic data capture technology which, far from lightening the load, merely shifts its focus and could even significantly increase manual work and risk.

The issue at stake is of course the “alternative” reporting nature of asset classes like private equity and hedge funds, which means that data often simply isn’t available to be easily downloaded and aggregated via brokers and custodians as is (hopefully) the case with traditional investments.

The industry is generally grappling with a lack of API-enabled interoperability that often stems efficient dataflows between disparate systems (proprietary, third-party and external). Yet the challenges with alternatives run far deeper: due to their esoteric nature, documentation often hasn’t moved on that far from paper in terms of ease of extracting data.

“Over 99 per cent of the original source documents, Schedule K-1s [US tax filings], capital calls, account statements and financials we see come in the form of meta-data based PDFs,” says Muniz, explaining that most alternatives managers only report in PDF or even hard-copy formats that in no way lend themselves to easy integration of information into an institution’s systems.

Large alternatives allocations
Lesser liquidity constraints often combined with higher return expectations result in alternatives weightings of half or more in the family office space: 2019 WealthBriefing/Family Wealth Report research found single-family offices allocating 60 per cent to alternatives on average (including private equity, hedge funds and direct investments such as real estate companies). (i) Muniz concurs that private debt has been a growing area of interest for family offices seeking regular cashflow.

The panoply of legal entities typically in play adds another weighty layer of complexity for family offices. Almost two-thirds of SFOs have 26 entities or more (ii), but many must cope with hundreds, particularly when families are very active in venture capital or widely dispersed in location or interests, as is often the case.

As Muniz observes: “All this creates a serious data extraction challenge. There is a direct, sometimes exponential relationship between increased allocation to alternative vehicles and the manual burden associated with reporting on and managing those. We’ve seen this pain growing significantly across the industry, and very much so for family offices.

“Because [family office] structures can be complex, professionals are likely managing capital account statements, call distribution notices and the execution of those notices across a number of entities for every commitment they make.”

Only one real solution
Muniz sees “the deluge of documentation accompanying the post-investment process forcing firms to become focused on operations and data management in a way that takes away their time from investing and growing portfolios in an efficient way.” In his view, there are several ways to attempt to cope, but only one real solution:

“The first option is to allocate time from investment research, or allocate accounting professionals to alternatives data extraction, but that tends to result in less than ideal output since their focus should rightly be elsewhere.

“Second, is building out an operational team, but that’s expensive and takes time for hiring and training. You’ll also need to hire in concert with growth, so if you spin out a new entity, for example, that means hiring more people.

“Third is outsourcing, but for family offices especially, this raises concerns about confidentiality, control and data quality. There have been breaches of sensitive family and commercial data.”

According to Muniz, the fact that many family offices prefer to focus on being dynamic investors - keeping operational infrastructure light, but also needing the highest standards of privacy - means that “there aren’t any optimal solutions outside technology.”

This, he observes, is arguably even more true for the multi-family offices and larger Registered Investment Advisors that are increasingly playing in the alternatives space. “These firms are progressively giving high het worth individuals access to alternatives funds to satisfy their desire for uncorrelated returns, and their acute need for scalability is also prompting them to turn to technological solutions.”

False economy
However, a trap certainly lies in wait amid the industry’s move toward broad-scale adoption of data extraction technology: attempts to make generic software fit the wealth management, and more specifically family office, model. (This is, of course, an issue also seen more broadly in investment reporting and analysis, along with other areas of wealth management operations like client relationship management systems.)

Generic data extraction software may be cheaper, but as Muniz explains, alternatives documentation is fundamentally incompatible with the Optical Character Recognition (OCR) technology generic tools rely on.

“Coming mostly in the form of meta-data based PDFs, the documents our clients are managing don’t fit with OCR strengths, which are in extracting images or data from very highly structured invoices and receipts,” he says.

“As a result, it becomes a very unreliable solution and your professionals end up spending just as much time administering, fixing or templatizing as they would have getting the data themselves.”

Muniz adds that in addition to acute inefficiency “upfront”, there is also little repeatability in processes attempted via OCR technology and remedied with manual intervention - further compounding the actual costs of this seemingly cheaper approach.

However, he asserts that the many prizes of automation - freeing up personnel, slashing error rates, improving reporting turnaround times, and preserving client and corporate privacy – are still very much there for the taking if firms invest in specialist data extraction tools.

Muniz is able to offer some very compelling evidence for institutions building a business case: “Savings vary according to a firm’s structure, processes and volumes, but we typically see clients achieve 80 per cent gains in efficiency from a cost and latency perspective,” he says. “On a more granular basis, an operation professional who might have been capable of managing documents and reporting for 250-line items previously, is enabled to manage up to 2,500 with our technology.” As such, larger firms can scale far more effectively, while the staff of smaller ones are empowered to focus on higher-value tasks.

Adding value
One such value-add might be analysing the “treasure trove” of previously fallow data that a specialist extraction software brings to light. “Currently, family offices necessarily focus on the datapoints needed to populate their systems, but there’s a lot more to leverage,” Muniz argues.

Wise institutions will also note that having sophisticated data extraction software in place makes it very much easier to upgrade their reporting and accounting systems (a move many seem to be gearing up for as clients’ expectations rise).

A further powerful draw towards more precise, flexible tools are the reporting and analysis nuances of ESG and impact investing, which are becoming increasingly popular even as their taxonomies and methodologies continues to evolve.

Summarising, Muniz says that with the investment universe expanding, wealth managers must find ways to maximise the portfolio benefits that an alternatives focus brings while minimising the downstream negative effects that can be introduced as a result.

“Ultimately, really automating the capture of critical datapoints from alternative investments’ documents calls for a tool designed by those with allocator experience and who know what that data means in context,” he concludes. “Attempting to use generic tools can completely negate any operational efficiencies you aimed to capture.”

This forms part of this publication’s latest research report, Technology Traps Wealth Managers Must Avoid. Download your free copy by completing the form below.

References:

i,  “Family Office Focus: Efficiency in Accounting and Investment Analysis”, WealthBriefing/Family Wealth Report, 2019
ii,  Ibid.