Change Happens… and Operational Complexity Increases

In our May Allocator’s Dilemma post, we talked about the importance of robust Operational Due Diligence teams and post-investment monitoring of non-investment risk. 

The Convergence annual study of operational complexity and risk across the private fund industry produced some insightful findings – the complexity scores of “Institutional” Managers with assets exceeding $1B, $5B, and even >$25B increased in no fewer than 33% and as many as 50% of managers across these size cohorts over the most recent one-, three-,  and five-year periods.

Investment managers across the size spectrum are constantly evolving, pursuing new strategies, adding new clients, and expanding into new markets, all aimed at generating differentiated returns and growing their business – with this context, it isn’t surprising that the corresponding business complexity is increasing. It was surprising however that 11.3%, 10.1%, and 6.1% of the increase in their Total Complexity Score over the most recent one-year period. The increases in risk for this group of 436 institutional investment managers represents a set of outliers with meaningful consequences to their investors and service providers – a level of change that is unlikely to be fully appreciated and merits further diligence to understand what is driving these changes, and to understand how increasing levels of risk are being managed.

A bit more than 58% of ~19,000 SEC-RIAs in Convergence’s database disclose advising unregistered private Funds – a mix of nearly 11,000 Exempt and Non-Exempt Private Fund filing advisers. RIAs to private funds are increasingly adding assets by advising investment companies (mutual funds), SMAs, sub-advising funds, and participating in wrap-fee programs. There has been a very public push by alternative investment firms attempting to #democratizeinvesting by adding high net worth and individual investors. All this change means one thing for sure – greater organizational complexity and operational risk! 

Convergence measures and scores the complexity and risk within an investment manager’s business across four non-investment dimensions using dozens of proprietary risk factors. We analyze these changes across size bands, strategies, and factors to identify patterns, trends, and inconsistencies across the industry and to provide our clients with actionable, proprietary “insights” about the changes, their meaning, and the conversations they can have with their investment managers to become comfortable that the risk is being managed.

If you are a pension plan, fund of funds, or family office that invests in the private funds or SMAs of RIAs please contact David Etzbach to discover and evaluate how changes in the complexity of your portfolio of managers can best be managed.