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Crypto investment trends: How alternative investments are diversifying with crypto

No longer just an elusive new trend to watch, crypto and other digital assets are now finding their way into portfolios everywhere, with institutional inventors like hedge funds taking it considerably more seriously than before. More and more asset managers are taking a chance on the likes of Bitcoin and Ethereum, with many seeing considerable success as they deliver substantial returns to clients, who are showing an increased appetite for diversified portfolios that boast digital assets.

We explore the state of crypto investment trends with One River Asset Management president of One River Digital, Sebastian Bea, who discusses One River’s own success with Bitcoin and Ethereum so far, as well as what’s in store for crypto in the near future.

This blog’s insights are based on Episode 17 of our In Conversation with Convergence podcast, hosted by Convergence Co-Founder and President, George Evans. In this episode, George is joined by guest speakers Sebastian Bea from One River Digital and Convergence’s own Adam Safi, who discuss crypto investment trends currently being experienced in the asset management industry, and what influence crypto will have on alternative assets portfolios in the future. Listen via the Convergence website or scroll down to continue reading the blog.

One River Digital’s involvement in crypto so far

Off the back of the conjoining of monetary and fiscal policy in 2020 and the risk of inflation being higher than what may have been anticipated, One River set out to deliver unique diversification opportunities by making its first large digital allocation to crypto in November 2020. Considering how robust the previous cycle of crypto investment was, the initial $600 million allocation, mostly into Bitcoin and some into Ethereum, saw the asset management firm crystallize over a billion dollars of gains to return to their clients.

While 2020 was a notably perilous year for firms and the industry overall, One River’s long-haul funds and trend funds, like their crypto investments, made money, and their alpha products remained durable, allowing the firm to deliver risk mitigation in times of uncertainty. Building on this momentum, the firm started collaborating with other investment firms and getting involved in the crypto community at large, sponsoring a meetup event known as CryptoMondays – a regular get-together for a decentralized global community of people passionate about blockchain and cryptocurrency. now. 

As the industry environment became increasingly decentralized, the adoption of new technology has been vital to the seamless transition to virtual. This has enabled firms to meet the important requirement of data centralization and aggregation and using centralized data formats so that employees can continue to access the necessary information they would typically only get at the office. This ease of access to shared data systems has been key to uninterrupted collaboration and business continuity. 

Crypto is more than a fad 

Once investment fad bubbles “pop” they tend to not come back. But when one considers the history of Bitcoin, it’s had a number of cycles and keeps coming back with new highs each cycle, despite questionable previous cycles. The growing number of Bitcoin wallets each cycle also shows the crypto coin’s growing popularity each cycle, suggesting that this asset class is certainly here to stay.

Although traditional finance investors remain focused on the uncertain regulation, price volatility and lack of identifiable cash flow that surrounds crypto investments, the persistent growth and increasing depth of the Bitcoin network – and therefore blockchain networks at large – is what piques decentralized finance investors’ interests.  

One River’s advice to investors considering this asset class is to consider the resilience of these crypto coins from cycle to cycle and be curious. As FinTech continues to evolve, the money-moving systems we’ve become accustomed to are becoming archaic, and it’s likely that cryptocurrency naysayers will actually look to crypto as a way to solve some of the legacy problems that are emerging in financial services. 

Key crypto fund considerations

When it comes to including crypto in funds, Bea notes that “everything is a little bit more difficult and it takes help, patience and perseverance” to get using this investment vehicle right. What firms cannot overlook is the benefit of great legal advice in this area, as guidance into what you’re doing, who you’re doing it for, what kind of vehicle you’re doing it in, etc. is invaluable, especially when considering possibilities both onshore and offshore and navigating ECI risks. 

While there is a high degree of uncertainty that surrounds trading crypto in a fund, just like in traditional markets, including equity market neutral funds and trends funds trading in futures, if it’s harder to do, then it’s probably worth it on the other side as well. Also, it may take more time than you would expect, but with patience and perseverance, the pay-off can be well worth it.

How traditional market service providers compare to crypto service providers

Unlike traditional markets where service providers are fairly stable, with a good amount of data and history on them available, crypto service providers have less history, are less stable and see more dispersion. Crypto custodians, for example, differ greatly from traditional finance custodians for a number of reasons. As digital bearer assets, crypto custodian processes and costs differ from traditional finance custodians, which stock portfolios usually take for granted, but firms need to think about custody as being vastly more time-consuming and important with crypto assets because of the associated security risks that have to be appropriately handled.

The nature of the assets also changes what firms need to focus on from operational due diligence and admin points of view, as well. For example, if you have a daily fund that runs Monday through Sunday, you need processes in place to take subscriptions or redemptions over the weekend when fiat isn’t flowing. So working through these administrative requirements with your fund administrator is also a key consideration that can differ between traditional and crypto finance funds. 

The state of funds investing in digital assets like crypto

Convergence currently tracks around 1,150 funds with some allocation to digital assets. The three most common fund profiles we are seeing in the market are (1) hedge funds trading or holding digital assets that trade on exchanges, (2) venture funds investing in the equity of digital asset-related firms (and in some cases, receiving tokens as part of their investment) and (3) large, multi-strategy funds looking to diversify and gain exposure to digital asset funds. These reveal that there are a lot of different investment theses surrounding digital assets, and there’ll likely be more as time progresses. 

Looking specifically at Bitcoin, we see some people treating it as digital cash, or a store of value, while others treat it more like a high-growth tech stock. Again, it’s interesting to see so many narratives converge in one asset class, with a number of funds that have come into the market seeing good growth as a result. 

What’s on the horizon for crypto investment trends?

It’s an exciting and critical moment for investing in digital assets, and what’s in store next for crypto investment trends is going to look a bit different from prior cycles. With regulation and use case growth a key focus, future cycles are going to be heavily driven by retail investor behavior, and Bea expects that the next cycle will be the first great regulated cycle for crypto.

More regulation is not just needed but sought out

Institutions like hedge funds losing money are less of a worry to regulators than the financial stability of the markets. Still, there hasn’t been a lot of evidence that the stable coin market at its current size is really driving any question of financial stability today. What the regulators are going to be on the lookout for is any damage done to retail investors. 

Looking at recent examples like Voyager and Celsius, these instances of retail investors being harmed and regulators kicking into action are ultimately constructive, as institutions considering crypto are looking at these as indicators of the regulatory climate that enables them to invest right now into an investment cycle that’s never been seen before. 

There hasn’t been a regulated cycle yet, and there’s a lot of institutional capital sitting on the sidelines waiting to see some common sense regulation in the market today that will protect retail investors that have been previously burned by digital assets. Regulation coming from the CFTC or SEC will be very useful and beneficial to the health of the asset management industry and institutional investors currently navigating crypto investment trends, but always seek out that regulatory overhang before investing.  

Growing use cases for block chain 

While institutions await more regulatory clarity, it’s also important that they see the growth of real-world use cases where blockchain scaling solutions and infrastructure are actually having an impact. The lightning-fast network on top of Bitcoin is an example of this. In cases where the financial system doesn’t work for you, for example, with the high costs of sending money to countries in Central America through Western Union, blockchain systems like Bitcoin make sending money much cheaper and easier. 

Disintermediating these middlemen who make moving money across borders difficult is a use case being seen right now, but institutions need to see more of these real-world cases where the rails of crypto are needed. As more of these use cases emerge, institutions will start to see and appreciate the value of these rails more, and start making digital assets a more concrete part of their funds. 

Convergence League Table Summary

With every episode of In Conversation with Convergence, we report on the findings of the Convergence League Table for that month, tracking and comparing the growth of over 600 fund administrators, 500 audit firms, 300 primes and 1400 custodians servicing the private markets through our comprehensive database. To unpack the highlights of this month’s Convergence League Table podcast, at the time of the July podcast release, the Convergence League Table revealed that between June 2021 and June 2022, funds specifically saw:

  • Overall growth of 11.5%
  • Fund administrators one through five grew at 21% – almost double the market growth, while admins six through 10 kept pace with the market with a growth of 10%, and admins 11 to 25 grew at 18%.
  • In terms of audit firms, the big four saw growth of about 7.3%, while, astoundingly, auditors five to 10 grew at almost 25%, and auditors 11 to 25 grew at 30%, indicating significant growth two to three times that of the market. 
  • Prime brokers one to 10 grew at a little over 4%, 11 to 25 saw growth closer to 7%, and all other primes grew at around 10%, showing a more even year-on-year distribution than with auditors and administrators. 
  • In terms of custodians, the top 10 grew at about 10%, while custodians 11 through 25 actually didn’t see growth, but rather shrank by about 2.5%. All other custodians grew close to 8%, however – an interesting phenomenon indeed.

>> Get access to the Convergence League Table

Jack Phinney No Comments

The Operational Future of Alternative Investments: Industry Reflections with KPMG

The alternative asset industry has thrived through a remarkable and truly unprecedented period in history. It has adapted well to new working environments, be them remote or hybrid, and has adopted new technologies, digital solutions, data centralization and outsourcing of resources to adapt to a world that changed almost overnight. Even the ways in which we communicate have changed, with the likes of Zoom and Microsoft Teams meetings being preferred over traditional in-person meetings, emails and phone calls.

Indeed, the industry has been extremely resilient to changes in practices like capital allocations and raising, and has innovated to meet investor demands. But how has this resilience influenced how firms operate and will operate in the future? We reflect on how the last two years have shaped the industry and what this reveals about the future of alternative investments. 

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This blog’s insights are based on Episode 16 of our In Conversation with Convergence podcast, hosted by Convergence Co-Founder and President, George Evans. In this episode, George is joined by special guest speakers Joseph Fisher and John Budzyna from KPMG, who discuss their industry observations and what they foresee happening in the industry in the next few years. Listen via the Convergence website or scroll down to continue reading the blog.

The industry at large is seeing a paradigm shift

The last two years have proven that the investment industry is not only agile in its response to unavoidable changes but resilient and very nimble. Overall, industry players were able to recognize critical issues early in a newly decentralized environment and made moves to address them to ensure they didn’t affect outputs or productivity. 

The asset management ecosystem at large has seen ongoing reliance on service providers and consistent collaboration among front and back office personnel, ensuring that the ever-important flow of information is maintained, even virtually. 

How virtualization and decentralization have influenced the industry

Across the entire investment management landscape, investment in technology has been key. From AI tools to the digitally transformed ways in which we reach out to investors, the predominant amount of spend seen at alternative firms recently has been on these technologies, which are among the trends shaping the sector now. 

As the industry environment became increasingly decentralized, the adoption of new technology has been vital to the seamless transition to virtual. This has enabled firms to meet the important requirement of data centralization and aggregation and using centralized data formats so that employees can continue to access the necessary information they would typically only get at the office. This ease of access to shared data systems has been key to uninterrupted collaboration and business continuity. 

The War for Talent and the future of alternative investments

While the adoption of technological innovations has been critical for business continuity amidst the pandemic, it has also resulted in a greater demand for more niche skills, contributing substantially to the War for Talent. For example, the demand for data scientists that can navigate new front office technologies has increased among alternative asset firms. This demand will only grow as the future of alternative investments becomes more technologically complex, and as employees become increasingly specific about the types of careers they want.  

However, there are economical factors that could impact this in the future. If there’s a recession, the pendulum may swing back, and the workforce may see less reshuffling and resignations as employees trade job flexibility for job security. While potentially too early to tell, the future of alternative investments and the talent the industry requires will be heavily dependent on the economy and the changes it may bring to work habits in the near future. 

While the War for Talent has expanded the talent pool for firms beyond geographical boundaries, which has impacted things like firms’ real estate footprints, the key theme for a successful decentralized working environment, both now and in the future, is a well-maintained culture underpinned by continued collaboration. 

How are firms maintaining culture in a hybrid world?

A key question that’s emerged in this changing world is “how does a firm maintain the attributes that made it successful before the pandemic?”. A study conducted by KPMG in conjunction with AIMA found that diluting, or losing, culture in a remote/hybrid environment is a key concern for firms. But the reality is that employees are currently in the driver’s seat, and with a high percentage of staff craving the hybrid environment, firms need to strike a balance to be successful. 

Within the context of the war for talent, culture has been a further concern in that hybrid work now enables firms to access talent in disparate geographical locations, but they’ve needed to weigh up the benefit of this versus insisting on more collaboration and teamwork that enriches their company culture. 

Whatever their approach, if firms are to maintain their culture and continue to thrive in the hybrid model, protocols need to be defined and established. Employees need to be available and reachable during business hours, client needs still need to be met promptly, and communications need to be ongoing. Making efficiency, in the office or at home, an integral part of their culture will be key to firms succeeding while meeting employee expectations. 

Reimagining the investment management operating model for the future of alternative investments

Organizations like KPMG have seen an increase in side letters, transparent reporting, structural variations, fee allocations and changes in how fees are charged. These changes, along with a potential regulatory rework on the horizon, suggest that firms are truly studying their operating models and looking for efficiencies to enable future growth, all while monitoring and protecting their operating margins. 

For investment managers to be successful, they have to have an eye on monitoring and creating efficient operating models to maintain their margins, and this will have a far-reaching impact on the industry and its ability to sustain itself in this new construct. This is true, especially in light of additional factors, like a looming recession, and whether, for example, funds are below their high-water mark currently. These all affect the trajectory of future operating models and how managers are monitoring their operating model risks.

Additionally, firms are going to continue to reevaluate their real estate footprints in light of remote/hybrid working and identify which individuals are core to their operating model, before building their footprint around these factors. This is a chapter on the future of alternative investments, and the industry overall, that’s still being written as firms continue to reestablish normality post pandemic.

Changing investor demands

Equally driving change and growth in the industry is the unparalleled demand for customized portfolio construction from investors. 

Gone are the days of “here’s what I have to offer, join my flagship fund”; investors are being more specific about what they want and the form they want it in.  This could be separately managed accounts, co-investment strategies, particular jurisdictions with particular tax motivations, etc. and all of these create a tremendous amount of operational complexity that can’t be easily scaled. 

Similarly, as a result of the pandemic, new strategies have emerged in the private credit, hybrid, private equity and hedge fund spaces, which had previously not followed a cookie cutter approach in terms of operations anyway. In catering to the demands of the investor, these factors are putting a tremendous amount of pressure on firms’ existing operating models, which will influence how firms operate in the future of alternative investments.

Regulatory headwinds to further impact operations

Perhaps too early to predict, but there have been some prevalent regulatory headwinds that may manifest themselves in the coming months. Developments such as the SEC’s private funds rule proposal, which discusses quarterly statements and disclosures, annual audits, and fairness opinions on secondaries, the dealer rule proposals, and AIFMD amends are all factors that are going to put more stress on the operating model, specifically compliance and operations. 

Environmental, Social, and Governance (ESG) have also taken front and center on due diligence questionnaires, and disclosures need to be able to answer ESG-related questions in a transparent manner. ESG disclosures are prominent in the public sector and will most likely make their way to the private fund world, but for now, they are on almost every deep due diligence questionnaire, and firms need to be mindful of the influence ESG is having on the future of alternative investments. 

Not to be forgotten is crypto, which has found massive popularity in recent years, though currently experiencing a loss of favor. Considering factors like FASB’s moves to establish crypto asset accounting rules, greater governance around crypto is set to take shape in the coming months. 

Conclusion

Whether it’s the adoption of technology post the pandemic, the war on talent, investor tastes, or regulations that are constraining margins, firms need to reassess their business operating models in accordance with the future of the alternative investments industry, to maintain the performance success they’ve been experiencing despite waves of change. 

Moving forward, firms need to take the lessons learned from the pandemic and try to shape a more efficient business operating model that can align with, and help sustain, the future of alternative investments. 

Convergence League Table Summary

With every episode of In Conversation with Convergence, we report on the findings of the Convergence League Table for that month, tracking and comparing the growth of various asset management industry players through our comprehensive database. June’s Convergence League Table podcast, revealed the below findings for the period of May 2021 – May 2022.

In terms of fund administrators:

  • While we saw a fund growth of almost 16%, admins ranked 1-5 increased substantially over that at 25%, showing market-level growth or better
  • Admins ranked 6-10 just about matched fund growth at around 16%
  • Admins 11-25 grew at 21%
  • All other 600+ admins grew at about 5%

In terms of auditors:

  • Everyone except the big four, which grew at about 8%, outpaced the market
  • Auditors 5-10 grew at about 28%
  • Auditors 11-25 grew at around 27%
  • All other auditors came in at around 14% growth 

From a prime brokers perspective:

  • Prime brokers 1-10 grew at a little over 4%
  • Brokers 11-25 saw growth at close 7%
  • All other prime brokers grew at around 13%
  • There’s also a large growth number that’s unattributed to certain primes

In terms of custodians:

  • The top 10 custodians kept pace with the market and saw growth of about 11%
  • Custodians 11-25 fell behind the market with growth of only 1.5%
  • All other custodians saw growth in excess of the market at about 16.5%

>> Get access to the Convergence League Table

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Three dominant trends in asset management to know about in 2022

Post COVID, businesses across industries are seeing new trends emerge that are influencing operations and challenging them to reassess how they do business. This is true for the asset management industry, too, where, even though growth has been sustained, ways of working have been disrupted.

We take a look at the top emerging trends in asset management, and how FinTechs are supporting firms in effectively managing these trends to ensure they keep ahead of growing demands. We also unpack the findings of the Convergence League Table for March 2022 and explore how the top 25 asset administrators, auditors, custodians and prime brokers have fared in terms of industry growth. 

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This blog’s insights are based on Episode 14 of our In Conversation with Convergence podcast, hosted by Convergence Co-Founder and President, George Evans. In this episode, George is joined by guest speaker Anup Kumar from Linedata, who discusses three trends currently being seen in the asset management industry, and how firms are dealing with these. Listen via the Convergence website or scroll down to continue reading the blog.

The industry post-COVID and the dominant trends in asset management that are emerging

COVID had a massive impact on the way businesses do business, particularly in terms of their infrastructure and whether it is sufficient for business continuity in the face of disruptions. Both in terms of infrastructure, but also in general, there has been a noticeable increase in outsourcing. This increased traction in outsourcing is also thanks to the need for specialized resources. Post COVID, the talent management spectrum is facing challenges attracting and maintaining talent, especially specific specializations that are becoming more difficult to find and retain. This is just one of the challenges businesses are attempting to address through outsourcing.

Overall, businesses are needing to reassess what they’ve built and what they want to continue to do themselves versus what they need to invest in to continue thriving. And with the emerging trends starting to be seen post-COVID, it’s an interesting time in the asset management industry with new, sophisticated solutions being sought out.

Increasing back-office complexities 

Fortunately, the private credit space is seeing a lot of growth, and assets under management in the market are expected to rise to $1.5 trillion by 2025. However, with explosive growth and the inherently bespoke nature of the industry, where every deal is customized, the back-office function is seeing increased complexities. 

Although businesses, like Bright Credit, pride themselves on providing customized credit arrangements, it’s become apparent that inefficiencies from a technology perspective are making scalability difficult, which is making meeting rising demand a challenge.  

Use of technology like artificial intelligence and machine learning in the back-office and IT operations has been slow, which has made things more difficult for analysts. Instead of focusing on investment decisions and monitoring investment performance, analysts have had to spend more time on administrative activities, particularly collecting, ingesting, normalizing and validating data for use by limited partners. 

Back-office functions like valuation processing or loans administration, as a result, have become more complex, and businesses require specialized resourcing and skills to manage, again, contributing to the increase in outsourcing solutions. 

Increasing cybersecurity concerns

Since the start of COVID, cyberattacks have increased 700%, and 80% of those attacks originate at the end points. Within financial services, the buy side industry is notably more susceptible to cyberattacks and a soft target for cyber criminals. As such, there is increasing interest from regulators like the SEC in how asset management and buy side firms are dealing with the threat of cyber attacks and the security processes and controls they have in place. 

This, too, is an area firms are outsourcing support for, with FinTech firms now offering full-service threat management solutions. This threat intelligence is being leveraged to protect infrastructures and endpoints, to help asset management firms stay ahead of cyber threats. Additionally, many firms are also looking to leverage these solutions for cyber policies, to ensure controls are sufficient for regulatory requirements.

Talent acquisition and management challenges

As mentioned, it’s become increasingly difficult to find good resources in the asset management space. With the so-called ‘resignation tsunami’ the industry is facing, finding and retaining specialized talent is becoming harder, and firms are needing to carefully navigate the future of work and how to handle concerns around remote or hybrid work constructs, while best meeting employee expectations.

From a policy point of view, the industry in general is responding positively and being more flexible and adaptive in policies. Despite this, the growth the industry is experiencing, paired with the high number of resignations being seen, talent management still continues to be a challenge, and losing key resources poses great operational and reputational risk.

Many firms have needed to slow down operations in order to work out what mechanisms to put in place to manage changing capacity. And because technologies like AI continue to see slow adoption, and functions like loan administration continue to be time-intensive, firms are needing to think of different operating models and approaches to ensure they keep scaling as needed to meet industry growth demands. 

Operating as an extension of clients’ operations

To meet the needs that come with these emerging trends in asset management, FinTechs are offering solutions that mimic client controls and processes and augment transformative technologies into those they already have in place. What this does is give clients a sense of operational control they would otherwise only achieve internally, because their solutions providers are now operating as an extension of their business, not as a “ticket it or leave it” type of service provider typically seen with third-party providers.  

Having a service provider operate under the same common operating leadership and setup, processes and control mechanisms allows businesses to hand off intensive work, like running capitalization tables, for more efficient management. Depending on a business’ unique needs, different degrees of support can be provided, but more effective, current day solutions are being implemented to make the separation between client and service provider less apparent from an operational perspective. 

Convergence League Table Summary

With every episode of In Conversation with Convergence, we report on the findings of the Convergence League Table for that month, tracking and comparing the growth of various asset management industry players. To unpack the highlights of this month’s Convergence League Table podcast, as at the time of the April podcast release, the Convergence League Table revealed that:

  • Overall, administrators growth from March of 2021 to March of 2022 was about 15.3%
  • In terms of administrators, admins ranked 1 to 5 grew at about 19.5%, admins in positions 6 to 10 registered the highest assets under administration growth at 26.5%, and admins in positions 11 to 25 grew at about 25%. Interestingly, all other admins positioned 26 and higher, only grew around 4.5%
  • Looking at auditors, auditors in positions 1 to 4 grew at about 8.5%, and positions 5 to 10 grew over 19%. Auditors in positions 11 to 25 grew almost 29%, which is almost three times the market growth!
  • Custodians greater than the top 25 registered the highest assets under custody growth, showing an industry growth of around 16% year over year. The top 10 custodians grew at about 14.25%, while the custodians ranked 11 to 25 grew at about 13.25%. From position 26 on, of which there are 1 400 custodians listed, custodians grew at about 31%
  • In terms of prime brokers, those greater than position 25 registered the highest growth in the number of funds, showing, on a fund basis, market growth of about 14.65%. Prime brokers in positions one through 10 grew at about 4%, while those in positions 11 to 25 grew at about 6.5%. All the primes grew a little above the market at about 15.5%, effectively outpacing the market.

See the Convergence database in action

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Alt Credit Performance and Services Award 2021

AltCredit Shortlisted Convergence for Best Data & Information Provider!

In a fast-moving environment where firms are increasingly leaning on their service providers for support, it is important to recognize and reward those companies that are leading the way in terms of innovative product.

We are happy to join in the celebration of key providers of services and solutions to the US credit hedge fund industry. It has been a challenging year which has left many funds in need of excellent and innovative solutions in order to move forward.

This award was a true badge of honor marking the recognition and respect our Advisor, Allocator and Service Providers have for our firm.

We are honored to showcase our success and leadership as our clients have made us best in class! Thank you from the entire Convergence Team!