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How keeping your business operationally fit can enhance your balance sheet

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By: Simon Burgess, Head of Alternative Investments, Ocorian

Fund Managers Prepare for Post-Pandemic Fitness Test

Note everyone enjoys the effort needed to get into shape, but it is often necessary in order to reap the long-term benefits of good health and improved performance.

The same notion can be applied to alternative investment funds. As financial markets begin to see the benefits of a vaccine-led economic recovery – and with allocations to alternatives expected to continue to increase – fund managers would be wise to ensure that their business is operationally fit so they can act swiftly to swoop on attractively priced assets when the time comes. 

Many asset prices were hit hard by the downturn whilst fund managers and investors, who had been waiting for more certainty, were happy to sit on record amounts of dry powder until they were convinced of more favourable market conditions. We expect the release of this pent-up capital in the system to drive a significant amount of activity in the coming economic cycle.

Managers will also need their operations to be in shape to navigate the challenges that lie ahead. Against the backdrop of an increasingly complex global regulatory landscape, margin pressures and investor demand for transparency, fund managers will want to instil operational efficiencies to build their competitive advantage. While CFOs and COOs have been unable to control asset values during the pandemic, it has given them the opportunity to take a step back and consider their own operating models and find ways to reduce inefficiencies and costs.

Outsourcing the Key to Operational Fitness

Whether fund managers choose to manage everything in house, fully outsource their fund administration and accounting functions or choose a blend between the each, this has required them to take a long, hard look at their operational model and service providers to identify where and how they can improve.

Outsourcing can be part of the solution. It can free up manager time to focus on their core competencies of managing investors and investments. Research recently conducted by Ocorian shows that 72% of fund managers expect outsourcing to play an even more central role for the industry over the coming three years. However, any outsourcing arrangement is only as good as the partner selected, the success measures and the core competences that they bring, so making the right decision on a provider is vital to unlocking these efficiencies.

Fund managers will increasingly be looking for not just outsourcers with deep knowledge and expertise of both processes and asset classes to share their administrative burden, but partners who can proactively come up with ideas that will enhance the operational performance of their funds. An ideal partner will offer a winning combination of global reach and scalability, especially through use of the best technology, but also maintain the ability to provide a high touch personal service.

Market dynamics make operational fitness even more important 

Earlier this year we conducted research amongst a panel of business decision-makers at mid-cap, large-cap and private capital businesses from across Europe, North America, Africa and Asia with the goal of helping firms and professionals working in private capital, fund management and capital markets take advantage of CovExit opportunities through better administration and compliance.

Our research paints a picture of growing optimism in the alternative fund management industry about the economic outlook. The vast majority (84%) of respondents expect a complete relaxation of COVID and social distancing measures within the next year. Most also expect strong gross domestic product (GDP) growth in the US, UK and Asia.

As economies around the world start to recover, most respondents anticipate quantitative easing to end and inflationary pressures to build. More than three-quarters (76%) expect interest rates in Europe to remain negative.  The survey was conducted in March and there are already signs of inflation building in both Europe and the US. Indeed, fund managers are allocating to assets that protect against inflation.4 This underlines how quickly the economy can change and how important operational agility is. 

More than four-fifths of respondents expect income taxes (84%) and wealth taxes (81%) to rise, as governments start to pass on the cost of supporting the economy and businesses during the pandemic.

Agility key to staying fit

The gradual withdrawal of government support for businesses, as industries start to recover from the pandemic, will lay bare which companies are fit for survival and which ones aren’t. This will likely present opportunities to fund managers seeking distressed assets in hard-hit sectors such as high street retail, automotive and infrastructure – all of which were cited as the most likely to attract investment by 85% of our survey respondents. 

More than four-fifths (83%) of respondents also expect significant corporate restructuring to take place over the next year, including 100% of private equity respondents. Over nine in 10 (92%) of respondents in our separate survey of capital markets professionals expect corporate insolvencies and restructurings to present opportunities to them, adding to the need to be operationally ready for a surge in prospective investments.

The downturn has also pressured asset prices in sectors such as retail, creating opportunities for fund managers to buy real estate or non-performing loans at depressed prices with the potential for attractive capital increases over a relatively short period. 

The business sectors that fund managers see as most likely to improve on their current performance include aerospace (81%), high street retailers (80%), automotive (79%), infrastructure (79%) and banks (78%).

Although businesses in such sectors that suffered during lockdown will bounce back, it is important to remember that there will also be long-lasting structural and behavioural change to prepare for. Remote and flexible working is already having an impact on large inner cities and the movement to lower and middle cost locations, for example. Office moves are being cancelled or postponed and office space reformatted to allow for more collaborative team working, which organisations have found difficult to replicate on videoconferencing sessions.

Fixed-income yields are expected to remain under pressure amid continuing low interest rates, although this may be impacted by inflation. Either way, the hunt for new sources of returns is expected to drive more investors to alternative assets. Nearly two-thirds of our respondents (64%) believe investors will increase their allocation to private capital and hedge funds (including private equity, real estate, venture capital, infrastructure, private debt and renewable energy) in the next three years. 

Fund managers will want to be ready to seize this expected influx of investment, but internal and external market pressures could impede them if they aren’t operationally fit. Past performance is also seen as key a factor in the success of fund raisings. Nearly nine out of 10 (86%) agreed that, over the next three years, the time it takes for private capital investment firms to complete fundraisings will become even more polarised depending on performance. And 88% said the role of the fund manager would become even more important.

Getting into shape for the future

What must alternative fund managers do to ensure efficiency and operational excellence? They need to be able to respond quickly to market opportunities. For example, real estate managers should be in a position to acquire property assets now whilst they remain attractively priced. Their business needs to be agile and scalable. This can be hard to maintain amid increasing demands on fund managers to keep on top of regulatory changes and all the other administrative demands in their in-tray.  

There are likely to be buying opportunities presented by distressed investments as they struggle with loan breaches in the wake of the pandemic. Again, fund managers need to move quickly to pick up on the opportunities but they may not have the relevant experience or expertise in-house to deal with restructures or insolvencies. Our research with capital markets professionals showed that while 87% were implementing direct lending strategies, only 47% had confidence in their loss recoveries.

COVID-19 forced many managers to re-examine their operating models, processes and procedures to find efficiencies and cost savings. With valuations under pressure, they have been looking at ways they can control costs, operate more efficiently and in some cases respond to seismic changes in their customer bases by completely pivoting into new markets. This is likely to continue into the future and firms will be looking for investment as well as help to do so.

Outsourcing is one solution but it needs to be implemented effectively. Fund managers won’t outsource for the sake of it. If it is too expensive to outsource and the efficiencies aren’t expected to counter that then they will likely keep the functions in-house. Size also matters. First-time funds often prefer a one-stop solution from their outsource provider because of economies of scale. Larger and more established funds are less constrained and can balance the risks by partnering with several providers. 

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