High-profile incidents in the financial services industry this year have highlighted the importance of due diligence and accurate data for private markets investors. Northern Trust’s Melanie Pickett explains how asset owners can harness the power of their data to assess risk and drive impactful results.
By Melanie Pickett | June 2023
As seen in FundFire, June 2023
Do you know all the risks and exposures you have in your portfolio?
It may seem a simple question, but as the dust settles from the failures of Silicon Valley Bank (SVB) and Signature Bank, many asset owners are starting to ask more probing questions of their asset managers.
The knock-on effects from these banking collapses have had a significant impact on some areas of venture capital, particularly in technology, where the two banks were particularly active.
As Melanie Pickett, Head of Asset Owners, Americas at Northern Trust, explained: “These events have opened investors’ eyes to all the elements of due diligence, and questions that they perhaps aren’t asking.
“What asset owners learned through these incidents was that not only were general partners [GPs] utilizing these banks for cash and lines of credit for their funds, but also how many lines of credit existed for the portfolio companies, for founders of portfolio companies, and even for GPs’ personal loans like mortgages.”
In some cases, GPs had even taken out loans to fund their own commitments to funds – the ‘skin in the game’ element that is so important to many asset owners to ensure alignment of interests.
“I don’t think asset owners have often asked how that commitment gets funded, but that’s all changing,” Pickett said.
Getting the answers
Armed with this new knowledge, investors need accurate data to ensure due diligence processes are robust – but they also must be equipped to use that data efficiently.
However, many investment offices consist of small teams who monitor large portfolios, which makes undertaking detailed due diligence on all assets and funds a significant, often time intensive, challenge.
In response, some turn to third-party providers with experience and expertise in private markets that can help asset owners stay abreast of the information gathered during initial due diligence and monitor any changes.
Northern Trust’s Front Office Solutions, for example, can help in monitoring any data element a client is interested in – from traditional exposure details such as sector, geography and strategy – to more risk-based details like counterparty banks, leverage ratios, and ESG criteria. In turn, asset owners can use that reporting to assess the risks they are exposed to and act nimbly to mitigate those they can address.
Some asset owners are co-sourcing or outsourcing some functions, such as data management, operational due diligence and routine data management, Pickett says, allowing them to free up time internally for other activities.
“The technology that exists today for asset owners helps them harness and collect this data,” Pickett said. Northern Trust, for example, uses robotics to pull documents in for clients and proprietary natural language processing and machine learning capabilities to extract data from those documents automatically, she added.
“That helps us populate characteristics of funds, transactions, and portfolio information gathered from GPs automatically and pair it off with other market sources, helping our clients get to the data that matters, and quickly. But perhaps what matters even more than the technology is our team of expert service professionals, who can assist our clients with the reconciliation and enrichment of this data - so they can focus their time on analyzing the data and leveraging it for investment decisions instead. More and more, asset owners are telling us that they need help with these types of middle office services.”
Taking it one step further
In addition to its digitization software and services business, Northern Trust has been developing several other capabilities to help address asset owners’ data management concerns.
Users of the bank’s Front Office Solutions (FOS) platform can customize their data models easily to incorporate metrics tailored to their portfolio and objectives, and clients can immediately incorporate these metrics in their risk, performance & liquidity analytics.
For some clients, those metrics might focus on factor risk, for others, it may be liquidity or ESG, Pickett says. “FOS allows asset owners to “track the metrics that matter to them, and in the language that best represents how they view their investment process or how they view the world.”
Northern Trust has been working with technology company Snowflake since 2021 for data storage and analytics. The functionality allows for data to be stored securely and retrieved promptly so that asset owners have an accurate view of their portfolios in real-time. Northern Trust can also collaborate directly with clients to build data science toolkits for ad-hoc analysis.
Timely issues require easy insights
Besides arming investors with powerful data for due diligence activities, efficient delivery of high-quality data can also help asset owners with addressing timely concerns, such as the recent topic of private equity valuations.
Typically, private equity managers provide valuation data at a lag to public markets, and in areas such as real estate valuations may only be provided once a year. When reporting to stakeholders and assessing portfolio changes, asset owners need more up-to-date information.
“Sometimes there’s tension between the smoothing of private equity valuations with accounting regulations that require fair market value assessment of assets,” Pickett said.
“We use technology to help our clients tackle this by allowing them to proxy the valuation of their funds, relative to a comparable that makes sense to them. While they’re waiting for GPs to value their assets, we’ll apply a proxy of public investments, such as a basket of specific stocks or a market index, to help ensure the performance of their portfolio is up to date.”
Beyond presenting the standard portfolio company data, Northern Trust helps investors gather valuation-related information from GPs, such as the governance structures around the valuation process and methodology, documentation, market comparables, and assumptions.
Obtaining and monitoring this information can help improve asset owners’ understanding of their private equity portfolios – and allow them to ask much more probing and informed questions of their managers.
Amidst a shifting financial landscape, advances in technology are equipping asset owners with a whole new toolbelt when it comes to data management, with many looking to partner with third-party service providers to stay competitive. Now more than ever before, asset owners in private markets must optimize their data to ensure accuracy in due diligence.
The esoteric and complex nature of alternative asset classes creates an increasingly complex data problem for asset owners. FundFire sat down with three experts from Northern Trust to learn how asset owners can effectively overcome the data challenge.
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