Operational risk has been an increasingly important topic in the alternative investment space, as systems built for fewer, less complex portfolios now need to accommodate portfolios that are increasing in size and complexity. Over the past few years, asset allocators have grown beyond managing money for a single organization or pool, and operational risk grows as processes grow. And while asset allocators have been the driving force behind fund managers upgrading their operational systems and processes, that attitude hasn’t necessarily translated to asset allocators themselves.
The size increase of allocator portfolios is attributed to an increase in AUM as well as a larger number of underlying fund investments and byproducts of those investments. Each of those investments also generates a large number of documents like financial statements and capital call notices, which can quickly overwhelm processing systems.
The issues that result from operational errors and insufficient or late information are known as “operational leakage.” These day-to-day challenges can lead to snowballing costs and challenges that, in turn, contribute to poor investment and distribution decisions. Other problems that can result from operational leakage include inaccurate or late reporting to auditors, missed capital calls, unfunded liability errors and incorrect cash flow projections.
To address these operational risks, asset allocators should conduct comprehensive due diligence of their operations to identify weaknesses and inefficiencies. They should also ensure their operating model provides a timely consolidated view of all holdings, state-of-the-art document management, institutional-grade operations and institutional-grade accounting. This can be achieved through investing in people and technology or by outsourcing the operational functions that are the most challenging. Outsourcing lowers operating costs while also limiting capital expenditures, as well as bringing with it new technologies.