Five Operational Factors Driving Emerging Markets Custody Forward
| Asia Pacific Head of Alternative Investment Services and Structured Products, BNY Mellon
A strong global economy, led by several emerging economies, continue to provide valuable investment opportunities for alternative managers. This global rising tide continues to reward all market participants, making it difficult for asset managers to stand out in a crowded field.
It follows there is increased interest in emerging markets as investors look for return and yield above their benchmarks and these economies demonstrate strong economic performance. The MSCI emerging markets index is up 49% since 20161, compared to a 29% gain in the S&P 500 during the same timeframe2 and the weighting of emerging markets in the MSCI all-country world index is up to 11% as of May 2016, compared to 7% in 20063 as the threshold for investable assets is reached by more companies in these markets.
This corresponds with increased investment in emerging markets from alternative asset managers. Recent data from Preqin show hedge funds increased their investment in emerging markets by 6% year over year from 2016 to 2017. While the rate might not yet seem substantial, the long lead times associated with entering emerging markets indicate the trend may soon pick up steam.
Interest in these markets comes at the ideal cross section of investment in people, process and systems around the world by global custodians. By providing alternative asset managers unprecedented global service coverage, the custodian becomes a partner that could help the asset manager avoid losing potential investment return to inefficiency and poor execution. As asset managers look to enter new markets, it’s important to consider the following five factors when planning for the potential impact operations may have on investment portfolio return.
- Local market participation requires long-term planning
Experience demonstrates alternative asset managers must take a long-term view and plan their entry into emerging markets sooner due to various local registration requirements with on-shore regulators that can take up to a year before an asset manager is authorized to trade. In order to rise above the tide and capitalize on investment opportunities the alternative manager needs to reduce operational lead time by establishing global custody relationships with local expertise.
- Technology has made the world smaller and more accessible
Though local market registration may take time, once authorized, emerging markets have never been more accessible and transparent. Due to advancements in telecommunications and global market connectivity, alternative asset managers are capitalizing on technology enhancements to seek new investment opportunities in previously under-invested markets. These trends have also improved connectivity with counterparties and provide new sources of data and information, providing the necessary infrastructure of more accurate reporting and portfolio accounting.
- Complex accounting and reporting require sophisticated systems
New investment opportunities in emerging markets are not limited to the listed markets, but also present in sovereign debt and private placement markets, creating challenges in valuation, accounting, and reporting. It’s crucial to the operations of a fund to get the basics right, ensuring the fund’s board of directors and investors are informed about the performance in new markets.
- FX is key
FX can carry an outsized importance in thinly-traded frontier markets, where a currency’s movement in a single day can mean the difference between a gain or loss on a trade. Handling these transactions properly requires a combination of local market presence, global market know-how and balance sheet strength to ensure the transaction is optimized across the trade lifecycle.
- Local market execution needs global strength
As the needs of investors grow more sophisticated, so too must the needs of their brokers, technology providers, administrators and custodians. Bespoke systems and operations may work well in one market, but do not translate into other markets with different rules and market participants. Global institutions are building out capabilities and reach through scalable technology and investments in people and services, offering the strength of strong balance sheets, international reputations and global syndicates to back local-market operations. As more alternative asset managers look to emerging markets for yield and investment return, it is important to ensure the optimization of the transaction lifecycle chain to maximize the potential for investment return, while reducing operational risk/cost. This can both help deliver alpha and provide investors with assurance that the price paid delivers on the bottom line. Accessing the strength and security of a global custodian can help deliver on both of these promises.
See here for commentary disclosures