Goldman Sachs: Staying ahead of the digital curve

Investing in technology can provide a first-mover advantage in private markets and has the potential to transform the investment life cycle, say Darren Cohen and Luke Flemmer at Goldman Sachs.

This article is sponsored by Goldman Sachs

How have you seen the use of technology change in private equity in recent years?

Darren Cohen

Darren Cohen: Every public asset class – equities, credit, rates, FX – has seen a similar transformation from manual, bilateral workflows to data-intensive, highly-automated digital markets with nuanced microstructures. As those markets digitised, early investments in technology platforms and data analytics enabled first movers to get ahead of the curve and capture disproportionate economics and market share. Those who were late to evolve and adapt suffered as competitive dynamics changed and the market structure shifted.

I think a similar transition is currently underway in private markets, fuelled by the proliferation of unique data sources and the emergence of digital marketplaces that enable automated underwriting. As a result of these trends, I would expect the leading private equity firms to materially increase their investment in infrastructure, data and engineering.

Luke Flemmer

Luke Flemmer: We are starting to see a real bifurcation in the market. Some private market firms were ahead of the curve investing in fundamental data requirements and systematising processes. Now these firms can operate at scale and have surplus capacity to invest in more advanced technologies that are leading to exponential gains.

Those that haven’t made investments are now playing catchup, spending most of their budgets to get basic data hygiene in place as the amount of available information proliferates. It is very similar to the dynamic we saw over the last 10 years in the public markets, where some banks had made foundational investments that allowed them to really scale digital and analytics capabilities, while others were just feeding the maintenance of legacy systems and operations.

Where in the investment life cycle are you seeing technology be most impactful?

DC: We have seen some of the biggest changes in deal sourcing and underwriting, initially in growth and venture, but increasingly in other asset classes too. Our teams now have access to valuable datasets that provide insights into private company funding rounds, recruiting trends, market shares and client reviews.

We are also able to augment these insights with our proprietary research, data and networks to further optimise our sourcing strategy, as well as enhance our underwriting diligence. By applying this bottom-up approach, we can build an incredible mosaic of data that helps our investment teams identify emerging category leaders early and integrate data-driven insights into our investment process.

LF: As we engage with companies, we are capturing more data than ever before across the full life cycle of the investment process. And that is not just the deals we have completed, but also the ones we have passed on. We have proven the commercial impact of applying these technologies and workflows across our teams and are now really scaling their application. Richer company and sector models not only support greater efficiency in our traditional investing processes, but also create opportunities for new methods of sourcing, underwriting and value creation.

How is technology being used to open new markets?

LF: Technology is allowing investors to source and underwrite pools of risk that historically could not scale. By being able to dynamically match businesses and consumers with different sources of financing, you can generate a more attractive risk-adjusted return for investors while also offering a lower cost of capital. We are seeing this happen in straightforward, standardised products like mortgages and auto loans, but activity is expanding into more opaque areas of the market.

DC: Consumer lending platforms are a prime example. Underwriting unsecured individual borrowers used to be nearly impossible at scale, but with rich datasets available today and sophisticated credit matching platforms, massive markets are being created. Similar innovations are taking place across various aspects of corporate and asset-backed lending, too. This is particularly powerful as the market structure of private asset classes changes.  These emerging and scaled lending marketplaces are increasingly effective at matching funding with risk, enabling capital to flow seamlessly between borrowers and lenders. This has created an opportunity to underwrite and access a diverse array of risk exposure that historically would have been challenging to access efficiently and at scale.

How is technology being used to assess and manage risk?

DC: Risk management is predicated on data, and it is clear to me that we can reap huge benefits as we start to capture more data across our portfolio companies. When that is done at scale across a large portfolio, it leads to a deeper understanding of broad economic developments, as well as valuation and operational benchmarks across sectors and geographies. Now, when a major event unfolds, we can quickly assess the potential impacts across the portfolio using data that is updated in real-time, rather than parsing stale reports and memos. This also makes us better in all types of scenario modelling, including forecasting funding and liquidity needs.

LF: For capital allocators, it is now easier to understand exposures across different private market asset classes and strategies. Only a few years ago, many investors were still thinking about asset allocation in broad buckets, without necessarily considering the various layers of exposures within specific strategies. By capturing detailed constituent-level data, we are able to conduct factor analyses that were previously only possible for liquid public positions.

How are better analytics changing the investment process?

DC: As analytics improve, it allows investors to assess risks along new dimensions. Rather than taking the typical top-down approach to asset allocation, investors will be able to construct a portfolio at an atomic level that provides more granularity and flexibility to tailor their specific risk exposures. And all of this can be delivered digitally. Using advanced analytics, we can pinpoint where a portfolio is lacking – whether it’s a diversification risk, liquidity need or ESG requirement. Technology and data can then be leveraged to deliver dynamic products that address the investor’s unique objectives.

LF: One of the biggest challenges lies with how less-liquid products are sold, traded and executed, which remains a very manual process. This is an area where blockchain technologies have attracted interest, as they potentially offer a different model for syndication, subscription and secondary liquidity.

Do you think blockchain is being actively adopted and integrated into the traditional financial ecosystem?

LF: I think there are two things happening, which are somewhat symmetric. There is a migration of traditional financial ecosystem assets and trading infrastructure into the crypto world, like new currencies and asset types, and the re-implementation of traditional trading platforms, derivatives, etc, into an at least nominally decentralised architecture. Conversely, there is the importing of crypto paradigms and technology into traditional financial arenas, primarily through the use of blockchains as the canonical shared record and tokens representing traditional financial claims.

“There is no doubt that blockchain is where significant talent is concentrating, so it seems almost inevitable that interesting solutions will be built – but it will take time”
Luke Flemmer

There has definitely been some hesitation to adopt blockchain technology broadly, partially because the technology is still so new, but perhaps more fundamentally because of the challenges it creates with a centralised authority model, which is still very much the one that our industry understands and trusts, for good reason.

Where I can see it being disruptive in the shorter term is because a crypto asset such as a non-fungible token is not only a representation of value or ownership, but it is also a computer program, meaning that it can impose additional features and behaviours on how it can be used and transferred. For example, rules around secondary trading can be programmed to restrict when the asset can be sold or to provide a royalty to the initial issuer. These features provide, at least in theory, more protection and consistency while also allowing for new workflows that could fundamentally change certain business processes, such as distribution and secondary trading.

DC: I think blockchain and digital assets have tremendous potential in the long term but will not directly reshape financial market infrastructure in the short term, given the regulatory uncertainty and the complexity of integrating these technologies.

Early in my career, we invested in several industry-leading trading platforms that ultimately supported the electronification of equities and fixed income. It would typically take the leadership teams three to five years to reach a minimal level of critical mass, and five to 10 years to achieve real scale. For digital assets, we would expect the innovation cycle to accelerate given the massive levels of funding and focus, as well as the pace of technology adoption.

However, in many areas of our business, I believe we will find more straightforward applications of technology that enable us to solve specific problems and address the inefficiency in the industry.

Areas with the most promise, such as automating fund distributions, would be incredibly powerful but cannot be solved easily due to lingering issues around data standardisation and reporting requirements. We think blockchain technology has promise and we follow it closely, but we have not seen a material impact in private markets so far.

LF: It is difficult to predict the timeline for development and adoption of blockchain technology, but the scale of investment and concentration of phenomenally talented engineers is noteworthy. Due to the intrinsic complexity of the space, the barriers to entry are high, and deep expertise is needed to build anything meaningful. There is no doubt that this is where significant talent is concentrating, so it seems almost inevitable that interesting solutions will be built – but it will take time.

Darren Cohen is global co-head of growth equity and Luke Flemmer is head of digital strategy for alternatives at Goldman Sachs


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