After 2024 promises for increased private equity movement failed to materialize, there is a quiet optimism that 2025 will be breakout year for deal activity.
Tim Toska
Group Sector Head, Private Equity
Top private equity trends in 2025:
Improving valuations present a more favorable backdrop for new deals, and crucially exits, in the months ahead
Traditional exit channels are springing back to life and visibility on valuations becomes clearer
Alternative sources of liquidity from secondaries and NAV providers will remain important options for GPs, even as conventional exit volumes rise
Improving exit fundamentals could have a huge impact on fundraising markets, as an uptick in distributions enables LPs to increase deployment into new funds
Hopes that a rebound would swoop across private equity markets in 2024 never quite materialized, but as private equity stakeholders start a New Year, there is a quiet optimism that 2025 will be breakout year for deal activity.
For deep dives into key trends driving the 2025 private equity outlook, read on.
Private equity trend #1: Valuation visibility
Improvement and stability in asset valuations will help to kickstart deal flow in the year ahead. Uncertainty around asset valuations was one of the main reasons for falling buyout and exit deal activity, resulting in a widening delta between vendor and buyer pricing expectations through the cycle of high inflation and rising interest rates.
It has taken time for valuations to respond to the first interest rate cuts registered in 2024, but there are finally signals emerging that private equity firms see asset prices moving higher.
Green shoots have emerged in the growth and venture capital space – one of the first private equity segments to experience the fallout from tightening liquidity, risk aversion and higher capital costs.
In November stalwart venture capital firm Sequoia, for example, a bellwether for the Silicon Valley investment community, marked up the value of its 2020 vintage fund by just under 25 percent. Even though the fund has yet to land any exits, the revised valuation represents a significant pivot in outlook from a market-leading franchise.
In addition to portfolio mark-ups, start-up companies have also encountered a more favorable backdrop for funding rounds. Smart ring start-up Oura, for example, achieved a $5.2 billion valuation in its latest Series D funding round, more than double the valuation secured in a 2022 Series C round, while Moneybox, the digital savings and investment app, almost doubled its valuation in its October 2024 Series D round.
The positive sentiment in the venture and growth equity space has bubbled up to the buyout market. The Argos Index, which tracks the average multiples of private, mid-market European M&A deals valued in the €15m to €500m range, for example, saw average multiples in Q3 2024 rally to 9.5x EBITDA after three years of continuous decline.
Private equity trend #2: Private equity exit channels creak open
A more stable backdrop for valuations has supported an improving outlook for exits, and is momentum is sustained this can unlock a wave of exits in 2025.
According to White & Case Debt Explorer figures, global exit deal value in Q3 2024 was up for the third quarter in a row, with combined exit value of US$94.06 billion representing the highest quarterly exit value in a year. Global exit volume numbers are also looking in encouraging, with the 429 exits posted in Q3 2024 representing the most active quarter for exits since Q3 2022.
GPs are not popping the champagne corks just yet, but there is a sense that asset class can build on this momentum and that the worst of the exit drought may be over.
A GP survey conducted by EY and published in Q3 2024 showed that more than half of GPs (53 percent) expect exits to increase in 2025 – up from 34 percent at the start of the year.
Private equity trend #3: Alternative liquidity
Even as traditional exit pipelines are unblocked, alternative liquidity options will remain a valuable source of liquidity – and distributions – as the private equity market transitions back to a steadier exit pace.
The slowdown in exit activity during the last 24 months has seen GPs explore alternative routes to liquidity in order to expedite distributions to LPs, and even as the exit backdrop improves, these alternative exit routes have proven their viability and will remain a key part of the exit mix.
Continuation funds, for example, where GPs shift selected assets into a separate vehicle, giving incumbent investors the option to either roll their interests into the new structure or take cash, have evolved into an established way for GPs to make distributions without selling prized assets. According to figures from Jefferies, continuation funds accounted for 14 percent of sponsor-backed exit volume in H1 2024 – a record high and a vindication of the continuation fund as a credible route to exit.
Similarly, NAV financing will continue to push further into the mainstream, providing liquidity for sponsors to fund portfolio companies beyond fund investment periods and in some cases make distributions. The increasing use and acceptance of NAV finance has seen the market more than double in size since 2023 according to 17Capital. Growing familiarity and comfort with the product among the GP community will drive ongoing uptake of NAV facilities through 2025.
Private equity trend #4: Unlocking fundraising in the private equity space
Upping distributions to LPs – through both traditional and alternative channels – will be crucial to reigniting a fundraising market that has been stagnant at best.
Pitchbook figures analyzed by EY estimate that 40 percent of the companies held by private equity companies have been sitting in portfolios for more the four years.
With significant pools of LP capital locked up in these assets, it is imperative that managers start to clear the backlog and get the fundraising wheels moving again.
Exits and distributions will have to reach a certain threshold to reignite LP interest in making new allocations, but even though there is still a way to go, there are flickers of light at the end of the tunnel, with LPs starting to talk about potential spinouts and first-time funds for the first time in years.
After a period of prolonged dislocation 2025 is a year for the private equity ecosystem to move back into balance.
Alternative asset annual review: how private markets fared in 2024
As 2024 draws to a close, Alter Domus sector heads Greg Myers, Anita Lyse, and Tim Toska take stock of a year where the market backdrop for private equity, private debt, and real assets has gradually improved, but managers have still had headwinds to navigate.
Greg Myers
Global Sector Head, Debt Capital Markets
Anita Lyse
Global Sector Head, Real Assets
Tim Toska
Global Sector Head, Private Equity
Private equity in 2024: a waiting game
Private equity firms have had to play a waiting game in 2024.
Falling interest rates and improving stock market valuations have been well-received by private equity managers, who have been waiting for the cycle of rising rates to peak and for clearer visibility on pricing risks to emerge.
But while the macro-economic backdrop has undoubtedly improved through the course of the year, the much anticipated “pent-up demand” in M&A and buyout activities, that was set to drive a surge in dealmaking, hasn’t quite materialized at the scale managers would have hoped.
Global buyout deal value has improved year-on-year, climbing by more than a third over the first nine months of 2024 to $637.02 billion, according to figures from law firm White & Case and Dealogic.
The uptick in deal value, however, does have to be placed in context. Buyout deal value has been in decline for two years, and despite the uptick in deal value in 2024, deal activity is still well short of the levels reached at the peak of the market in 2021.
The challenge the industry still faces on the road to a full recovery is particularly stark when reviewing exit value figures. At the end of Q3 2024, global exit value was close to a third down on figures for the same comparative period last year. As was the case in 2023, landing exits at attractive valuations has remained the single biggest challenge for private equity firms in 2024.
Tepid exit markets have meant thinner distributions to investors, which has had an ongoing impact on fundraising.
According to PEI figures, private equity fundraising fell the lowest levels observed in four years during the first three quarters of 2024. Much of the capital that has been available, meanwhile, has been absorbed by a small cluster of large managers. Bain & Co figures show that for the calendar year to the middle of May 2024, the ten largest buyout funds that closed during the period accounted for almost two-thirds (64 percent) of capital raised.
With distributions and liquidity constrained, LPs have directed the capital they do have available to large, trusted managers that offer scale and protection against downside risk. For managers outside of this cohort, the upshot has been longer fundraisings, with PEI noting that, on average, funds that closed in 2024 took 19 months to close, more than double the average time period taken to reach a final close in 2020.
In an effort to kick start distributions, and hopefully fundraising, managers have demonstrated the asset class’s ingenuity and growing sophistication by sourcing liquidity options outside of traditional exit channels.
Secondaries – the primary source of liquidity in illiquid asset class – has thrived in a cash-constrained environment and provided an essential pool of capital to managers and investors seeking cash. According to Jefferies, secondaries deal value for the first half of 2024 climbed 58 percent on figures for the same period in 2023 to reach an all-time high of $68 billion, with GP-led and LP-led deals both making double-digit year-on-year gains during the first half of 2024.
Financing markets have provided further optionality for GPs seeking alternative levers to generate distributions.
NAV financing, once a niche product area, has seen remarkable growth since the turn of the decade, with analysis from 17Capital, an NAV finance provider, showing that the market more than doubled in size between 2020 and 2023.
NAV finance – loans issued at fund level against the value of portfolio companies in funds – have been used not only to provide addition capital to portfolio companies in funds that have moved out of investment periods, but also as a tool to unlock liquidity in unsold portfolio companies and make distributions to investors.
Managers have also demonstrated their expertise and knowledge of leveraged finance markets to expedite liquidity, with dividend recaps (where issuers of debt borrow to fund dividend payouts) back on the table as interest rates come down and lenders look for opportunities to put their capital to work.
The reopening of primary exit channels will be the biggest catalyst to fire up private equity distributions and fundraisings, but in 2024 managers, lenders and advisers have demonstrated the asset-class’s flexibility and ability to innovate and adapt in challenging times.
Private debt in 2024: steady state
After a standout 2023, private debt sustained strong performance in 2024 as it continued to deliver attractive risk-adjusted returns and attract investor interest.
Private debt fundraising has been robust through the course of 2024, with Private Debt Investor figures showing private debt fundraising for the for the first three quarters of 2024 coming in just fractionally below figures for the same period in in 2023 – a striking result when compared to a private equity market where fundraising has been subdued.
Steady fundraising has been driven by solid returns and private credit portfolio resilience. According to research from Morgan Stanley, direct lending strategies, for example, delivered average returns of 11.6 percent between the beginning of 2008 and the end of Q3 2023, outperforming both leveraged loans (5 percent) and high yield bonds (6.8%).
Portfolios have also held up well through the rising interest rate cycle. Defaults have ticked up as interest rates have ratcheted upwards, but according to analysis from law firm Proskauer, which tracks 872 senior secured and unitranche loans, worth a combined US$152 billion, the overall private credit default rate was sitting at only 1.95 percent in Q3 2024.
Losses have been kept to minimum through a period of elevated interest rates, evidencing the ability of private credit managers to work with management teams and financial sponsors in partnership to steer credits through volatile periods and protect value.
Consistent returns and the control of downside risk are also reflective of the efficacy of the private credit model more generally, where managers invest time and resource to due diligence prospective credits in detail, maintain relatively small but high-quality portfolios, and work intensively with portfolio credits through hold periods.
Private credit, however, has not had everything its own way in 2024, with the reopening of broadly syndicated loans (BSL) during the year intensifying competitive pressures and challenging private credit market share.
As interest rates have come down through the course of the year, BSL markets, which have been effectively shuttered for the last year, have sparked back to life, with White & Case figures showing issuance of leveraged loans in the US and Europe almost doubling year-on-year during the first nine months of 2024.
Offering cheaper cost of capital, leveraged loan markets have been able to refinance unitranche loans issued by private debt managers at cheaper rates, winning back business that went to private debt managers during the initial series of interest rate hikes.
According to Bank of America figures reported by Bloomberg, there have been at least 70 private debt deals in the US, worth close to US$30 billion, that have been refinanced in the BSL market at lower rates.
Private debt funds have had to bring down margins to remain competitive with the cheaper cost of capital offered by BSL markets, which has limited the spread of opportunities managers can pursue, given the returns private debt is expected to deliver for investors.
Private credit lenders are still able to differentiate their propositions by offering flexible loan packages, speed of execution, and reduced syndication risk. Price is not the only factor borrowers consider when choosing a financing solution, but as competition from the BSL market intensifies, managers will have to sharpen their pencils to keep margins as low as possible.
Real assets in 2024: pockets of opportunity
Despite cooling inflation and interest rate cuts, real assets managers and investors have remained on a cautious footing in 2024.
Indeed, fundraising for real estate and infrastructure funds has been muted through the course of the year. PERE figures show a decline in year-on-year real estate fundraising of more than a third during the first nine months of the year. Infrastructure fundraising has been more stable, with Infrastructure Investor reporting an uptick in year-on-year fundraising for the first three quarters of 2024, but noting that full year figures could still fall short of the annual total for 2023, as there was a surge in activity in the final quarter of last year that could be difficult to replicate.
Even though macro-economic fundamentals have improved through the course of the year, managers and investors have taken a patient approach, waiting to build a clearer picture on how the outcome of a US Presidential election and intensifying global tensions could impact real assets over the longer term.
Volatility has continued to linger, but green shoots did begin to emerge in the real estate sector in second half of the year, with JLL reporting an improvement in real estate transaction activity as lower debt costs and more pricing data points gave dealmakers the confidence to progress with new transactions.
Large, developed real estate markets, most notably the US and UK, have seen the biggest rebounds in deal activity[4], with JLL noting that improving macro-economic conditions have boosted consumer-facing segments such as hospitality and retail real estate. Office real estate has stabilized as companies pivot back to more office working, but logistics activity has been more reserved, with corporates reviewing supply chain dynamics and existing footprints before expanding into new space.
In the infrastructure sector, meanwhile, deal activity has also varied by subsector. CBRE notes that over the first half of 2024, overall infrastructure M&A activity was down year-on-year, but that in select verticals, such as power and transport, there were strong year-on-year gains.
Two mega trends that have continued to drive both real estate and infrastructure fundraising and deal activity have been data centers and decarbonization.
Investment in data centers has barely skipped a beat through the cycle of rising interest rates, with the huge demand for data to power digitalization and AI sustaining data center build outs despite wider macro-economic dislocation. According to JLL the colocation data center market in the US alone has more than doubled in size during the last four years, supporting ongoing M&A and debt financing transactions opportunities.
Decarbonization, meanwhile, has remained a core priority for real estate investors, who have recognized the importance of reducing emissions across the sector, which accounts for an estimated 40 percent of global emissions, according to CBRE.
Decarbonization has become a regulatory and compliance necessity, with the introduction of new frameworks such as the Sustainable Finance Disclosure Regulation (SFDR) and the phasing in of higher real estate energy efficiency standards.
Transitioning to cleaner, lower-emissions buildings will require significant investment from the private sector, and present opportunities for investors and developers to build out differentiated property portfolios with the potential to generate higher returns.
Real assets investors and managers will continue to rely on these two megatrends to drive portfolio performance in 2025 but will be hoping that lower interest rates can boost other segments within the asset class too.
Liquidity in private markets: part four – securitization
The cycle of rising interest rates has put liquidity at a premium for private markets investors and managers, who have responded by showing flexibility in using new products and technology to kickstart capital flows in an otherwise tight market.
In the fourth and final installment of this article series on how to capture capital to locate liquidity- exploring the tools alternative assets stakeholders have used to source liquidity in a challenging market- Alter Domus looks into the use of securitization structures across the industry.
Michael Janiszewski
Chief Operating Officer
A period of high interest rates has made liquidity hard to come by for private markets managers.
According to MSCI figures, private equity distributions came in at just 8.7 percent of valuation in Q1 2024, little more than a third of the average distribution rate of 23.5 percent for the period between 2015 and 2019. Slowing distributions have had a direct impact on fundraising efforts, as LPs wait for cashflows from existing portfolios to come through before ploughing resources back into a new vintage of funds.
With liquidity at a premium, the still relatively young alternative asset ecosystem has demonstrated its ability to adapt to changing circumstances and embrace new mechanisms to generate capital and keep momentum. and embrace new mechanisms to generate capital and keep momentum.
In the fourth and final article in a series exploring the alternative routes to liquidity that managers have available, Alter Domus looks into how securitization structures, including collateralized fund obligations and rated feeder funds, have enabled managers and investors to unlock capital flows in a tight market.
Part 4: Securitization
Securitization- the bundling together of assets into a vehicle that sells shares to investors- is an established practice in fixed income markets, but has been rare in the private funds space.
The slowdown in private equity distributions and fundraising as a result of elevated interest rates, however, has supported growing interest from managers and investors in securitization as a tool to enable capital to flow into the private markets ecosystem more easily and through different channels.
In October 2024, for example, AlpInvest, the integrated private markets platform owned by the Carlyle Group, secured its second securitization with the successful close of a $1 billion collateralized fund obligation (CFO) that exceeded its $800 million target.
Private funds securitizations are still relatively uncommon, especially when compared to the high volumes of securitization deals seen in other markets, such as the issuance of collateralized loan obligations (CLOs) in the broadly syndicated loan space. Interest in private funds securitization, however, has been growing steadily in recent years and we at Alter Domus have been helping our clients navigate this, particularly through the rising interest rate cycle as other liquidity channels have tightened.
Private funds securitization: how it works
Securitizations are complex transactions, but in essence, in a private funds context involve the pooling together of LP interests in a variety of underlying private markets into a special purpose vehicle (SPVs), which then sells rated debt notes to investors.
These SPVs are organized in tranches, with different tranches then sold to investors, in line with specific investor requirements and risk appetite. Senior tranches will carry lower risk and offer more predictable returns, with the risk-reward balance shifting accordingly for lower tranches of the SPV structure.
In private funds, securitization can be executed through either a CFO structure or rated note feeder (RNF). There are important technical differences between CFOs and RNFs, but there are also broad similarities, as both structures effectively allow investors to gain exposure to private markets funds, but through a debt-like product rather than an equity investment.
The securitization channel into private markets funds is especially attractive for investors and institutions who have to consider regulatory capital requirements when deploying capital.
CFOs and RNF tranches have to receive credit ratings from ratings agencies, and as debt instruments with high credit ratings receive more favorable regulatory capital treatments than direct equity investments into private markets funds, CFOs and RNFs have proven especially appealing to insurance companies and sovereign wealth funds. The structures have been an ideal fit for these institutions, who have wanted to grow private markets exposure without throwing their regulatory capital ratios out of whack.
CFOs and RNFs, however, have also been gaining appeal with other investors, who do not have to comply with strict regulatory capital rules, as the tranches within the vehicles enable investors to tailor private markets exposure to their particular investment requirements.
For managers, meanwhile, the structures have provided additional routes into new investor bases at a time when capital is at a premium, and traditional fundraising options have been constrained.
Operational excellence essential
Taking advantage of the potential liquidity that securitization can provide, however, requires a manager to have robust back-office rails in place to manage the complexities and operational demands that come with CFO and RNF vehicles.
The reporting, disclosure and fund accounting demands that come with a CFO or RNF are at another level when compared to conventional, 10-year closed ended LP-fund requirements.
For starters, receiving credit rating for a CFO or RNF requires a manager to provide high volumes of often unpublished information on financials, governance, risk management and business strategy and earnings forecasts. Applicants will also often be asked to make detailed presentations to ratings analysts before a rating is issued. The demands the application process places on back-office teams is not to be underestimated.
The day-to-day management and accounting of a CFO or RNF will also require significant back-office support from a trusted partner like Alter Domus, with managers obliged to keep track of payment waterfalls to various investors, according to which tranches of the structure that they hold, as well as ensuring that the sponsors or originators of the securitization maintain the necessary risk retention thresholds in the securitized vehicle to comply with regulatory requirements.
Help at hand
An experienced fund administrator that is well-versed in the mechanics of securitizations and private markets can provide managers and their investors with invaluable bandwidth and experience when it comes to setting up and operating an CFO or RNF effectively.
Alter Domus, for example, has more than US$2.5 trillion of assets under administration and network of 39 offices in 23 jurisdictions, giving it the scale and global regulatory and commercial expertise to support CFO and RNF formation.
We also have extensive securitization experience, and our CLO manager services practice has a long track record of successfully providing managers with comprehensive operational support that extends beyond core loan servicing tasks to include compliance with governing guidelines and rating agencies, scenario planning and modelling, and managing trustee data.
Specialist fund administrators also have the scale and resources to make significant investment in specialist, proprietary technology tools focused on securitizations. Our innovative technologies have been relied upon by asset managers and trustees in the CLO space for decades to streamline processes, lower operating costs and limit errors and risk.
Replicating this experience, technology infrastructure and back-office scale is incredibly difficult for managers to do in isolation, as it involves large upfront capital expenditure and ongoing maintenance and servicing costs.
Working with trusted partner enables managers to plug into established infrastructure and institutional expertise, allowing managers to take advantage of the liquidity that securitization can bring their firms, without having to worry about mushrooming operational costs and risk.
Michael Janiszewski shared his insights in December’s PEI Perspectives report about what tools, technologies and support GPs and LPs will need to set them up for 2025.
Michael Janiszewski
Chief Operating Officer
December 5, 2024
Interview
How important is a manager’s operating model to its fundraising success in today’s market? To what extent has this changed and why?
Private markets assets under management have more than trebled to $14.5 trillion over the past decade, according to analysis by Bain & Co. In a climate of increased competition, LPs are placing a growing emphasis on private markets firms’ operating models.
This is in part because LPs have substantially larger pools of capital invested in private markets today. As a result of these larger exposures, they are leaning towards managers with robust operating models in order to limit the downside risk.
At the same time, managers with best-in-class operating infrastructure are better positioned to collect, analyze and harness data to improve deal origination, execution and portfolio company performance. Of course, dealmaking will always remain the core priority for managers, but GPs have come to realize that back-office capabilities and operating models can contribute to front-office success and play an important role in supporting future fundraising.
What areas are LPs scrutinizing in particular? What are the must haves and the red flags for investors doing their due diligence on operating models prior to committing to a fund?
Investors are certainly demanding more when it comes to reporting, compliance and technology. Having the right bespoke operating model in place puts GPs in a better position to differentiate their firms through speedier, more detailed, value-add reporting to investors. In addition, LPs are looking to interact with their GPs in a more digital and data-driven manner, gaining access to information about investments in new and deeper ways.
As well as supporting fundraising, how else can fit-for-purpose, future-proofed back-office infrastructure support front-office activities?
A rigorous back-office capability is essential for GPs who want to offer more co-investment opportunities, take advantage of the liquidity offered through NAV financing, or are considering GP led deals that require solid accounting and reporting frameworks. These are all inherently data-driven activities, which means that the way in which they will ultimately be delivered will be through the use of technology.
What role is technology playing in supporting the modern private equity operating model more generally, and what opportunities does this present?
Technology is undoubtedly playing an ever more important role across the private equity industry. This initially played out in the back office, with various types of financial statement reporting, cash management solutions, as well as workflow and case management tools coming to the fore. Then, in the middle office, we started to see a focus on fund performance and portfolio monitoring, with information being collected across asset classes to support risk management and sophisticated reporting.
Finally, in the front office, technology is now being used to support investment and diligence processes, as well as investor relations. What I think is particularly new and exciting is the proliferation of specialist private markets tools that we are able to leverage today. This is in complete contrast to what was available a decade ago.
It used to be that if an alternatives manager was looking at an aircraft lease, for example, we would have to adapt that into the fund accounting system in the form of some sort of bond. That is no longer the case. Technology now has the language of alternative investing built into it, enabling us to provide different views on risk, better access to data to support superior decision making, and allowing LPs to actively monitor their investments.
The other area where we are seeing significant changes, and where development is primarily driven by LPs, is an enhanced digital experience. It’s still early days, but we are seeing generative AI being used to answer client queries, to leverage large knowledge bases and to respond to requests for proposals. Then, from an operational perspective, optical character recognition is being widely used to make tasks that were historically manual more automated.
Looking ahead, I cannot think of a single operational function where we won’t be using some sort of AI to either extract or manage information differently, or to start drawing conclusions based on that information to support reporting or decision-making, at some point in time.
However, the focus should not just be on AI, but automated machine learning as a whole the process of taking upstream and downstream data and standardising it – given the sheer volumes of financial documents that come into play.
To what extent is artificial intelligence being integrated into digital solutions?
Technology is being used to create great UI, visualization and mobile access, for example. A wide variety of digital interactions – from something as simple as getting a K-1 in the US to performance analysis, cashflow fore[1]casting and benchmarking – have all become, if not the norm, then certainly the expectation for investors. Alternatives have become a much more digital and data-driven industry.
Is the rapid adoption of technology also creating challenges?
I would say the biggest challenge for managers involves data management. While we have made great strides in systems that speak the language of alternatives, we are nonetheless faced with significantly increased demands from clients – both GPs and LPs – when it comes to managing that data. Of course, the cloud has helped us a great deal in that regard, but there is still a lot of hard work involved in operationalizing data that has historically been manually inputted into spreadsheets. Finding ways to ensure that data can be accessed and analyzed in sophisticated ways is something that will certainly be enabled by technology, but there is still some way to go.
The service that an administrator provides reflects directly on the manager. It is a reputational issue for GPs, and therefore for LPs too. LPs are looking to interact with their GPs in a more digital and data-driven manner.
How are all of these developments impacting the decisions that managers are making around what to outsource and what to keep inhouse, and how are third-party providers responding?
Rather than investing large amounts of capital into ever-expanding back-office teams and technology, managers are increasingly working with third-party administrators in order to benefit from the scale, cost advantages and specialized back-office focus. This enables managers to instead invest capex into their core business of dealmaking. In response, fund administrators are evolving their offering from the provision of basic outsourced fund accounting services to providing technology best practices, together with support for managers to enable effective implementation and harness technology in modular operational models.
What is particularly exciting for us is that we are receiving a lot of inbound interest regarding solutions to many of the challenges that I have described. Those enquiries sometimes center on the use of data to support better investment decision-making, for example, or the need to provide different types of information to end clients.
The focus can also be on improving the manager’s cost profile. In short, managers are looking to third parties to fulfil functions that they either can’t or don’t want to invest in at the level that an external provider can. Another driver, meanwhile, is the desire from managers to partner with organizations that are able to glean insight and experience from working with market participants across the entire industry.
As a result, third-party administrators are being approached not only as outsourced service providers but as accelerators for the strategies that their clients are trying to implement.
Is the choice simply between insourcing and outsourcing, or are other models emerging?
Co-sourcing is certainly a trend. That is something that managers are talking to us about and it is something that we have the flexibility to implement. However, I would add that most of those conversations are followed by questions about what our plans are as a third-party administrator to provide some of those functions in a fully out[1]sourced manner.
Co-sourcing is typically seen as a step on the journey towards outsourcing.
What questions should LPs be asking of a potential outsourced provider?
Operational excellence is, of course, incredibly important in this space, because the service that an administrator provides reflects directly on the manager. It is a reputational issue for GPs, and therefore for LPs too. Other sources of differentiation among third-party providers include the degree to which these organizations are investing in their own core systems and operations in order to take advantage of industry trends. GPs should also select an expert partner with firsthand experience in managing processes across multiple strategies and different investment vehicles.
An understanding of cross-jurisdictional knowledge is also vital, should they wish to expand investment beyond their regional boundaries. In addition, LPs should consider the extent to which administrators are investing ahead of the curve, thinking about the next wave of innovation, whether that be generative AI, sophisticated data management or the provision of different ways for LPs to access information.
That kind of forward-thinking approach can help put managers on the front foot when fund[1]raising, and give LPs the comfort that operations are being well run by experienced industry specialists, and that it can scale as their firm grows.
What is your number one piece of advice for a manager re-evaluating its existing operating model with the intention of building something that is sustainable and that will allow it to scale?
My number one piece of advice would be to take time to review the market. I would add that it is also important to understand that the role of the fund administrator has changed.
Today, the right outsourced partner can provide operational support from back-office accounting, all the way through to client services, thereby enabling firms to focus on their own value proposition in a very different and much more sophisticated way.
Liquidity in private markets:
part three – feeder funds
The impact of higher interest rates on private equity exits has taken its toll on private equity fundraising, as managers battle to make distributions to investors, who have paused on making allocations on new funds until liquidity from distributions starts to flow again.
In the third of a four-part series exploring the tools and options private equity managers have available to source capital at a point in the cycle when liquidity is constrained, Alter Domus explores how feeder funds are helping managers to open up new pool of investors and sustain fundraising at tough point in the cycle.
Michael Janiszewski
Chief Operating Officer
Raising a private equity fund has been hard-going during the last 36 months, with a few minor exceptions.
Rising inflation and elevated interest rates have seen sharp declines in private equity exit activity, which has bottlenecked distributions to investors resulting in limited capital to plough into the next tranche of private equity funds.
Limited flows of capital from private equity programs have given LPs fewer options, and in a choppy, volatile market, most investors have set aside the capital that they do have available for a select cohort of the biggest private platforms, seen as the safest pairs of hands.
The upshot is that a bigger share of the smaller private equity pie has been absorbed by a smaller group of managers. Bain & Co analysis shows that in the buyout space from January to May this year, the ten largest funds to close took out almost two-thirds (64%) of total capital raised during the period.
As capital has been funnelled into fewer hands, managers have had to adapt and explore other options for fundraising and new investor pools.
Private wealth and non-institutional capital has been an obvious avenue to turn down, and feeder funds have provided one of the most valuable channels to reach this emerging cohort of private equity investors.
In the third of a four-part series exploring the alternative routes to liquidity that managers have available, Alter Domus looks into how feeder funds can help managers sustain fundraising efforts against a challenging backdrop.
Part 3: Feeder Funds
At a point in the cycle where institutional investors have taken a “risk-off” approach to new private equity allocations, the potential of the non-institutional space has been pushed firmly into the spotlight.
Managers have seen non-institutional capital as a long-term driver of private markets assets under management (AUM) growth. Bain & Co forecasts have estimated that during the next ten years individual allocations to alternative assets (AUM) could triple from current levels to reach as much as US$12 trillion.
As the supply of institutional capital has tightened, however, managers have accelerated efforts to secure more capital from non-institutional clients.
One of the primary channels for reaching individual investors have been feeder funds, and the private markets ecosystem has been ramping up efforts to increase capacity to reach more potential non-institutional investors.
What is a feeder fund?
Feeder funds are investment vehicles to pool together capital commitments from groups of investors and then funnel this capital into an umbrella or master fund, deploying the capital in new investments.
The feeder fund structure has helped to widen access to private markets investments by bringing down the investment minimums that would usually be required secure exposure to new a fund.
By pulling together capital from groups of non-institutional investors, feeders can amass sufficient scale to gain traction with GPs on the fundraising trail, but keep investment minimums at a much lower threshold than if an individual were to invest in a fund directly.
Feeder funds have been around for a long time, but predominantly through the private wealth divisions of investment banks, who draw in allocations from high-net worth clients and then effectively interact with managers as single LPs.
As more individuals and non-institutional investors have noted the returns on offer in alternative assets, however, other channels with feeder fund attributes have emerged to service growing demand. Online platforms, such as Moonfare and Reach Alternative Investments, to name but a few, are examples of innovative, tech-enabled feeder fund platforms that enable investors to make allocations with investment minimums as low as €50,000 in Europe and $75,000 in the US.
Putting the right rails in place
For managers that are seeking capital from non-institutional investors via feeder fund structures, it is crucial that managers have the necessary back-office infrastructure in place to manage the additional requirements and obligations that come with taking on investment through feeder fund structures. And that’s where Alter Domus comes in.
The underlying investors in feeder funds will require different levels of education and reporting to what managers are used to in an institutional context. Private banks and online platforms will provide invaluable support in curating reporting and investor materials to align with what non-institutional investors require, but it ultimately does come down to manager to lead on the production of regular reporting and net asset valuations for a non-institutional audience.
The requirement for more frequent reporting, and reporting that differs from what is already produced for institutional backers, does place added workloads onto back-office teams. We have found that the use of technology-embedded bespoke processes can elevate this burden.
Workloads are further ramped up as targeting a non-institutional investor also requires significant investment in the production of investor marketing and education materials. The back-office becomes a crucial enabler of front office fundraising and marketing efforts, are teams require information packs and educational materials to engage with individual investors, explain how private equity works, and what investors should consider when allocating to private equity.
There are also individual tax considerations that managers have to be aware of, as well as regulatory frameworks covering individual investors in different jurisdictions.
Depending on the jurisdiction, non-institutional investors have to meet certain eligibility criteria. This is usually linked to a minimum levels of investment assets or evidence of investment expertise, in order to qualify as private markets investors.
Onboarding high volumes of non-institutional investors and making the required know-your-client (KYC) checks can also become overwhelming for managers that don’t have operating models of a certain scale.
Seeking support
Working with a third-party fund administrator, like Alter Domus, can help managers seeking to raise capital from feeder funds with scalable resource and extensive non-institutional experience.
With an extensive global footprint and large compliance teams, Alter Domus has the capability to cover the eligibility criteria and tax arrangements of underlying feeder fund investors around the worlds, freeing up GPs to focus on winning new non-institutional clients knowing that regulatory and tax issues are being manager by an experienced and trusted partner.
Third-party administrators will also have the bandwidth to invest in proprietary technology, AI-powered software and automation to process high volume back-office tasks – a helpful resource for managers that find they have to manage rapidly rising volumes of KYC checks and client onboarding as more individual investors gain access to their funds.
The opportunity to secure more capital from individuals presents not just an invaluable short-term fix for slowing institutional allocations, but a long-term opportunity to build a new category of LP that could be the main driver of long-term AUM industry growth.
Seizing this opportunity requires not just an excellent investment track record and returns profile, but a robust operating backbone to handle the particular demands that come with serving a non-institutional client base.
An experienced fund administration partner can be there to support managers along every step of that journey.
We evaluate the historical performance of BDCs to better understand how portfolio variation provides investors opportunities to better manage across the risk/return and portfolio diversification spectrums.
Rudolph Bunja
Head of Portfolio Credit Risk
Nick Harris
Junior Data Analyst
Our previous research has shown that there are significant differences of diversification across the portfolios of business development companies (BDCs).
This portfolio variation provides investors opportunities to better manage across the risk/return and portfolio diversification spectrums. In this paper, we evaluate the historical performance of BDCs to better understand this risk/return dynamic.
The selected sample of publicly traded BDC returns, which covers 2019-2023, includes a period of notable volatility. We also make use of broadly syndicated loan (BSL) returns covering the same period. Although we acknowledge that BSL have certain differentiating characteristics, BSLs could provide a reasonable reference that can add further insight into our analysis.
The historical returns data in our study, which covers 2019-2023, includes two significant recent economic events. First, the onset of the global COVID pandemic, which led to a period of severely curbed economic activity followed by extraordinary fiscal and monetary stimulus to alleviate the economic impacts from the shutdowns.
Second, the accelerated pace of central banks tightening monetary policies to address the spike in inflationary pressures. The combination of disruptions to the usual supply chain channels and extraordinary stimulus is widely recognized as significant contributors to the market volatility during our period of study.
The returns are based on daily price and dividend distribution data for two publicly traded ETFs that track well-established public BDC and BSL indices. These indices provide transparent insight as to the relevant performance of their respective underlying asset class.
BDCs are reasonable proxies for private credit performance since the underlying assets of BDCs consist predominantly of senior secured loans to smaller and middle-sized corporate borrowers. The private credit markets have key features, as we have previously highlighted, that can mitigate risk while offering investors and borrowers a valuable investment and funding alternative.
The daily returns are used to compute total returns, relative volatility measures and the compounded annual growth rate (CAGR), which consists of the respective ETF price return and its dividend distributions.
The CAGR provides a proxy for the average annual total returns of the underlying investment portfolio performance as well as that of the respective ultimate underlying investment portfolios of those BDCs that comprise the index.
The dividends effectively represent the net investment income (NII) (i.e., net of management fees, expenses, and debt servicing costs) of the underlying portfolio as regulations stipulate that these funds (including the underlying BDCs) distribute at least 90% of earned investment income.
Note that BKLN and its underlying portfolio of BSL are unlevered. However, because BDCs operate with leverage against their portfolios, we take a simple approach to applying a leverage adjustment to the BKLN returns to make them more comparable.
The leverage adjustments applied to BKLN assumes the initial debt amount (and its service cost) used to finance the underlying BSL to be fixed during the entire period. We made assumptions of initial debt-to-equity ratios (DERs) that are between 1.0x to 1.75x, which is within the range of BDCs.
Note that under the Small Business Credit Availability Act passed by Congress in 2018, BDCs can elect to increase their DER to 2.0x (or decrease their asset coverage to 150%) subject to certain conditions.
The DER effectively magnifies the daily price returns while the assumed debt servicing cost implies an incremental excess yield (or NII) that is earned. This excess yield is based on the difference between the assumed (i) yield on the underlying investments and (ii) the debt servicing cost. Fees and expenses are already reflected in the underlying ETF returns.[1]
BDC and BSL returns – highlights
Table 1 displays the historical return statistics for BKLN (with various initial DER assumptions) and BIZD. We assumed an excess yield of 1.50% for this range of DERs based on insight from arbitrage BSL CLO and BDC financings and what BSL portfolios would reasonably yield.
The reader can also make their own inferences based on our sensitivity analysis between different DER and excess yield combinations shown in Table 3.
Initial observations indicate that the unlevered BKLN results are intuitive and to be expected as compared with BIZD. The BDC index returns appear to be relatively volatile but generated a higher CAGR over the period.
However, once leverage is introduced, and as to be expected, the BSL index returns imply more volatility, including a higher CAGR, as the assumed initial DER increases. But the CAGR increases at a relatively lower rate as compared to its volatility. Note that the volatility of the levered BSL index does, however, come closer to that of the BDC index.
Another noteworthy observation is that, for both indices, the dividend returns (representative of NII) contribute to most of the CAGR, even more so for BSL.
Amongst other factors, this is because the BSL index introduces primarily performing loans, which typically trade at or around par. In that case, there is limited upside in those instances when loan prices trade at a premium, reflecting the credit improvement of the borrower, as those loans will likely be pre-paid (or refinanced).
This phenomenon is especially the case for BSL borrowers as they are larger and have more access to alternative financing sources.
In contrast, private credit borrowers are typically smaller and often with a relatively riskier profile (most without public ratings) and hence less likely to find alternative sources to funding. However, these borrowers do compensate lenders with a relatively higher premium.
In this case, for those lenders (and investors) that can hold for the long-term (like BDCs), they can realize the rewards that the incremental premium these loans yield. BDCs will also often invest in equity securities, which offer some upside return potential.
Chart 1 illustrates the relative underlying performance.
It is interesting to note that the BDC index and levered BSL index had similar drawdowns at the onset of COVID pandemic shutdowns during March 2020. However, as the BSL levered index appears to have recovered sooner, the BDC index accelerated later during 2021.
This can be partially explained by many BDCs having significant investments in subordinated assets including private equity that could offer some upside returns potential. In contrast, BSL had relatively limited upside with returns that ultimately relied on distributed NII. In fact, most of the increase in NII was due to the BSL floating base rates reflecting the Federal Reserve rate increases.
We also collected daily price and dividends for the BDCs that underlying the index. Chart 2 illustrates an example of how wide the range of BDC returns, for a sample of the BDCs in the index, were during this period.
This wide-ranging returns and volatility of performance among the BDCs can be explained, amongst other factors, by the diversity of portfolio compositions and prudent operational management exercised by the BDCs that could have further contributed to NII.
The range of CAGRs and volatilities for most BDCs analyzed within the index were between ~5% to ~21% and ~25% to ~43%, respectively.
The daily return correlation matrix below provides further insight as to the diversity across the sample of BDCs and the BSL index. Although the BDCs are positively correlated with one another, the correlations imply that the BDCs returns do not always move with the same direction or of comparable magnitude. It also appears to correspond to Chart 2 above.
As another example, Chart 3 displays a comparison of returns for two BDCs with quite different portfolio compositions (based on posted Q4 2023 earnings presentations).
Note that the BDC with a higher CAGR (and higher volatility) had significantly more exposure to investments outside of first-lien senior secured loans. Approximately 50% of that BDC portfolio included a combination of second-lien or subordinated loans and equity type investments.
The other BDC had an investment portfolio comparable to a typical direct-lending portfolio with more than 90% first-lien secured loans. The chart is not surprising as it would be expected that riskier portfolios could generate higher returns along with more volatility, holding all else equal.
Chart 4 compares the second BDC mentioned above with the BSL index since this BDC had a more comparable portfolio composition, at least in terms of seniority.
At first glance, the levered BSL returns give some intuitive explanation as to the behavior of the BDC. Also, one can argue that this BDC was riskier with more volatility (at least during 2020), however, this volatility could be explained by a variety of factors, including the fact that the underlying assets are less liquid and generally considered to pose more credit risk than BSLs (of course, with more risk comes higher expected returns). One proxy of market volatility for BDC assets could be the divergence between market price and fair value as applied by BDCs in accordance with their established valuation methodologies.
Underlying investments within BDCs are mostly illiquid and private in nature and hence do not have readily observable market prices. In fact, BDCs report portfolio NAVs quarterly and mainly rely on established fair value determinations for portfolio investments.
History has shown that market prices could deviate from NAVs (for other less liquid and fairly valued asset classes as well) especially so during extreme times of market distress, implying a significant discount. This was the case for BDCs during early 2020, at the onset of COVID.
Alternatively, there are moments where this deviation can work in the other direction (i.e., in cases of market euphoria with market prices implying a premium to NAV) only exacerbating market implied volatility. Periods of significant discounts or premiums to NAV could provide some explanation as to the differences in volatility across BDC investments and BSLs.
Table 2 below illustrates how BDC discounts drifted during our period of analysis with discounts as low as 50% in March 2020, with a subsequent rebound to an average modest premium at the end of our assessment period.
Table 2: BDC Discount / Premium to NAV
As of
Average Discount / Premium
12/31/2018
~10% Discount to NAV
3/31/2020
~32% Discount to NAV
12/31/2023
~3% Premium to NAV
Averages are based on a sample of eight BDCs (ARCC, FIDUS, FSK, GBDC, HTGC, PSEC, TSLX, and OBDC (NA on 12/31/2018)).
As already noted, we utilize the levered BKLN analysis to further demonstrate how the NII and DER are critical in explaining CAGR performance. Table 3 shows the relative sensitivity of CAGR (and volatility) based on various combinations of DER and excess yield assumptions.
Table 3: Levered BSL ETF with varying DER and excess yield assumptions
The CAGR results are not surprising – CAGR increases when the DER and/or excess yield increases. The CAGR changes are more muted for lower excess yield assumptions (e.g., 0.50%) as more leverage is added.
Volatility, on the other hand, increases quite significantly as DER increases for each assumed excess yield, but is less sensitive to changes in excess yield while holding DER constant. In this case, the daily price returns explain most of the changes.
The above results are insightful when comparing the levered BSL index return statistics against the BDC index. Based on the historical returns during this period, the CAGR (and volatility) comparisons between the levered BSL index and BDC index converge closer when approaching a 4.00% excess yield and a 1.75x DER.
However, this would have been an unlikely scenario for a levered BSL portfolio (especially the 4.00% excess yield).
For consideration
Bringing this together, we present some key factors that can account for the variation in historical return performance across these BDCs. Some are likely topics for further Alter Domus research.
Dividends and NII: It is quite clear how significant dividend distributions (representative of NII) contribute to the CAGR of a BDC as was demonstrated through a simple example. This further highlights how important the operational management of the BDC is to CAGR as is the manager’s investment decisions (e.g., level of diversification and credit risk).
Some examples include the efficient management of the BDC’s asset-liability structure (e.g., maturity profiles, payment mismatches, debt servicing cost), operating costs, and level of management fees.
Historical observation period: Although the period during which these historical returns cover is a significant one, it is nonetheless a sample. A particular vintage or timing of investments such as at the beginning, end or middle of a business cycle can be a key reason for performance.
Market price versus NAV: The historical returns are based on observed market prices, which can be divorced at times from what the underlying NAVs may indicate. This is especially the case for BDCs whose underlying assets are predominantly private in nature and where the NAVs typically rely on fair value determinations, as mentioned earlier.
Hence those prices implied by the market can be relatively more volatile during times of turbulence and illiquidity, particularly for the equity security of a BDC, or alternatively during times of market euphoria. It is important to emphasize, BDCs are typically not directly exposed to day-to-day market price movements as BDCs have a relatively stable asset-liability profile in contrast to regulated banks, for example.
BDC index: The index underlying the BIZD ETF represents a subset of the BDC market and includes those BDCs that are larger, more liquid, and publicly traded. As of 2023, BDCs represented about $315 billion of AUM, where roughly half of that was publicly traded BDCs.
Furthermore, BDCs represent a small subset of the larger private credit market (of almost $2 trillion). While BIZD could be a reasonable proxy for the investable BDC market, it may not be suitable in all cases for the entire private credit markets.
Conclusion
We have previously demonstrated through observations that BDC portfolio compositions can vary significantly based on different metrics. This portfolio variation can provide investors opportunities to better manage across the risk/return and portfolio diversification spectrums.
As BDCs consist predominantly of private credit, we have also highlighted in previous research key features that can mitigate risks within the private credit market while providing investors and borrowers a valuable alternative.
In this paper, we took a simple approach in our analysis for evaluating the historical performance across BDCs. We also made use of BSL portfolio performance, adjusted for leverage comparable to BDCs, to provide further insight. We relied on public market data for our analysis based on ETFs that track the performance of established BDC and BSL indices. We also included return performance for a sample of BDCs that underly their relevant index.
Our review shows that diversity across BDC portfolios can present a range of long-term risk/reward opportunities. The observed correlations further reflect the benefits of variation in portfolio compositions across BDCs.
Thus, BDCs could provide additional diversification benefits to a fixed income portfolio. As we have noted amongst other factors, the ongoing operational management of any BDC is also an important consideration to BDC returns as is of course the more observable asset manager’s credit and portfolio management acumen.
[1]To be clear, BIZD is an unlevered ETF, which passes through the returns of the underlying BDCs, and hence no further adjustment is made.
Liquidity in private markets: part two – NAV finance
Private equity managers are holding record levels of unexited assets, and with M&A and IPO markets yet to fully recover after a cycle of rising interest rates, sponsor are exploring all options for unlocking liquidity and making distributions.
In the second of a four-part series exploring the tools and options private equity managers have available to unlock liquidity in their portfolios, Alter Domus looks at how the once niche NAV financing space is providing sponsors with a valuable source of alternative liquidity in changing markets.
Michael Janiszewski
Chief Operating Offcer
Investors in private markets funds have had to play a waiting game when it comes to receiving distributions from managers.
Rising interest rates have put the brakes on M&A and IPO activity, forcing managers to hold portfolio companies for longer. Buyout funds in North America, for example, saw hold periods rise to 7.1 years in 2023 – the longest hold average hold period in more than two decades, according to the Preqin figures reported by S&P.
With exits at a premium and liquidity more prized than ever, managers are exploring all options available in an effort to realize value and start making distributions to investors.
In the second of a four-part series exploring the alternative routes to liquidity that managers have available, Alter Domus looks into how the NAV finance industry has stepped up to offer new routes to liquidity for managers.
Part 2: NAV Finance
Less than a decade ago there would have been few corners of the capital markets ecosystem that would have been as less understood then NAV Finance.
Sponsors would have used other fund finance tools, such as subscription line finance (where sponsors take out short tenure bridging loans to streamline the capital call process) regularly, but NAV finance, where managers take out loans secured against the underlying portfolio companies in their funds, was a small, niche part of the market, used by only a handful of managers.
During the last five years, however, the NAV finance has undergone a remarkable phase of growth. Between 2020 and 2023 NAV finance more than doubled to around US$44 billion, according to figures from 17Capital, an NAV Finance market pioneer.
The shuttering of mainstream financing sources in the immediate aftermath of the first pandemic lockdowns, followed by the rising cycle of interest rates in 2022 and 2023, saw the NAV finance option rise to prominence.
NAV loan terms are bespoke, and can offer loan-to-value (LTV) ratios starting at ten percent of the NAV part of a portfolio, with scope to move as high as 60 percent for quality portfolios that are highly-diversified, with spreads varying accordingly.
Relatively low LTV ratios, and the fact that NAV loans are cross-collateralized and secured against a portfolio of assets in a fund, rather than individual portfolio companies, has made the product an attractive option for lenders and investors, helping to grow the market. At Alter Domus, we have seen firsthand the growth of this trend and supported our clients to maximize the opportunity.
A liquidity lifeline for GPs
For managers, NAV finance has become a valuable source of additional liquidity, particularly given the tight financing conditions of the last 24 months.
Managers have used NAV finance in different ways.
For managers that have built up a solid portfolios of assets, but are approaching the end of the typical five-year investment period, NAV finance has served as a source of capital to fund additional rounds of platform company acquisitions or inject further capital into portfolio companies where they continue to see opportunities and the opportunity set has surpassed initial growth plans.
A NAV loan can provide a cheaper line of capital to fund these opportunities and save managers from having to deal with the complexity of extending investment periods or bringing in additional outside equity.
NAV finance can also be used to support portfolio company refinancings and capital structures. Rather than individual portfolio companies having to carry the load of more onerous refinancings in a higher rate environment, a manager can bring in financing at fund level to maximize operating leverage without squeezing headroom at individual portfolio company level.
In recent years, managers have also used NAV loans to help finance GP commitments and in some cases, managers have also used the products to make distributions to investors.
Rather than selling assets into weak M&A or IPO markets, where vendors will more than likely have to accept discounts to NAV, even for quality assets that would trade at a premium against a different macro-economic backdrop, sponsors have taken out NAV loans and used the proceeds to make distributions back to investors.
In an otherwise illiquid market, this has enabled managers to send cash back to investors without having to sell prized assets into a down market.
In a NAV structure, where LTVs are calculated at NAV, rather than at a discount to NAV, managers can take out liquidity without having to compromise on valuation.
On the whole, investors have accepted that NAV financing can provide a cost-effective way to support and fund portfolio companies beyond initial investment periods.
There are, however, also concerns among investors that NAV loans are adding further layers of debt into already leveraged private equity structures, and that there the cross-collateralized nature of NAV loans can see stronger companies in a portfolio impacted by under-performance in weaker portfolio companies.
These reservations will have to be addressed by managers and NAV financing providers, but even though some stakeholders are yet to be fully convinced of NAV finance’s value, there is momentum and a track record behind the industry that will see it continue to grow.
As more managers use the product, 17Capital and Oaktree Management (which acquired a majority stake in 17 Capital in March 2022) are forecasting that NAV finance could grow into a $145 billion market by 2030.
Given some of the investor concerns around the use of NAV financing listed above, transparency is essential for securing long-term investor buy-in, which will require back-office teams to clearly communicate and engage with LPs on NAV loan usage in accounts and investor reports.
Managers will want to avoid situations where LPs find out about the use of NAV loan facilities before a manager has proactively disclosed that it has taken out an NAV loan facility.
There are further reporting and accounting demands that come with NAV loans. Investors will expect reports on how the use of additional leverage at fund level is impacting distributions and returns.
Distributions from NAV loans can also be clawed back in some circumstances, with tax, cash flow, and interest cost implications that managers should be modelling and disclosing.
Back-office teams will also have to be able to produce regular NAV calculations in order to establish LTV ratios (rather than the typical quarterly NAV reports) and will also have to account for the potential impact of a weaker company’s default on the wider portfolio, given the cross-collateralized nature of the typical NAV loan structure.
Taking on a NAV facility can squeeze back-office teams that are still coming to terms with the ever-rising regulatory, reporting and disclosure requirements that managers have had to deal with in recent years.
Working with a third-party fund administration partner like Alter Domus can help managers to scale-up their back-office capability without having to incur high capital expenditure technology and staff costs.
We work with managers as a co-sourcing or outsourcing partner, and also counsels managers on how to select and implement best-in-breed alternative assets software to improve operational efficiency
Fund administration specialists will also have the experience and technical capability to handle the reporting and disclosure requirements that come with taking on NAV loan facilities, giving managers piece of mind that their organizations are tracking NAV loan usage and providing accurate and regular reports to investors on the facilities.
Finally, we have the scale to make investments in proprietary technology, powered by AI, that help back-office teams to handle higher volumes of work and have the bandwidth to cope with NAV loan reporting and disclosure requirements.
As mentioned in the first article in this series, Workflows is an AI-powered application that automates high volume back-office tasks, freeing up key back-office resources to handle bespoke and complex NAV loan facility disclosure and reporting work.
Managers who have a solid operational foundation place will be in the best position to take advantage of the flexibility and a liquidity that NAV finance provides at a point in the cycle when mainstream sources of capital remain constrained and conventional exit pathways narrow.
Switching a fund administrator is not a decision to be taken lightly, but as private markets managers look to broaden its investor base, expand into new geographies, leverage technology, and manage increasing regulation, changing a fund administrator can be a necessary step to support a firm’s ongoing development and evolution.
Over the years Alter Domus has helped hundreds of managers, operating across all private markets asset classes, to migrate their funds to its platform and has deep expertise in the steps required to avoid transition pain points and ensure that the migration process is seamless and value additive for clients.
Switching to a fund administrator is not a decision that managers should take lightly. Given the significant role of back-office operations such as financial and investor reporting, compliance and regulatory needs, tax and audit support, among many others, finding the proper administrator to strategically walk through every step of a transition to go-live operations are critical.
Ultimately, the decision for a fund administrator can be one that accelerates optimal back-office operations or can be a hurdle to achieving such success; thus, it is important to get the decision right. Lastly, building a strong relationship with a fund administrator and collectively working together can support significant growth and long-term success for decades.
When making the decision for a fund administrator, it is important to balance the short-term with the long-term outlook for a manager, with fund growth being a key driver. This is highlighted in the last decade as private markets assets under management have almost tripled to US$14.5 trillion, according to Bain & Co figures.
During this ten-year growth surge the private markets investor base has expanded and become more international; co-investment and special accounts have become more prevalent; non-institutional capital has entered the funding mix; regulatory and investors reporting obligations have intensified; and firms have expanded their platforms to include myriad new investment strategies, including private credit, real assets, secondaries and minority stakes.
As managers adjust to this brave new world, and seek to take advantage of the opportunities it offers, there are inevitably key milestone moments where firms have to reappraise their operating models and make changes to ensure that they have firm foundations in place to support long-term growth ambitions.
When to make the change: the key trigger points
Changing a fund administrator is often a key step along a manager’s evolution. As a platform grows, key trigger points will emerge to commence with migration to a new administrator:
Demand for more support In its 2024 Service Providers & Advisors Report, Preqin found that almost a third (32%) require better and more comprehensive back-office and reporting support as they grow AUM. When managers reach a certain size, the scalability of back-office infrastructure becomes crucial, and will often prompt managers to switch administrators.
Cost considerations According to Preqin’s research, more than a quarter of managers (29%) cited competitive pricing and transparent fee structures as playing a significant role in the decision to change service providers.
The ability to evidence value for money to investors, and to be able to benchmark fund administration costs in order to prove this, have become especially important during the last 24 months, when liquidity has been tight, and it has been important to show that fund resources are been deployed effectively.
Investor demand As investor allocations to private markets strategies have grown, investors have demanded more regular and detailed reporting from managers, as well as assurance that managers are meeting the highest compliance standards. Higher expectations from investors have pushed managers to switch to better-equipped administrators, that have the scale, specialist regulatory expertise, and geographical reach to stay on top of reporting and regulatory change.
Technological capability The basic, proprietary technology systems that managers and some fund administrators may have relied on for years are struggling to meet the needs, and managers are recognizing the value of installing best-of-breed alternative assets software suites to support growth and give investors comfort.
The fund administrator has evolved into not only an outsourcing partner, but a key counsel on the selection, installation and operation of industry-leading software into private markets firms. It comes as no surprise, then, that the Preqin research found that for just under a fifth of managers (18%) technological factors, such as upgrading technology stacks, automation and real-time data access, were a major reason for administrator change.
The need to consolidate fund administrator relationship, access better, more joined-up service, build in scalability, stay up to date on compliance, and improve access to technology will be key trigger points for migrating to new administrator.
Choosing a new administrator: the key questions
When it is clear that the time has come to switch fund administrators, it is essential for managers to assess their current situation and ask key questions that will guide them toward the right choice. What are the gaps in back-office operations today? Does the current administrator have the scale, asset class expertise, geographical reach and technology to support future growth? Are compliance and reporting needs being met efficiently?
Once these key questions have been addressed, managers can proceed to the next stage in the process – identifying the ideal fund administrator for their funds.
Here are eight points for managers to add to their selection checklists:
Expertise, Geographical Reach and Specialization A fund administrator’s track record and specific asset class expertise should align with the manager’s investment strategy or strategies. Deep knowledge of private equity, real assets and private credit are key attributes for fund administrators supporting managers active in these markets.
Managers will be turning to their fund administrators to ensure that investor communications, fund structures and regulatory compliance for their respective investment strategies meet the highest standards across all their jurisdictions.
Technology and Reporting Systems Managers who operate proprietary, inhouse technology, or work with fund administrators that operate legacy systems, can unlock significant improvements in fund reporting, transparency and automation by partnering with an administrator that has developed deep expertise in asset specific, best-in-breed private markets software.
A good administrator is well versed in the market-leading private markets software platforms (including Allvue, eFront, Private Capital Suite (formerly Investran) and Yardi) and will be able to advise clients on the most appropriate software systems for their organizations and investment strategies and ultimately to provide the necessary scaling effect overtime with automation, workflow application, or AI initiatives.
Workflow tools and automation infrastructure are becoming key differentiators for administrators, with research showing they are influential to 75% of General Partners when selecting fund administration partners.
Administrators utilizing advanced automation and digital workflows have demonstrated reductions in operational inefficiencies, such as a 600% decrease in audit/risk-related issues and a 20% reduction in email volume. These tools also enhance client transparency and trust, saving significant time through streamlined processes and secure, real-time updates.
An administrator with the bandwidth and expertise to stay informed on evolving regulations across multiple private market asset classes and jurisdictions can significantly reduce the regulatory compliance burden on the manager. This support provides clients with confidence that the firm is effectively managing compliance with today’s dynamic regulatory environments.
Long-term Value A fund administrator of size, with a large geographic footprint, can leverage economies of scale that most private equity firms would find difficult to replicate without heavy upfront and ongoing capital expenditure on staff and technology.
Administrators with scale can bring down operating costs significantly, without compromising quality, as they have a critical mass of clients that enables them to reduce costs and deliver value of money for fund manager clients.
Service Quality and Communication As investor demands of fund manager back-office teams increase, with managers expected to produce more frequent, detailed and bespoke reporting, the ability of a fund administrator to deliver communicative, responsive service with accuracy and an appreciation of a manager’s unique context, has become more important than ever.
Measuring customer service levels can be difficult – slick pitches from account managers do not always translate into sustained high levels of service. In addition to reviewing industry benchmarks and third-party research into customer service provision, managers are also advised to reference prospective administrators with peers and other clients to build a fuller picture of administrator service levels.
Scalability When changing administrator, a manager isn’t only choosing a fund administrator that can service current requirements, but an administrator that can grow with a manager and provide ongoing support as AUM grows; as investor bases and fund families expand, as managers broaden out into new investment strategies; and as complex co-investment, special accounts, and non-institutional capital sleeves become more prevalent.
Seamless Transition Process A good fund administrator will have a deep bank of live experience when it comes to a migration process, and will be able to identify and mitigate pain points in advance, as well as laying out detailed timeline and process for executing a migration.
An administrator should have a firm grip on data migration, news systems implementation, strategic timing and obtaining any necessary regulatory clearances in place.
Good administrators will also provide clients with constant support and communication throughout the process, offering not only seamless execution, but also peace of mind.
Global Expertise and Presence Private markets is a global industry, and managers will be operating across a number of countries and raising capital from investors based all around the world.
A global manager requires a global fund administrator that has the footprint and capacity to serve a manager and its investors across multiple jurisdictions, and handle specific regulatory, tax and fund structuring requirements as required where a manager is active and operating.
Working with a long-term partner
Switching to or from a fund administrator is not easy, but in a constantly evolving private markets industry will be a decision that most managers will have to face at some point.
Growing AUM, higher regulatory and reporting obligations, global investor bases and more complex deal and fund structures require a step change in back-office capability. When managers approach these bottlenecks, a change in fund administrators will have to be considered.
Selecting a new fund administrator is a decision that requires careful consideration and long-term outlook.
Alter Domus has a successful and long-track record of working with private equity, private credit and real assets managers in a range of jurisdictions to execute fund migrations to the Alter Domus operating and technology platform.
As a fund administrator with a network of 39 offices in 23 jurisdictions, Alter Domus is well-placed to support fund managers with global investment strategies and international LP bases.
With more than $2.5 trillion assets under administration and more than 5,500 employees, the firm has the bandwidth to scale services in lockstep with client growth, regulatory expertise and tax support, as well as extensive technological capabilities.
The firm also has built deep insight into private markets operating models, and established a proven track record for executing rigorous and efficient staff and data migration transitions.
This experience has enabled the firm to provide invaluable counsel to managers on how to evolve and upscale operating models, choose and implement technology platforms, and assist with the curation of a bespoke structures to support specific manager requirements.
If you are a fund manager at an organizational inflection point and considering a change to your fund administrator, the team at Alter Domus is available to discuss your requirements and deliver a seamless migration that delivers value for money and enhances a manager’s operational capability.
Our 4,500 global experts specialize in alternative funds, providing advanced services to help you navigate complexity, streamline operations, and stay ahead of the competition.
Head of Tech Operations, North America Fund Services
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Analysis
Liquidity in private markets: part one – secondaries
Flat M&A markets have made it difficult for private equity managers to secure exits, make distributions to investors, and unlock liquidity for fundraising. In the first of a four-part series exploring the tools and options private equity managers have available to unlock liquidity in their portfolios, Alter Domus looks into how the increasingly sophisticated secondaries industry is supporting managers and investors
Michael Janiszewski
Chief Operating Officer
The last two years have seen a dramatic about-turn in the private markets industry. In 2021, at the peak, private markets raised a record $1.7 trillion, according to Bain & Co. However, by 2022, managers found themselves operating against a completely different macro-economic environment, as the Ukraine war, rising inflation and climbing interest rates brought the private market bull-run to a sudden halt.
More than two years on and investors who had upped allocations to private markets in 2020 and 2021, fully expecting to have received some distributions back from these commitments by now, have found that assets are still very much in the ground with limited visibility on when realizations will materialize.
This has left a liquidity problem. According to Bain & Co analysis of Preqin data, buyout managers alone were sitting on $3.2 trillion of unexited companies in their portfolios- an all-time high. Extended hold periods and limited exit pathways have seen the average number of companies in portfolios double over the last decade.
Liquidity, once taken for granted, is now front of mind. For many managers and investors DPI (distributed-to-paid in capital), rather than internal rate of return (IRR), has become the new priority.
With the main exit funnels of M&A, secondary buyouts and IPOs still jammed, managers have had to explore other options to realize value and start getting capital back to investors. At Alter Domus, this is something we have seen firsthand from our clients.
In the first of a four-part series exploring the alternative routes to liquidity that managers have available, Alter Domus looks into how the secondaries industry is stepping up to give managers and investors optionality when mainstream transactional volumes are at a low ebb.
Part 1: Secondaries
The private markets secondaries industry is the original provider of liquidity in an asset class that by nature and structure is illiquid.
The current liquidity bottleneck facing investors and managers has made this the secondaries market’s moment shine.
The industry has come a long way from its beginnings, when the sale of an LP-stake in a fund was often seen as a blot on manager’s track record and the last option for investors that had run out of ideas.
Attitudes have changed, and as the secondaries industry has matured, evolved and innovated, managers and investors have recognized the value it adds as a tool to reconfigure investor portfolios, release capital for allocations to new funds and tweak asset allocations.
Indeed, the value and flexibility that secondaries offer the private markets ecosystem have been on full display during the market dislocation of the last 24 months. As primary deal activity and fundraising has dipped, the secondaries industry has moved in the opposite direction.
In the most recent Jefferies Global Secondary Market Review, secondaries deal value for H1 2024 was recorded at a high of $68 billion, a 58 percent increase on figures for the same period in 2023, putting the industry on course to deliver forecast deal value in excess of $140 billion by the end of 2024.
With some $253 billion of capital still available to deploy, the secondaries managers are well-positioned to continue playing a key role in keeping liquidity cogs turning across private markets strategies.
A broad suite of options
Secondaries managers have been there to provide both LPs and GPs with liquidity pathways, and the strong demand has sustained robust levels of activity in both LP-led and GP-led transactions.
According to Jefferies LP-deal activity accounted for 59 percent of overall activity to come in at $40 billion for H1 2024.
The increase in LP-led deal volumes has been driven by myriad factors, with LPs using the secondaries market not only to manage the impact of the denominator effect (where private asset allocations exceed preset thresholds) on their target asset allocations, but also to free up and reallocate capital to favored managers who are coming to market with new fundraisings.
LP willingness to pursue LP-stake deals has been underpinned by relatively moderate discounts to NAV. Investors have not panicked and dumped assets at fire sale prices, with secondaries pricing remaining stable and narrow enough to make an LP-deal reasonable for selling investors.
According to Jefferies, LP-deals traded at almost 90 percent of NAV through H1 2024, and with equity markets stabilizing and interest rates coming down, pricing is expected to improve even further through the rest of 2024.
This has allowed LPs to sell stakes without leaving too much value on the table, and when considering the growth on NAV that private markets portfolios have delivered over the mid-to-long term even when selling at a ten percent discount, LPs can still be realizing reasonable returns on investment as they take liquidity in secondaries trades.
GP-stakes deals on the up
GP-led deals, meanwhile, accounting for around 40 percent of the overall secondaries market, have also delivered strong transaction volume growth, with deal value up 56 percent year-on-year to reach US$28 billion for the first half of 2024, according to Jefferies.
GP-led deals and continuation fund transactions, where sponsors roll-assets into a new vehicle, with backing from a secondaries investor, and offer LPs the option to either take liquidity or roll-over their stakes into the new structure, are now firmly established as a credible alternative to an exit by an M&A transactions or IPO.
Indeed, Jefferies notes that in H1 2024 continuation fund deals represented 14 percent of sponsor-backed exits, the highest share on record.
Rather than selling their best assets at sub-optimal valuations in flat M&A and IPO markets, continuation funds have given managers a pathway to release liquidity without letting go of top performing portfolio companies.
Putting the building blocks in place
Secondaries managers are providing much needed liquidity for private markets, and managers with high quality back-office infrastructure and best-in-class fund reporting and technology will be positioned to take advantage of the flexibility and liquidity that secondaries investment can offer.
Administering and accounting for secondaries has become a more complex, demanding task for manager back-office teams as the secondaries industry has grown and evolved.
Alter Domus has helped a number of managers to upgrade operational models and put the foundations in place to handle rising secondaries volumes while being in a position to take advantage of the liquidity on offer in the secondaries market.
There are a higher volume of secondaries trades for back-office teams to track in the first instance, and deals will not just include LP-led deals, but also GP-led transactions, single asset deals and continuation funds, which introduce additional fund reporting and governance obligations for each and every continuation fund vehicle. A mix of secondaries deal asset classes, which have broadened out beyond buyout funds to include private debt and real assets, require further accounting and reporting bandwidth.
For back-office teams that are already stretched and are adapting to rising regulatory and investor reporting requirements on a day-to-day basis, the additional demands that come with monitoring assets alongside commitments that have traded in secondaries transactions, demand investment in operational infrastructure.
Alter Domus’ Workflows Application, an AI-powered tool that can automate high volume back-office tasks, making it easier for managers to keep track of growing and increasingly complex secondaries transactions in their funds, as well as continuation funds orchestrated by managers themselves.
A digital link between manager and fund administrator leadx to greater accuracy in data, as well as transparency, improved efficiency of data collation and higher-quality analysis.
Managers can also turn to Alter Domus for more general outsourcing, co-sourcing and technology support to build back-office capability that can be scaled at pace and adapted to unlock secondaries liquidity.
In markets where liquidity is tight, having the infrastructure in place to assist and facilitate secondaries deal flow helps managers and investors to keep capital flowing in through a challenging period in the cycle.
Acing loan agency: What to look for in an administrative loan agent
As private debt managers’ operations grow in complexity, outsourcing more of the administration burden to a loan agent offers the opportunity to streamline middle office duties.
Pete Himes
Head of Debt Capital Market Products
November 12, 2024
Private debt has encountered explosive growth as an asset class in recent years. The industry started out 2024 with $1.5 trillion in assets under management, up from $1 trillion in 2022, according to Morgan Stanley.
As direct lenders and broadly syndicated loan managers seek to grow their funds and returns alongside this industry growth and investor demand, the burden of their fund operations can begin to have an effect on their success.
This is especially the case with loan agency operations, known for their intense level of work across complex credit investments at high quantities.
Under these industry conditions, using a loan agent becomes much more appealing for many managers, and firms who already depend on a third-party loan agent may look to increase their outsourcing or select a new provider that more closely meets their needs.
To understand more about loan agency and how a good loan agent operates, read on.
What is a loan agent?
In the credit and private debt space, a loan agent is the party that facilitates all ongoing operations required to adhere to the loan terms and liaises between the lenders and counterparties to do so. Tasks that are central to loan agency include:
Calculating a loan’s interest over time
Coordinating loan and interest payments between multiple lenders and counterparties
Sending loan communications between lenders and counterparties
Engaging outside parties like lawyers or fund administrators to move along loan operations
There are a few different kinds of loan agents depending on a lender’s needs or depending on the nature of the loan:
Administrative agent
A lead administrative agent, or a named agent, fully represents the lender on the loan and is named in documents as the administrative agent. By taking this lead administrative agent role, the partner takes over all loan agent responsibilities from the lender.
Sub agent
The sub agent role exists for lenders who want to take the lead role in the loan agency process and be listed as the lead agent on their own deals. For the behind-the-scenes responsibilities that they hope to outsource, they would work with a sub agent who is not named on the loan but handles elements such as payment distribution and managing interest rates.
Successor agent
A successor agent steps in when the administrative agent resigns or is replaced, a situation that frequently arises in restructuring scenarios and liability management exercises (LMEs). This change can disrupt the smooth administration of a credit facility and potentially delay the LME or restructuring process. Acting as a neutral third party, the successor agent ensures a seamless transition, aligning the goals of all involved parties and facilitating a the swift progression of the constituents’ objectives and desired outcomes. At Alter Domus, we’ve served as successor agent on many high-profile LME and restructuring deals such as Amsurg, Apex Tool, Boardriders, Brightspeed, Revlon, Trinseo, and Wheel Pros, among many others.
What to look for in a loan agent
While lenders can insource loan agency responsibilities, many choose to outsource some or all of this imperative, labor-intensive fund operation. By outsourcing these responsibilities to a loan agent, lenders benefit from tighter headcount in their operational teams and the close attention and expertise of teams specifically focused on all aspects of the loan agency process.
But not all loan agents are created equal. Loan agency involves painstaking and bespoke work to carry out the terms of a loan over the multiple years of its life. When evaluating partners to serve as a loan agent, here are some key elements to help decide if they’re up for the task:
A balance of bespoke expertise and ability to scale operations
As the direct lending and BSL spaces grow and managers hone their strategies along with that growth, more complex loan terms and transactions emerge. It’s encouraging to see our industry mature in this way, but it does make for more complex fund operations, particularly on the loan agency side.
For a loan agent to work effectively, they need to have direct and deep expertise in these bespoke strategies and debt vehicles. At Alter Domus, we pride ourselves in operating at the intersection of bespoke expertise and high volume. Our servicing teams are segmented out by asset class expertise and work cohesively for an end-to-end approach, as opposed to the siloed operations of our competitors. We have the experience and the team size to achieve the balance needed for fickle loan agency challenges.
Technology-enabled service
Loan agency services may take plenty of time, attention, and expertise from your provider, but it’s also crucial that your provider has capable technology underpinning their loan agent duties. When a provider relies too much on manual processes in administering loan agency, their lender client absorbs the high risk of error.
At Alter Domus our loan agency teams rely on our proprietary software platform Agency360 to service our direct lender and BSL clients. There are key benefits to relying on a proprietary tool for these needs. For example, we control the updates and maintenance of the tool ourselves rather than relying on software from a third party. We also avoid having to pass along rising fees from a third-party platform.
A reliance on powerful technology should also extend to the client experience. When outsourcing loan agency operations, lenders should still have a view into the service they’re receiving and a 24/7 ability to access their loan data and reporting. A third-party loan agent should offer a tech-enabled and convenient way to check in on their operations and download relevant reporting.
At Alter Domus, we offer Agency CorPro as a home base for our clients. The proprietary portal platform serves as our purpose-built solution to exchange sensitive asset information and important loan documentation between our teams. That means our work is available to you at all times in a self-service fashion.
Breadth of loan agency and other middle and back-office service capabilities
An ideal loan agent should offer additional services throughout the loan lifecycle to support your operations. By placing multiple outsourced needs with the same firm, your teams can benefit from a more holistic data and technology experience.
Optimize your loan agency operations with Alter Domus Agency Services
As a top provider in the market, Alter Domus’ Agency Services offering meets all these needs and more. Our servicing teams are trained specifically in bespoke credit vehicles and are large and experienced enough to handle high volumes of loans. In fact, our peak seasons see us processing more than 100,000 payments in a single day.
Ready to see what Alter Domus can do for your loan agency needs and beyond? Learn more about Alter Domus’ Agency Services here. To speak with our Agency Services team about how our services can help your middle- and back-office operations, contact us here.
