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Portfolio optimization is a cornerstone of modern asset management, aiming to balance risk/return, promote portfolio diversification, and improve overall portfolio efficiency.

Fixed income managers actively seek to optimize their portfolio allocations such that the portfolio is expected to generate the maximum return with the least amount of risk. In this context, managers may apply an internal scoring methodology to grade assets as part of their investment decisions. These scoring methods in many cases rely on a weighted approach based on certain factors, many of which may be subjective. In addition, managers may rely significantly on a single guiding metric, such as yield, but still need to further control for other factors, such as credit risk, to be comparable.

Investment decisions are further complicated by various constraints. Constraints may be market driven, such as the availability of investments or market prices. Investor-mandated factors such as average credit quality, percentage limitations and duration may also come into play, as do regulatory factors, such as SEC, NAIC, Federal Reserve, Basel III rules.

These constraints can apply across all areas in fixed income, whether the asset is an investment grade credit, a high-yield bond, a broadly syndicated loan, private debt or structured credit. Constraints could also extend to other ‘cash flow intensive’ investments, such as commercial real estate and infrastructure.

Given the myriad factors that investors must consider, it comes as no surprise that portfolio optimization in fixed income is a sophisticated process with complex methods and techniques.

In this paper we present a framework designed to address these complex portfolio allocation challenges. This framework offers a single universal metric, the Alter Domus Score (‘ADS’), which can arm managers with a solution for efficiently measuring an optimal portfolio allocation that is objective and comparable across any fixed income investment.

The ADS, which is an asset-based measure, is also robust and controls for information relevant to any fixed income investment – including those tied to asset based loans – ranging from cashflow characteristics and credit worthiness to market price, pre-payment, and illiquidity costs.

We will detail the elements of the ADS, including the underlying framework, and illustrate the relationship between the ADS and changes to certain key asset-based characteristics.

Why Trade Optimization?

Trade optimization addresses a fundamental economic problem: maximizing the efficient and productive use of limited resources, specifically investable capital. Fixed income managers must, therefore, choose from among various investment opportunities to maximize the overall portfolio return given each investment’s attributes, which include cashflows, credit risk, and market price.

In most cases, managers are also faced with a variety of constraints, such as credit quality, maturity, and diversification limits, to name but a few, which adds more complexity to their decision-making process.

Essentially, managers aim to navigate these variables to deliver the best value for their investments.

The ADS presents a framework that relies on a single metric and objectively accounts for economic factors that are key to any fixed income investment. This framework is particularly valuable for managers bound by constraints, helping them to make the best investment allocations when weighing tradeoffs. The ADS serves as a complement and support to existing methods used by investment managers.

The ADS: an objective and universal measure for trade optimization

The ADS is an objective measure that is rooted in fixed income theory.

Essentially, it represents the discounted and risk-adjusted cashflows for any expected stream of cash flows, including fixed income instruments, such as bonds, loans, and asset-backed securities (ABS).

The ADS is easily comparable across all securities since it is a measure based on a single dollar (or any currency) value at risk. This feature allows any prospective universe of fixed income investments to be rank ordered on a pro-forma basis to determine an optimal portfolio allocation that is subject to constraints.

The score means that a fixed income investor can compare a bond to a loan or an ABS security – or even a real estate investment – when selecting the optimal portfolio allocation investment decision.

The score is agnostic as to the type of underlying investment and relies on the individual cashflow characteristics of the asset, factoring in the time value of the expected cash flow and uncertainties due primarily to the credit risk of the borrower and potential prepayments.

Digging into the detail: the formula behind the ADS

The ADS is calculated based on the following formula (see Appendix for detailed description of inputs).

To make effective comparisons across assets, the outstanding principal balance of the asset is first normalized to an indexed value of 1, which results in the market value (MV) to be a percentage of the indexed value. Therefore, we can break down the key inputs into two groups – one group is based on asset-specific attributes and the other reflects cashflow uncertainties.

To present it simply, the numerator represents the present value of the risk-adjusted weighted cashflows over the duration of the asset, the Cashflows Risk-Adjusted Value (C-RAV) while the denominator is the MV[1].

Some key factors to consider are that the risk related inputs can be based on the manager’s judgement or can be used to gather insight as to what the market value implies.

The ADS can also be used to generate trade ideas for making asset substitutions, when, for example, seeking a better relative-value opportunity, and thus can increase the likelihood that a portfolio will be better off or more optimal.

Applying the ADS in different scenarios

It is noteworthy to begin highlighting three possible scenarios of the ADS for any given security.

ADS > 1 (i.e., C-RAV > MV),
ADS < 1 (i.e., C-RAV < MV), and
ADS = 1 (i.e., C-RAV = MV).

Example 1: In cases where the ADS score is greater than 1, the time-value adjusted and risk-adjusted cashflows based on the manager’s expectations is greater than what the market price is reflecting. The asset is therefore ‘undervalued’, as indicated by the asset’s risk/return profile.

These are assets that offer the manager favorable investment characteristics, as the value of the risk-adjusted cash flows is greater than the price to acquire those cash flows.

Example 2: In cases where the ADS is less than 1, the time-value adjusted and risk-adjusted cashflows based on the manager’s expectations is less than what the market price is reflecting. The asset is thus ‘overvalued’, as indicated by the asset’s risk/return profile.

The manager will seek to sell these assets since the proceeds from those sales would exceed the manager’s fundamental assessment of what those cash flows are worth.

Example 3: In cases where the ADS score is equal to 1, the time-value adjusted and risk-adjusted cashflows based on the manager’s expectations is equal to what the market price is reflecting. So, the asset is ‘fairly valued’, as indicated by the asset’s risk/return profile. These assets have market values consistent with the manager’s fundamental assessment, and the manager would therefore be indifferent to holding, buying, or selling these assets.

When working through these scenarios, it becomes clear that a manager can begin to utilize the ADS as a metric for comparing and effectively rank-ordering decisions across different types of fixed income assets.

The ADS can also be used as a tool to inform the manager as to what the risk-based inputs the market is implying. With these inputs on hand, the manager can better assess whether an asset’s market price is rich or cheap.

Manager judgement, of course, is an important element to calculating the ADS.

The ADS could be pre-populated with apparently objective inputs and additional manager overlay could significantly improve the quality of the ADS and its utility as a tool to support portfolio optimization.

Assessment of prepayment rates and credit risk inputs are informed by asset manager expertise and play a big role in calculating the ADS.

Dissecting the AD-Score

The tables below illustrate the relationship between the ADS and changes to certain key inputs holding all else equal. We have intentionally kept the analysis simple so that we could better illustrate the mechanics behind the score.

A more thorough analysis, inclusive of actual cash flow payment dates (we assume annual for our simple analysis), spot risk-free rates (we assume a flat risk-free curve), more dynamic prepayment rates, and other more precise inputs are considered as part of the ADS.

For simplicity we also assume the assets are floating rate senior secured loans, but set at a fixed rate, and have a narrow band of possible recovery rates. The probabilities of default (PDs) are based on the Moody’s idealized default rate table.

The Tables that follow illustrate how the ADS score may shift under different scenarios:

Table 1: Impact of Coupon Rates and Credit Risk Ratings to the ADS

The first part of the analysis (see Table 1) shows the calculated ADS for a group of six stylized loans. The loan coupons range between 5.50%-10.75% (4.50% risk-free rate and risk premiums between 1.00%-6.25%) and have current ratings in the Ba2-Caa1 range. The loans have six-year stated maturities (with 10% constant prepayment rate – CAP) and assumed recovery rates of 45%. Note that for further simplicity we assume the current market values are 100% (or equal to par), and that the stated coupons are such that the current ADS is 1.00 (or ‘fairly valued’ at par).

Table 1 also shows a range of possible ADS scores based on changes to credit risk ratings and coupons. It can also be viewed as changes in the manager’s opinion of credit risk (or PD) associated with the loan. Furthermore, the ADS values can reflect the manager’s opinion on its own fundamental assessment of the loan cashflows (or C-RAV), holding all else constant.

In other words, these ADS values can reflect the manager’s opinion on what the fair value (or price) should be as a percent of par and can be used to compare to what the market price is offering.

Table 1: Impact of Coupon Rates and Credit Risk Ratings to the ADS

Initial noteworthy observations show that investors require compensation via higher coupons that are commensurate with lower rated loans, holding all else equal, such as a larger risk premium for riskier loans.

This can be reflected in the highlighted cells across the loans where the market price clears at par (also reflected with an ADS of 1.00). Notice that for each loan, a change to rating (or PD) impacts the ADS through C-RAV.

For example, if the stylized loan rated B2 were to be upgraded (or downgraded) by +/- 1 subcategory, the ADS value would change from 1.00 to 1.03 (and 0.96) respectively, assuming the market value of the loan remains pegged to 100%.

Table 2: Impact of Prepayment Rates to the ADS

Table 2 displays ADS values after reducing and increasing the CAP rate from 10% to 0% and 20%, respectively.

This scenario, of increasing prepayment rates, effectively reduces the asset’s weighted average life expectation, thereby reducing overall coupon cashflows, while also reducing the exposed amount to default, or in other words, prepayments are not subject to loss.

We first notice that those loans with lower ratings (and higher coupons) appear to be the most sensitive to CAP. A lower CAP rate scenario seems to generate more than enough coupon cashflows to compensate for the longer period of exposure to default, such as relatively higher C-RAV and ADS.

In contrast, the higher CAP rate scenario appears to reduce the coupon cashflows enough to lower the ADS (and C-RAV).

Keep in mind that this is an isolated scenario analysis meant for comparison. The outcome can be sensitive to other variable inputs, such as the default timing profile.

Table 3: Impact of Maturity to the ADS

Table 3 displays ADS values after reducing the stated maturity of the loans from 6 years to 5 and 4 years, respectively.

The stated maturity scenario analysis above shows that it has a similar effect to increasing the CAP rate (see Table 2) thereby drawing a similar conclusion.

Table 4: Impact of Recovery Rate to the ADS

Table 4 displays the sensitivity of ADS values at various recovery rates – from 40% to 50%.

This scenario analysis impacts the ADS through the loss given default (LGD) expectation of the asset. The table results are clear and intuitive in demonstrating that as recovery rates increase (or, as LGD decreases), the ADS naturally increases.

The extent of the increase appears to be in the range of 1-3 points of incremental ADS as recovery rates increase by 10% (from 40% to 50%). The larger ADS impacts are reserved for the lower-rated, or riskier, assets since the benefit of the higher recovery rates is most pronounced when the probability of default is relatively high.

A tool to navigate the complexities of fixed income portfolio allocation

Fixed income portfolio managers seek to optimize their portfolios to achieve the maximum return with the least amount of risk. However, they face numerous challenges, including market-constraints, investor/lender mandates, and potential regulation.

As managers strive to optimize their portfolios, they often utilize a scoring approach for generating trade ideas. In this paper we presented a framework that can support decision-making for these types of complex portfolio allocation challenges and complement frameworks that may already be in place.

The framework provides a universal score, the ADS, that is easily comparable across all cash-generating assets. The ADS is also simple, robust and controls for critical information, whether it is objective or subjective, relevant to any fixed income investment.

For AD clients, including clients of Solvas and Enterprise Credit & Risk Analytics, the ADS is offered as an additional measure to support our clients with their trade optimization, portfolio allocation, and risk analytics.

Please contact [email protected] for further information on how to access the ADS.

Appendix: Calculation of the Alter Domus Score

The first step to compute the Alter Domus Score (ADS) for any fixed income instrument is to normalize the initial face amount to a value of 1 in the relevant currency. The ADS is then calculated as follows:

Where:

[1] The MV can be adjusted in cases where the manager is subject to certain trading criteria. For example, CLOs commonly carry any loan that was purchased below a certain threshold (or ‘deep-discount’) at the purchase price, which results in a haircut to par in the OC tests. The ADS would effectively be capped (potentially at 1) in this instance.

A team of our real estate-focused sales and operational leaders attended IMN’s Winter Forum on Real Estate Opportunity & Private Fund Investing in Laguna Beach, California this past week. Held from January 22-24, 2025, at the Montage Laguna Beach, the conference attracts more than 1,200 attendees and holds an agenda of more than 40 sessions with more than 200 speakers participating, including our own Manager Director Michael Dombai.

While there, we spoke with fellow servicing firms, software providers, and real estate managers of all sizes and niches while also listening in to the expert opinions on the top trends affecting the segment.

What’s clear is that real estate finds itself at an important junction with the new year ahead – whether it’s a new U.S. administration, the still-evolving commercial real estate recovery, or the closely watched interest rate cycle. As a result, there was plenty to discuss with our industry peers over the course of the conference – here are some of the most buzzed-about trends.

1. Fundraising is down

As cited in a speaking session from our valued partner Matt Posthuma at Ropes & Gray, PERE has published that fundraising is down 50% from its peak in 2021, and down around 30% from 2023. Of this shrunken fundraising pool, the largest real estate managers are claiming the lion’s share – a trend we are seeing not only in real estate but across the broader alternative asset landscape.

While fundraising may be tempered, returns and investment values show promising signs of health, as the U.S. real estate sector is forecasted to submit better returns than the public equities market.

2. Interest rates continue to bring uncertainty

When it comes to interest rates, few feel confident enough to make a defining statement on what is to come, particularly with the volatile last five years in mind. However, with a recovered market, vocalized rate cuts by the Federal Reserve, and a likely extension to the U.S. Tax Cuts and Job Act, the broadly held hope is that we will settle into stable period of interest rates.

3. Outsized insurance risk is our new normal

Skyrocketing insurance rates were also heavily discussed – a timely topic given the event’s proximity to the L.A. fires that tragically continue to burn through the metropolitan area. Speakers suggest that while these natural disaster events are often referred to as “once-in-a-lifetime events”, they will transition to our new normal. Insurance rates in high-risk areas are unlikely to return to the past levels we’re accustomed to, and that added cost must be factored into future real estate deals and underwriting processes.

4. All eyes are on the new U.S. administration

As a new U.S. administration entered the White House earlier this week, the industry is on the lookout for changes in regulation, tariffs, geopolitical conflicts and more. The consensus is that impending deregulation could have a favorable effect, but other question marks remain. For example, how could impending tariffs affect the costs of building materials, and how might the possibility of mass deportations affect access to building labor and construction timelines?

Even with the uncertainty of a new administration’s impact on the real estate space, foreign managers and investors have a favorable eye to U.S. real estate exposure due to its strong market recovery in a post-COVID world.

5. Several sectors are producing exciting activity

Activity in the data center niche creates the most excitement. Though they require ample energy to operate, some think we will see a renewed rise in nuclear power plants to power these data centers. Open air shopping centers have also performed well and new opportunities in this niche are attracting healthy deal attention.

Luxury housing conversely has a poor outlook as a sector, even amid high building activity since materials and labor costs to build remain high. At the other end of the spectrum, demand for workforce housing may be at an all-time high, but the real estate investment space isn’t feeling optimistic about the possibility of returns for such projects, which tend to require a private/public partnership.

In all, we had a productive few days rubbing shoulders with some of the brightest minds in the real estate investment space. This new year is certain to hold wins, challenges, and changes, and we’re excited and committed to helping our clients navigate what’s set to be a fascinating 2025.

Ready to talk about your real estate servicing needs for 2025? Reach out to our team here.

Global infrastructure outlook trends in 2025

The data center and decarbonization mega-trends will animate infrastructure fundraising and deal activity in 2025
Significant opportunities will emerge in building out utilities and power provision to support the data center boom
Signs of a soft landing after the rising interest rate cycle bodes well for toll road, airport and port assets
After a tough year for managers, fundraising sentiment should improve as sliding base rates drive up investor appetite for yield

The infrastructure space is well-positioned for a solid year of deal and fundraising activity in 2025 as interest rates subside and macro-economic conditions improve.

As has been the case for other private markets asset classes, 2024 has been a challenging year for infrastructure with a notable gap in financing and development needs. Annual fundraising is at risk of falling below 2023 levels, according to Infrastructure Investor, while CBRE has recorded declines in year-on-year infrastructure M&A during 2024.

The next 12 months are likely to remain challenging and unpredictable for infrastructure managers and investors – after all, infrastructure fund dry powder has recently hit a record 24% of total global AUM, according to Preqin, indicating managers’ caution to deploy. But falling interest rates will help to put the asset class in a more stable position.

For deep dives into key trends driving the 2025 global infrastructure outlook, read on.

Infrastructure investment trend #1: Fundraising on a firmer footing

Fundraising activity will derive potentially the greatest benefit from lower rates, as investors emerge from the defensive crouch of the last 24-36 months and resume the search of yield as interest rates come down.

Infrastructure will be ideally placed to serve investors as they gradually look for opportunities to take on more risk, as it offers returns at a premium to the risk-free rate while retaining defensive, inflation-resistant qualities, according to asset manager ClearBridge Investments. For investors who are still wary of downside exposure as economies emerge from a period of high inflation and rising interest rates, but have to sustain yields, infrastructure will be an ideal fit.

The 2025 infrastructure vintage also holds the potential to deliver attractive returns for investors.

ClearBridge Investments analysis shows that over the long-term infrastructure asset returns correlate strongly with infrastructure asset earnings growth. Since 2022, however, a recalibration of risk and valuations across all asset classes has seen infrastructure asset valuations drop even though earnings growth has proven resilient. This delta between earnings and valuations will fall back into the long-term pattern, presenting early movers with an opportunity to invest at potentially highly attractive entry multiples.

Infrastructure investment trends #2: Going green and going digital

Fundraising and deal activity in infrastructure will be driven by the two mega-trends that dominated the asset class during the last 24 months – decarbonization and data centers.

Both subsectors are underpinned by robust underlying fundamentals and have experienced little if any impact from recent capital markets dislocation.

Decarbonization and targets to reduce emissions to net zero by 2050 have become compliance and regulatory essentials for all sectors, with regulators mandating higher energy efficiency standards and disclosure on emissions.

The cost of constructing new, green, low emission infrastructure, as well as repurposing existing legacy infrastructure assets will involve substantial resources and investment. According to S&P Global estimates $5 trillion of annual investment in energy transition will be required every year between 2023 and 2050 to meet Paris Agreement emissions reductions goals – triple current levels, highlighting the need for sustainable and economic growth in this sector.

Governments will be unable to shoulder this obligation alone, opening up an investment opportunity of vast scale for infrastructure players.

The fundraising market is already pivoting in this direction, with renewable energy fundraising the largest category for infrastructure project-specific fundraising in 2024, according to Infrastructure Investor. And the deals are following suit – per Preqin’s Infrastructure Global Outlook, renewable energy accounted for 69% of primary deals in 2024 – its highest share since at least 2006.

Decarbonization will not be a one-way street, especially as the costs of energy transition are felt by taxpayers and consumers, pushing decarbonization into the political sphere. Nevertheless, the fact that decarbonization can also address other long-term energy pain points, such as cost of energy and energy security, gives the net zero project the necessary momentum to withstand any political or consumer resistance. The risks posed by climate change are simply too severe for governments to ignore.

In the data center space, meanwhile, similarly robust fundamentals will power sustained investment opportunities.

Demand for data is surging, particularly given the huge amounts of computing power that will be required to support the rapid growth of the AI sector, which private markets platform Partners Group forecasts will grow at a remarkable compound annual growth rate (CAGR) of 42 percent to become a $1.3 trillion market by 2032.

Investors and dealmakers have been racing to provide capital and gain exposure to this dynamic sector, via both equity and debt investment strategies, including public-private partnerships. The scramble for data centers and infrastructure project funding shows little sign of slowing in 2025.

Infrastructure investment trend #3: Classic categories. New opportunities

But while data centers and decarbonization will grab the headlines (and with good reason) 2025 also promises to be a good year for more established infrastructure categories in various countries. Emerging markets provide regions with distinctive infrastructure development challenges, requiring unique financing solutions.

Indeed, as data centers grow so will the core utilities required to service them, most notably power generation. According to McKinsey, the power generation capacity required to support electricity-hungry data centers will have to more than double by 2030. Grid connection capacity will have to be ramped up in similar increments.

Outside of utilities, other sub-segments such as airports, toll roads and ports are also set for a positive 2025, as the inflationary pressures that have weighed on consumer spending start to ease, and travel activity and demand for goods increases.

According to the International Air Transport Association (IATA) global air passenger numbers are forecast to exceed 5 billion in 2025 for the first time, while global container volumes passing through ports are expected to climb by as much as 7 percent in 2025, according to shipping and logistics group Maersk. Toll road traffic is also expected to increase, particularly in centers with growing populations, with usage on most routes now back at or above pre-pandemic levels.

New verticals may be expanding the options and growth opportunities for infrastructure stakeholders, but “old-fashioned” infrastructure assets look set to remain as attractive and valuable for investors as ever. This global performance will depend on effective management, the industry’s responsiveness to technology trends, and the impact of climate resilience initiatives.

Key trends in 2025’s real estate outlook

Lower interest rates will ease the pressure on real estate investors in 2025, but the rebound in real estate deal activity will be uneven
The sector continues to grapple with secular shifts in the market following pandemic. Opportunities will arise but risk lingers
Data centers, logistics and the living sector present the most compelling near-term investments, but there is value to be found in other verticals
Real estate players still have to manage a large wall of debt maturities. This will be a challenge, even as interest rates recede

Real estate is in a much stronger position than it was 12 months ago, but while the asset class is set to rally in 2025, the road to recovery will be uneven and complex.

The good news for the sector is that as near-term interest rates have cooled and stabilized, so have real estate valuations, with asset manager abrdn noting that the pricing corrections that weighed on the sector through the rising interest rate cycle appear to have run their course.

As valuations stabilize, returns are set to improve, with abrdn forecasting annualized global all-property total returns of close to 7 percent for the next three and five-year periods.

For deep dives into key trends driving the 2025 real estate outlook, read on.

Navigating real estate’s recovery in 2025

Navigating the real estate recovery, however, will not be straightforward, even as the macro-economic fundamentals improve.

The sector is still in the midst of a period of reconfiguration following pandemic lockdowns, which has driven large, secular shifts in usage patterns.

Remote working and AI, for example, have had a profound impact on office real estate assets, which continue to encounter headwinds even as large corporates lean on employees to return to the office. Retail is another real estate sub-sector that has been challenged following the pandemic, and then the squeeze on consumer spending as inflations and interest rates climbed. In the two-years following the first pandemic lockdowns, retail vacancy rates climbed to new record levels in some jurisdictions as rents saw drops of more than 10 percent.

Other real estate verticals, however, have thrived. Private markets investment platform Partners Group notes that living and logistics assets have benefitted from long-term secular growth drivers and constrained supply, while the data center space has gone from strength to strength.

In the US alone, the colocation data center market has doubled in size during the last four years, defying the rising rate cycle to continue meeting surging demand for data and digital infrastructure to power AI and digitalization.

The rub for real estate investors as they move into 2025 is that real estate remains bifurcated and complicated market. There will be a recovery in pricing and deal activity, but there are still banana skins that investors will have to avoid.

Balance sheet housekeeping is still a key real estate focus

In addition to trying to read the real estate rune sticks, investor bandwidth will also continue to be absorbed by existing portfolios, for which large amounts of refinancing are imminent in the next four years.

According to Trepp data analyzed by asset manager Franklin Templeton around US$1.2 trillion of commercial real estate debt will mature in 2024 and 2025, with a further US$1.7 trillion falling due between 2026 and 2028.

Falling interest rates and lower debt costs will ease refinancing pressure to a degree, as will stabilizing pricing, which will support more favorable loan-to-value ratios.

However, even though interest rates have eased in 2024 and are expected to continue moving in favor of borrowers in 2025, base rates remain materially higher than they have been for years and will test capital structures put in place prior to the rising interest rate cycle.

Even as the wider real estate market shows green shots, there will simultaneously be pockets of distress in the sector in 2025 as borrowers battle to service debt costs while base rates remain elevated relative to the prior cycle.

Amid a 2025 real estate outlook, risk remains – but opportunity beckons

Against a background of looming maturities and market bifurcations, investors are likely to continue leaning into the most robust and fastest growing real estate segments, with the red-hot data center space leading the charge.

There will, however, be a window of opportunity for savvy investors with solid operational track records as well as sector and regional know-how to lean into less popular real estate segments and invest in high quality assets attractive valuations.

Retail real estate, for example, which has been struggling and out-of-fashion for years, appears to be turning a corner as global retail sales recover.

JLL notes that in key jurisdictions such as the US, vacancy rates in high-quality retail locations are approaching record lows, with tenants jumping at opportunities to lease new space as it becomes available. Not all locations will see an uplift, but prime space is well placed to generate attractive returns.

The office segment, which looks challenging overall, also presents opportunity for investors and developers that can identify sites in the right location and price risk effectively. According to JLL, office vacancy rates are forecast to peak in 2025 with availability for high demand locations falling. The narrative around offices may still be broadly negative, but early movers who pick the right assets will see the potential in 2025 vintage deals.

Real estate risk will continue to linger in 2025 – but so will new opportunity.

Close-up of hand with pencil analyzing data, reflecting trends and insights in the private debt outlook.

Exploring private debt trends in 2025

Private debt is in line for a bumper year of deal flow in 2025 as M&A activity rebounds
Interest rate cuts will squeeze returns a little, but the asset class will continue to present compelling risk-adjusted investment opportunities
Private credit defaults are likely to track higher, but within manageable levels for managers equipped to troubleshoot
Competition for deals will intensify as broadly syndicated loan (BSL) markets continue to rally. Securities offered in this space are also predicted to evolve with trends, further enhancing attractiveness to investors. Debt funds must adapt pricing while leveraging securities to maintain competitiveness in core sectors.

Private debt’s so called “golden age” will still have room to run in 2025, even as interest rates come down and broadly syndicated loan (BSL) markets reopen. The financial landscape is evolving, bringing new views and strategies into private debt.

The asset class has proven resilience through rising inflation, benefiting from market shifts and proving reliable returns. With its floating rate structures benefitting from rising base rates at the same time as risk-averse BSL markets pulled up the shutters, opening the way for private debt managers to gain market share and take their pick from the best credits on offer.

These favorable dynamics have shifted in 2024, with central banks cutting rates as inflation subsided and BSL markets bouncing back to record double-digit gains in year-on-year issuance. Lenders will continue to provide diversified financing solutions to support various sectors.

Private debt managers will face increasing competition from global banking institutions and investors in 2025, impacting future financing. BSL markets in 2025 as a result, with BSL arrangers and investors showing strong appetite to lean back into M&A and leveraged buyout financings after a stepping back through the period of interest rate dislocation.

The last year has already seen BSL markets claim back market share, offering lower pricing to win back credits that were financed with private debt-backed unitranche loans.

Data from Bank of America and information from Bloomberg show that at least US$30 billion worth of private debt deals in the US were refinanced in the BSL market in 2024 at lower rates. BSL market participants will remain competitive, not solely based on pricing, but through strategic asset management. Arrangers, noting the speed of execution and certainty offered by private debt providers, have worked hard to get BSL pricing spot on to avoid flex and mitigate syndication risk.

For deep dives into key trends driving the 2025 private debt outlook, read on. Insights into how institutional investors view private debt’s role will be shared.

Pricing pressure for private debt investment targets

Banks and other financial institutions are reshaping their service profiles to adapt to these changes. Increased competition will keep private debt managers on their toes, but the asset class is still well placed for a strong year of activity and opportunity in 2025.

Managers will have to acknowledge the need to reduce margins to stay within a reasonable range of the pricing banks and BSL markets can offer in the year ahead. Many have already done so.

But while margins may have to come down, and interest rates are lower, private debt managers will still be able to deliver consistent, high single digit returns, as base rates remain well above levels from 24 months ago. On a risk-adjusted basis, private debt will continue to appeal to investors, even if returns are slightly lower than those delivered in 2024. Significant asset growth is anticipated across the private credit sector. Global trends indicate increased private market activities, including corporate financing.

Lower returns, however, will be more than made up for if a much-anticipated uptick in M&A activity is realized in 2025. Interest rate stability and the urgent requirement for private equity dealmakers to make distributions to LPs promises to deliver a meaningful uptick in deal volume and demand for private debt financing. With emerging corporate partnerships, private debt providers are poised to capitalize on substantial investment opportunities, also supported by significant asset allocations.

Private debt players have demonstrated the capability to finance significant credits during the period of interest rate rises. BSL markets may be open again, but private debt managers now have a track record of clubbing together to deliver financing for massive credits that not too long ago would have been the exclusive preserve of BSL markets. This showcases the increasing access to diverse private credit options that accommodate less traditional financing preferences.

Recently, for example, a club private credit managers teamed up to provide a £1.7 billion loan to help finance the take private of UK investment platform Hargreaves Lansdown. Private equity firms are exploring additional private market ventures, including direct lending strategies to leverage growth. While BSL markets will appeal to borrowers with lower pricing in 2025, but large credits will no longer default to BSL markets, as private debt managers show that they have the scale and appetite to offer flexibility and certainty of execution on big credits.

Dealing with private debt defaults

Strategic partnerships will be vital for managing private debt portfolios effectively, including asset risk considerations. A rise in deal financings, however, will not be the only thing taking up private debt manager time in 2025. Portfolio management will remain a key priority, as managers move to protect value and limit losses.

Private debt portfolios have proven resilient through a period of rising rates, and while defaults are expected to increase in 2025 as the impact of rising rates trickles down to borrower balance sheets, overall default levels should, all being well, remain within manageable thresholds.

Asset management strategies will need to adjust to address defaults. An uptick in defaults, however, will see a bifurcation in the market between managers with the capability and resources to steward credits through periods of stress and distress, and those that have strong transactional capabilities but haven’t made the investment in restructuring capability. This will become especially apparent in a market where defaults track higher at the same time as new financing deal volumes start to rally. Managers with lean teams will find it increasingly difficult to keep on top of new opportunities and keep troubled credits on track.

Regulatory changes influencing private debt

The evolving regulatory environment in 2025 is reshaping how companies value private debt. Emphasis on transparency ensures valuations precisely reflect the market conditions. This heightened scrutiny requires comprehensive and meticulous financial reporting.

Independent evaluations and transparent financial information will ensure asset values align with actual market conditions. Private credit managers must comprehend and strategize around regulatory shifts to manage obstacles. Emphasizing regulation can foster improved business practices among private credit managers, thereby offering clients more secure and stable investment options in a dynamic market landscape that features stringent regulatory standards from both global and regional authorities.

Leveraging global trends to expand in private credit

Banks are also participating more actively, providing complementary services to bolster private credit growth. Private credit is increasingly global, with heightened investor access to cross-border investment opportunities. The allure of high yields and diversification benefits is attracting global investors, making private credit a key strategy for asset managers aiming to harness international opportunities while managing financial risks. As global demand for securities evolves, embracing trends will be vital to stay competitive.

A good time to be in private debt

The next year might not be quite as good for private ~~credit~~ debt as 2023 and 2024, but the asset class is still set for a good 2025.

Winning deals will take more work as competition increases, and margins and returns will have to be adjusted accordingly for private debt to remain competitive in a market where other financing channels are beginning to function normally once again.

There will, however, be more deals to go for if M&A activity rebounds as expected, which should balance out the challenges posed by rising competition and tighter margins and returns.

The private debt “golden era” may have run its course, but private debt is an asset class that looks likely to retain is luster for some time yet.

technology data on boardroom screen plus people in meeting

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

As private equity managers go into 2025, they will be hoping that after two years of declining buyout deal activity and flat fundraising, a long-awaited market recovery will finally manifest.

With increased attention to acquisitions and sharper capitalization strategies, optimism is mounting that the investment environment is improving.

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. The focus is notably on strategic offerings and increasing capital commitments from investors.

For deep dives into key trends driving the 2025 private equity outlook, read on. This section offers detailed insights and essential information for investors and private equity managers.

Private equity trend #1: Valuation visibility

Providing clear insights into valuations remains a priority for both investors and managers. 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 capital 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 rise in valuation aligns with companies’ improved business strategies and a more positive investment term outlook.

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 improved outlook for exits, and if the momentum continues, this can unlock strong returns through 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. These numbers reflect a strong market performance and hint at potential returns for investors.

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. This marked increase in expected exits signals a potential for increased returns and incentivizes investment in private equity funds.

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. Additionally, public offering options and strong secondary markets will continue to complement these alternative liquidity avenues.

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. Sponsors see it as a vital liquidity tool to ensure business operations remain robust. 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: Emerging sectors in focus

In 2025, private equity interest is notably turning towards technology and energy sectors, with managers focusing on increased investment in sustainable and high-growth areas.

Technology, a driving force for innovation across various industries, has seen private equity firms channeling significant capital into tech ventures, recognizing strong growth potential. Investors and private equity firms see the year as an opportunity to leverage investments in these promising sectors.

Renewable energy within the energy sector is another hotspot, drawing massive investments as the global shift towards sustainability continues. These investment trends are aligning private equity with larger industry movements, responding to investor needs, and promoting impactful and sustainable capital allocation.

Private equity trend #5: 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. This encourages stronger fundraising activity, offering investors and managers new opportunities.

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. As companies reposition, the need to share insights and transmit crucial market information becomes evident.

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 driven in part by more innovative and adaptive private equity solutions.

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. These dynamics are also closely monitored by alternative asset managers seeking to optimize allocation strategies across their portfolios.

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, and support related to the CLO OC test.

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.

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.

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.

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