As private markets open up and regulatory oversight intensifies, managers are turning to tech and outsourcing to keep pace with new developments, says Alexander Traub at Alter Domus as he speaks with Private Funds CFO for their Future of Fund Services Report.
Alexander Traub
Chief Commercial Officer
Given ongoing fundraising challenges in private markets, how do you see funds addressing liquidity issues?
Managers are getting creative; continuation funds are on the rise and secondaries activity has stepped up significantly in the last 18 months as GPs have sought to provide liquidity to LPs to allow them to re-up into their next funds. Those solutions all work, but we will potentially see private equity hold periods getting longer than the three to four-year turnarounds that have been typical. Extended periods of high interest rates will lead to returns coming not from leverage, but from longer hold periods, creating efficiencies and driving value creation.
Meanwhile, we feel the markets are starting to rebound, and macro trends in the US are now going in the right direction. The IPO markets should follow, and we would expect Europe to follow and liquidity to gradually return.
There are also opportunities for managers to raise open-end funds from retail-type investors. Those managers with larger platforms have big ambitions to expand and diversify their LP bases and there is a significant amount of capital there to be raised. Broadly, the opportunity for fundraising starts to look better going forward, whether tapping existing LPs or a new LP base.
What has been the impact of recent regulatory developments for managers?
Most of the regulatory developments related to the US Securities and Exchange Commission’s Private Funds Rule are a 2025 problem, with nothing new required until then. Right now, managers are trying to understand what they need to do, and we are looking at how we can be part of the solution.
A lot of the data that will be required by regulators is already there, so this is about being able to pull that out and put it into a digestible format. This regulation is a significant shift for the market that justifies us putting the resources into creating a new service to assist clients on the reporting demands these regulations have created, and we have a product almost ready to go before next year’s compliance deadline.
Bar any significant political change, we see the SEC becoming more involved in oversight, which creates a further opportunity for administrators that have data and regulatory reporting capabilities. In the US, managers have not been subject to the same level of disclosures and regulatory reporting, but in Europe this is very much part of our product offering.
What themes are you seeing in the evolution of operating models for private funds?
One of the big themes we are looking at is the opening up of the private funds market and the way that is driving how the back office is run. We have seen the market move from a partnership approach with minimal reporting to managers now having to comply with Institutional Limited Partners Association standards and regulatory requirements around reporting to LPs, and those requirements continue to increase.
Even if the US decides against further rulemaking, Europe is a regulatory hotbed, and it is not going to get any easier for managers to navigate that. That is driving more outsourcing around core functions, as well as funds looking to outsource more ancillary functions. The outsourcing pie continues to grow because there is much more that managers need to report on. We are also seeing more co-sourcing as a middle ground, where we provide the expertise and the people, but the data and systems remain with the client.
Meanwhile, since the pandemic, hiring challenges and increasing costs have given managers cause to reflect on their operating models and cost bases. With quieter dealflow, CFOs and COOs have been able to step back and review approaches, so we see a lot of larger managers engaging with us as a result.
Finally, consolidation in the industry and the M&A going both ways as alternatives seek to acquire traditional asset managers and vice versa is shifting the approach to the back office. Traditional asset managers come to alternatives from a very different margin environment, which drives more focus on the right cost models and making use of technology and workflow tools to gain efficiencies. Likewise, as alternatives platforms diversify into new sectors and strategies and become larger and more complex, more firms are investigating outsourcing options.
How is consolidation impacting the service models of fund administrators?
For fund administrators, we need to take on the challenge of building up the people, processes, sector expertise and geographical reach that our clients need access to. That is core business for us and inevitably if we are scaling up for one client, we are doing it for 10 or 20 others. That is a challenge we need to keep ahead of.
The arrival of open-end funds in alternatives was a big evolution that we had to create solutions for and address, which we were able to do. Now, as managers get bigger and more institutionalized, and as private markets merge with traditional asset management and the investor base includes more private wealth, the reporting requirements are elevated, and operating models need to reflect that. There will be a point where the line between traditional and private fund administration services becomes blurred, so we need to continue to look carefully at what is coming and what we need to solve for.
How is the industry embracing artificial intelligence and automation?
Internally, we are now using AI in various parts of the business. For clients, automating the subscription process is now relatively well advanced, but there is still a lot of manual process. That is definitely a focus for managers and something they are expecting administrators to be able to solve. We have taken steps to build on the existing digital subscription process we have, in direct response to manager demands.
From an analytics perspective, for managers that are maybe partially outsourced or those with multiple administrators using multiple systems alongside inhouse systems, there is a need to consolidate data in one place. Having a single data lake that you can manage, secure and be able to use efficiently for maximum impact is critical, whether in relation to deal sourcing, transaction management or valuations. That is something managers are looking to administrators to help with, so funds don’t need to build that infrastructure in-house.
Clearly in private markets there is more and more data, firms are getting bigger and deploying more strategies, so pulling all the data together in one place is becoming more important. AI and automation are still relatively new, and firms are at different stages of the journey with different priorities. Those with leaner middle- and back-office teams can see the benefits and are now looking to embrace AI and automation to a greater degree.
Opportunistic credit funds are gearing up for a busy year, as increased interest rates start to bite. Greg Myers, Group Sector Head of Debt Capital Markets, shares his thoughts with Private Debt Investor for their Opportunistic Credit and Distressed Debt special report.
Greg Myers
Group Sector Head of Debt Capital Markets
We have seen significant fund closings and even bigger fund launches in the opportunistic credit space. Why is that corner of private debt proving so attractive?
Opportunistic credit, or special situations, is proving popular for a lot of the same reasons that private credit as a whole is attracting the attention of investors. The difference, of course, is that opportunistic credit funds offer a potentially greater uplift, particularly if you are talking about heavily distressed scenarios. Those types of restructuring deals come with significant outsized return expectations when the distressed assets get restructured or repositioned.
We have seen institutional investors increase allocations to private credit consistently in recent years to take advantage of the yield profile offered by those investments, which are now in the high single to low-double digits for performing loans, even stretching into the mid-teens. On a levered basis, you can go even higher. When you consider a special situations or opportunistic credit strategy, you are looking at returns in the 20-30 percent bracket, which is clearly attractive. I think that is the fundamental draw these funds are able to offer to investors anticipating a credit cycle correction.
What are the key macro factors propelling this opportunity set in the current market environment?
The impact of higher interest rates is starting to make itself felt. A lot of businesses, and particularly sponsor-backed businesses, are beginning to feel the pressure of that increased interest rate burden. At the same time, there has clearly been a profound impact on the consumer, in terms of maintenance of household budgets and the ability to consume. That, in turn, is having knock on implications for the companies manufacturing and selling products to consumers, especially if they have meaningful levels of indebtedness.
I think those trends will continue this year. We have not seen the same level of refinancing that we did a few years ago. Deals are not being restructured at the same velocity and that is inevitably going to impact borrowers, with structural defaults and covenant breaches pushing some credits into meaningful restructuring scenarios, which is often a precursor to a broader market trend that might lead more distressed opportunities.
There have been some aggressive predictions made, suggesting that private debt default rates could reach 5 percent this year. What are your thoughts on that and what implications could that have for opportunistic credit?
Yes, Bank of America research produced in October last year estimated that private debt defaults would soon reach 5 percent, thereby exceeding de[1]fault rates for syndicated loans, based on the fact that around one-third of deals in debt fund portfolios were due to mature within 30 months. That default risk is certainly one cloud hanging over the private credit industry right now, while at the same time creating potential opportunities for opportunistic credit managers.
Which loans are particularly at risk and therefore where do you see opportunistic plays emerging?
Private debt, as an industry, is still relatively young. It only really emerged as a fully-fledged asset class in the aftermath of the global financial crisis, when banks were retrenching from new lending to rebuild balance sheets and manage legacy portfolios.
Since that time, the private debt industry has expanded rapidly. In fact, according to PitchBook, it has swelled from $280 billion in assets under management in 2009, to $1.5 trillion in 2022, as managers have seized the opportunity to fill the void left by banks.
During that time, private credit has never really had to tackle a true market downturn and many of these credits now maturing were issued in a bull market, characterized by high levels of leverage and loose terms. Meanwhile, some managers, particularly those looking to build market share, took on more marginal transactions with especially aggressive capital structures. Those are the credits that will be particularly exposed.
In general, I would say that larger and more established platforms will have been less likely to chase the market in 2021 and 2022 and will therefore have more resilient portfolios. Those managers are also more likely to be well resourced when it comes to managing out any credits that do fall into stress. By contrast, newer managers with smaller teams are likely to come under more pressure. Ultimately, this could lead to a bifurcation in the private credit market, with top tier firms attracting an ever-larger share of both dealflow and fundraising.
Are there any particular sectors where opportunistic credit situations are more prevalent, in addition to consumer and retail?
With the exception of consumer and retail, I wouldn’t say that there is any pronounced trend with regard to the industry focus of our clients in this space right now. We are still in the early stages of how this interest rate environment is going to play out, so I think it is too early to tell. However, I would say that there has been a fair amount of portfolio rebalancing in the oil and gas industry. A lot of the traditional lenders in that space – the big retail banks – are starting to rotate out.
How is the opportunistic credit GP landscape evolving? Are we seeing many new entrants?
I think the players that have been active in this market for some time are continuing to raise funds to take advantage of the anticipated market dislocation. But I would say we are also seeing new managers looking to build teams in or[1]der to enter the space. Some of these new entrants are big name asset managers with a strong legacy in private equity. Others have a strong legacy in direct lending. They are not only looking to access these opportunistic credit deals, but also to market new strategies and new funds to their existing investor base.
How do you see the opportunistic credit market evolving?
I think that there will be a lot more borrowers testing the limits of their credit agreements. That is going to lead to forced divestment for the legacy credit funds that are currently holding onto those assets. It will therefore also lead to opportunities for opportunistic credit funds to participate.
There will probably be some initial mispricing of risk with those credits, but over time, and as the volume of dealflow grows, I think the market will establish a cadence and risk will begin to be priced correctly.
Perhaps, the biggest issue that I see on the horizon is the fact that some of these broadly syndicated loans are billions of dollars in size, which is not something that special situations of opportunistic credit funds have come across in a while. They have more typically dealt with mid-market private credit loans of a couple of hundred million dollars. It will be interesting to see how managers choose to participate in those situations and how pairings of certain GPs plays out.
Alter Domus secures strategic investment from Cinven
New international private equity firm joins founders and Permira to support Alter Domus on next stage of growth
Luxembourg, London and Chicago, March 4th, 2024 – Alter Domus, a leading global provider of end-to-end tech-enabled fund administration, private debt, and corporate services for the alternative investment industry, today announced that it has secured a new strategic investment from Cinven. Cinven is a leading international private equity firm focused on building world-class global and European companies. The transaction gives Alter Domus an Enterprise Value of €4.9 billion ($5.3 bn).
Through the transaction, Cinven will support the long-term strategic growth of Alter Domus, working in close partnership with the founders of Alter Domus and Permira, who will continue to be significant shareholders. Their continued involvement and investment in the firm is a huge endorsement for Alter Domus as a business, its global growth strategy to date and its future potential. The new structure means Alter Domus will now benefit from the support of three fantastic partners in Cinven, Permira and the founders, and this transaction strengthens the capital base of the company enabling it to focus on the next stage of its growth.
Established in 2003, Alter Domus is one of the largest fund administrators globally, with over $2.5tn assets under administration (AUA). Solely dedicated to alternative assets, Alter Domus offers end-to-end tech-enabled fund administration and corporate services across three sectors: private equity, real assets and private debt. With the support of Permira since 2017, the firm has grown rapidly to meet the evolving needs of its client base, building a global network that now spans 23 jurisdictions, servicing 90% of the top 30 asset managers globally. Since Permira’s investment, Alter Domus has increased revenue, EBITDA and employee numbers by 5x.
Additional investment characteristics of Alter Domus that were attractive to Cinven include:
Its impressive financial track record, with Alter Domus having consistently outperformed the market, delivering double-digit organic growth and attractive margin performance;
Alter Domus represents a scarce, market-leading global fund services platform that delivers market-leading service levels to a blue-chip customer base including 90% of top-30 asset managers served;
It is a proven M&A platform in the fragmented fund services market that has a successful track record of acquisitions, and a strong further pipeline of potential buy and build opportunities across a range of markets and geographies;
The company operates in attractive markets, with the fund services subsector benefitting from the structural growth of private capital markets, increasing regulation and a continued trend towards outsourcing of fund services, together with downside-protection through strong revenue visibility and cashflow generation;
Alter Domus has received significant investment in the tech-enablement of the company – resulting in best-of-breed third-party platforms, workflow automation and a leading data and analytics product capability to better serve the increasingly complex needs of its global client base; and
It has an experienced and highly respected management team that has led the strong performance to date.
In little more than two decades, Alter Domus has grown from being a small Luxembourg-based spin-off from PwC to become a world-leading fund administrator. The investment from Cinven is a significant milestone in the development of Alter Domus as it continues along this trajectory. Together with Permira, we are confident that Cinven is the perfect partner as it continues to grow and scale internationally, and I am excited to continue to be a part of the Alter Domus journey.
Alter Domus Founder and Chairman of the Supervisory Board, Rene Beltjens
With an enviable track record of investing in fast-growing, world-class businesses, we are thrilled to welcome Cinven as an investor in Alter Domus. Cinven shares our strategic vision and commitment to developing long-term technology-enabled partnerships with the leading alternatives firms globally through the delivery of operational and client service excellence. Together we look forward to further accelerating our international growth and delivering innovative new services to our clients.
Cinven is delighted to make this investment in Alter Domus. Fund services has been a priority subsector for Cinven’s Business Services team due to the attractive business model characteristics and strong growth drivers. Cinven’s Business Services and Financial Services sector teams have worked together in close partnership and have followed Alter Domus closely over many years and admired it as a global leader, with blue-chip clients and leading service levels. Looking forward, we see significant potential for further growth and we look forward to working with the management team and shareholders in the next phase of its journey.
Cinven Partner and Head of the Business Services sector team, Rory Neeson
We would like to thank René Beltjens, Doug Hart and the entire Alter Domus team for their hard work and passion that has allowed our partnership so far to be so successful. The company is now well positioned as a global leader to enter its next phase of growth with the support of an aligned set of shareholders, and we’re looking forward to working closely with Cinven, the founders and management to continue capitalising on the growth opportunity ahead.
The transaction is subject to regulatory approvals and other customary closing conditions.
Alter Domus was advised by Goldman Sachs International and Raymond James (M&A), DLA Piper, Jamieson Group (Dedicated advisors to management), Oliver Wyman (Commercial), EY (Financial & Tax) and Clifford Chance (Legal), Kroll (Compliance), Crosslake (Technology).
About Alter Domus
Alter Domus is a leading provider of tech-enabled fund administration, private debt, and corporate services for the alternative investment industry with more than 5,100 employees across 39 offices globally. Solely dedicated to alternatives, Alter Domus offers fund administration, corporate services, depositary services, capital administration, transfer pricing, domiciliation, management company services, loan administration, agency services, trade settlement and CLO manager services.
Cinven is a leading international private equity firm focused on building world-class global and European companies. Its funds invest in six key sectors: Business Services, Consumer, Financial Services, Healthcare, Industrials and Technology, Media and Telecommunications (TMT). Cinven has offices in London, New York, Frankfurt, Paris, Milan, Madrid, Guernsey and Luxembourg.
Cinven takes a responsible approach towards its portfolio companies, their employees, suppliers, local communities, the environment and society.
Cinven Limited is authorised and regulated by the Financial Conduct Authority.
In this press release ‘Cinven’ means, depending on the context, any of or collectively, Cinven Holdings Guernsey Limited, Cinven Partnership LLP, and their respective Associates (as defined in the Companies Act 2006) and/or funds managed or advised by any of the foregoing.
Permira is a global investment firm that backs successful businesses with growth ambitions. Founded in 1985, the firm advises funds with total committed capital of approximately €80bn and makes long-term majority and minority investments across two core asset classes, private equity and credit.
Permira is one of the world’s most active investors in the Services sector, having deployed over $11.5 billion to partner with more than 40 companies globally. Current and previous investments from the Permira funds in the sector include: Acuity Knowledge Partners, Axiom, Cielo, Clearwater Analytics, DiversiTech, Engel & Völkers, Evelyn Partners, Kroll, Motus, Relativity, Reorg and Tricor.
The Permira private equity funds have made approximately 300 private equity investments in four key sectors: Technology, Consumer, Healthcare and Services. Permira employs over 500 people in 15 offices across Europe, the United States and Asia. For more information, visit www.permira.com or follow us on LinkedIn.
Alter Domus announces partnership with T-REX to automate EU regulatory reporting for credit asset managers
Alter Domus has partnered with fintech firm T-REX to enhance data management capabilities and automate regulatory reporting. US credit asset managers will be the first to take advantage of the automation, streamlining European Securities and Markets Authority (ESMA) reporting, and opening up market opportunities for EU investors.
ESMA reporting is in place to drive transparency and protections for investors, and requires granular, asset-level reporting. Many firms do not have the data infrastructure to respond to the reporting obligations without significant operational burdens, thus limiting their abilities to sell securities to EU-based investors.
In response, Alter Domus has partnered with T-REX, a fintech specializing in complex data and structured finance, to transform the manual workflows associated with data management and regulatory reporting for the credit market, including CLOs. T-REX’s technology will automate data pipelines from all parties including issuers, servicers, agents, and trustees, standardizing formats and mapping the data to ESMA reporting templates.
“The automation capabilities coupled with data integrity expertise alleviates challenges in aggregating the right data from various parties, standardizing data across disparate formats, and ensuring regulatory reports are compliant and readily accessible. T-REX looks forward to partnering with Alter Domus and ultimately providing more market participants with solutions to their hardest data challenges, including regulatory-readiness” says Benjamin Cohen, CEO of T-REX.
Clients on the Alter Domus platform, or serviced by Alter Domus on a co-sourcing basis, will now be able run ESMA reports powered by T-REX.
Alter Domus’s partnership with T-REX will deliver a market-leading service to our clients; that ensures they can continue to engage with EU-based investors without taking on significant operational costs and burdensome workflows. Simply put, it will make a difference in their readiness to do deals in the EU, and we’re dedicated to offering the right technology to help them do that.
Tim Ruxton, Managing Director, North America at Alter Domus
A recent article from Middle Market Growth discusses the increasing trend of private equity firms shifting their focus towards smaller deals and fundraising in the middle market. As larger deals become more competitive and expensive, firms are seeking opportunities in the middle market, which offers attractive valuations and growth potential. This shift has led to increased fundraising for middle-market-focused funds, as investors recognize the potential for higher returns and lower risk compared to larger deals.
Middle-market companies are often overlooked by larger private equity firms, creating a less competitive environment and more attractive investment opportunities. These companies typically have strong growth potential and can benefit from the operational expertise and capital provided by private equity firms. Additionally, middle-market companies are more likely to be founder-owned or family-owned businesses, which can provide a smoother transaction process and better alignment of interests.
Despite some recent successes, fundraising was down significantly year-over-year. “2023 was the most challenging year for private equity in the last decade because of high interest rates, slow exits, limited M&A and limited liquidity and challenging economic conditions,” Alter Domus’ Regional Executive North America, Jessica Mead said.
LPs want to see a proven track record and have deeper access to qualitative portfolio analysis.”
Could AI answer the SOS of ESG managers drowning in responsibility and tasks?
As private markets scale up their sustainability efforts, time pressed ESG managers often have to set aside strategic planning to focus on day-to-day activities. But AI can give them precious hours back, helping ESG managers increase their impact on business, says Victoria Gillespie, Head of ESG at Alter Domus.
In an interview with Private Equity International, Gillespie says it’s the breadth and depth of their responsibilities, coupled with a glut of data, that is making it more challenging for EGS managers to be effective. AI can help control those issues.
“We see AI as … taking on some of the more mundane tasks to free them up for more strategic thinking, as well as enhancing their day-to-day processes by leveraging analytics,” she says.
Victoria Gillespie
AI can also improve risk management by looking at the materiality of regulations, a vital role given that regulation around ESG has grown exponentially over the past decade.
Read the article, which also includes Gillespie’s take on how to reduce the risks associated with AI use, on the Private Equity International website.
Simplifying European Long-Term Investment Fund regulations is expected to make it easier for investors to access private assets, but will it live up to its promise of enabling more players to enter the market?
Antonis Anastasiou
Group Head of Product Development
In the February 2024 edition of Private Equity International, Alter Domus Group Head of Product Development Antonis Anastasiou is among those weighing in on ELTIF 2.0.
Some observers say that despite the new rules, ELTIF remains a highly regulated regime with high barriers to entry and the advantages apply only to EU customers and retail segments. By contrast, Anastasiou says ELTIF 2.0 is a win-win for US asset managers:
“The ELTIF 2.0 setup gives US asset managers, for example, a regulated fund regime that they know here in Europe and that they can invest into as a parallel sleeve to the US master fund.”
Antonis Anastasiou
Anastasiou says the managers he’s spoken to are looking at a minimum launch size of €200 million-€500 million, while target sizes are expected to quickly move to the €1 billion-€2 billion range.
Alter Domus creates dedicated Key Client Partnerships team
Fund services leader forms Key Client Partnerships, a dedicated team of industry experts to co-create operating and financial models customized to meet specific client priorities.
Luxembourg and New York, January 23, 2024 – Alter Domus, a leading provider of tech-enabled fund administration, private debt, and corporate services for the alternative investment industry, today unveiled the creation of its Key Client Partnerships (KCP) practice to help private markets firms scale their middle- and back-office infrastructure to meet increasing investor demands and mounting complexity. This creation comes as a natural consequence of the firm’s 20-year track record of building long-lasting relationships with major private markets firms.
As the pace of growth in the private markets continues to increase, so too has technology, regulatory and investor reporting requirements. In response, Alter Domus’ KCP practice aims to meet private markets firms’ need for dedicated support on defining and implementing new target operating models to support their future growth and scalability.
The Key Client Partnerships approach is centered on investing in long-term relationships with clients that covers everything from migrating products from one platform to another, to handling all outsourcing and technology interfacing, to managing all the governance and risk mitigation aspects of team and technology transitions.
Depending on their strategic priorities, joint operating models are built on one of three broad operational foundations:
Co-sourced: Alter Domus’ expert administration team continues to use a client’s technology, processes and data infrastructure. The benefits of this model include Alter Domus managing HR responsibilities for the client’s team, no disruptions from the client’s current model, and retention of any bespoke technology platform developments.
Managed service: An expert team actively manages a client’s technology and processes, while the client controls its data infrastructure. The advantages of this model include access to Alter Domus’ deep administration, technology and process expertise, its absorption of technology costs, and retention of bespoke data interfaces and developments on behalf of the client, as well as Alter Domus’ ongoing investments in technology platform upgrading and innovation.
Out-sourced: Alter Domus experts handle every aspect of a client’s administration needs, including technology and data infrastructure. Information is delivered through Alter Domus’ client portal, CorPro, or direct API connectivity. Alter Domus absorbs data and infrastructure costs and provides the client with full access to its industry-leading platforms, servicing and technology developments and innovation.
In addition, Alter Domus’ KCP team will support its clients in building the relevant financial model for the partnership, and lead the transition to the target operating model.
Alter Domus head of Key Client Partnerships Steve Krieger, said: “The focus of clients is investment management – raising money, deploying capital, managing risks – not fund servicing, accounting and compliance. Our new practice responds to private markets managers’ growing requirement for hands-on support on how to renew entire operating models that are no longer fit for purpose. Supported by our decades of administration expertise and industry-leading technology, fund managers can now partner with a dedicated team of Alter Domus experts to ‘co-create’ global operating models customized to their specific priorities.”
A spotlight on ELTIF 2.0: A path towards democratization?
In the third article in a four-part series on raising capital in Europe, we look at the updated European Long-Term Investment Funds regulation or ELTIF 2.0. Insights come from Antonis Anastasiou, Group Head of Product Development, and Conor O’Callaghan, Head of AIFM Ireland.
Anticipation is high in the alternative assets space. But to understand why fund managers are so engaged with ELTIF 2.0 – which came into effect on January 10 2024 – you must first appreciate why the original ELTIF framework did not live up to expectations.
In the eight years that it was in place, the original ELTIF regime managed to raise fewer than 100 funds with total assets under management estimated at approximately €7 billion. Tellingly, most European Union member states did not establish any. In our view – and this is an opinion which appears to be almost universal across the industry – the take up was slow because the original ELTIF was, in some instances, too restrictive. This was particularly true in relation to eligible investments which required a minimum €10 million value threshold, and the ability to invest other funds was limited to other ELTIFs. Additionally, there were limitations to marketing rules for retail investors, all of which contributed to ELTIF 1.0 not being widely adopted.
Fortunately, Article 37 of ELTIF 1.0 mandated that the European Economic and Monetary Affairs Committee (ECON) had to start a review of the application of the regulation no later than June 9 2019. From this review, ELTIF 2.0 was born. In its November 2021 report to the European Parliament and Council, the Committee noted the key problems with the framework –on both the demand and supply sides.
So what has changed?
Demand side
On the demand side, with the ‘democratization’ of alternative assets, the enhanced regulatory regime promises to support managers in addressing the retail market, and to broaden investment opportunities. Under ELTIF 2.0, the entry barriers for individual investors have been removed, including the minimum investment threshold of €10,000 and net-worth requirements.
One of the main components of ELTIF 2.0 – which we discussed in the opening article of this series looking at pre-marketing – is the ability to use the European marketing passport to distribute an ELTIF 2.0 product. This greatly simplifies the distribution setup and removes the retail barriers of ELTIF 1.0, although a suitability assessment, as required under MIFID II, still applies to retail investors.
Supply side
On the supply, or product, side the changes in ELTIF 2.0 aim to remove the restrictions that hindered the success of ELTIF 1.0. The key changes as outlined in the table below, coupled with the relaxation in redemption limitations provide for the desired flexibility that was absent in the original regime.
Supply Side Changes
ELTIF 1.0
ELTIF 2.0
Threshold for Eligible Assets
70%
55%
Maximum concentration limit
10%
20%
Borrowing limit (retail)
30%
50%
Max market cap of equity or debt issuers
EUR 500m
EUR 1.5bn
Minimum Investments in real Assets
EUR 10m
EUR 1.0m
Ability to invest in AIFs (Fund of Funds)
No
Yes
Ability to invest in underlying securitizations
No
Yes
Investment in non-EU assets
No
Yes
Ready for the new regulatory framework
Even before launch, interest in ELTIF 2.0 was gathering momentum. As we mentioned in the second article of this series, some of the biggest players in the market, from Blackstone to KKR to Apollo, were already engaging with this new framework, looking to make the most of the regulations. But what should fund managers who are looking to raise capital in Europe be thinking about?
In the fourth and final article in this series, we will be taking a closer look at the expected impact of ELTIF 2.0 as well as the challenges and considerations for managers and service providers. Now that ELTIF 2.0 is live, what should you be considering, what are the challenges and how might you manage them?
While they offer significant opportunities, OEF characteristics also come with enhanced commitments. Marry these with the nuances of alternative asset classes and you need experts to unlock the opportunity.
Alter Domus sector heads Tim Toska, Greg Myers and Anita Lyse share their views on how they expect private equity, private debt, and real assetsmarkets to perform in 2024.
Private Equity: outlook for 2024
Tim Toska Global Sector Head, Private Equity
What to watch out for 2024:
Securing exits will be the number one priority for GPs in 2024, as they strive to return cash to LPs and get fundraising moving again
GPs will explore all routes available to them to realise liquidity, including alternative GP-led secondaries and using NAV loans to make distributions
LPs will use secondaries markets extensively too, exiting existing holdings to free up cash and make commitments to the new funds of top tier managers
The peak of the interest rate cycle should reignite M&A and IPO markets, helping to clear the backlog of unexited assets sitting in GP portfolios
The private equity industry goes into 2024 coming off the most challenging period for the asset class in more than a decade.
The combination of rising interest rates, higher acquisition finance costs and geopolitical dislocation have had a chilling effect on year-on-year buyout, exit and fundraising activity.
Jammed up deal markets have had a direct impact on fundraising. As exits have dried up, managers have been unable to realize value and return cash to investors. According to Burgiss data quoted by Bloomberg, private equity limited partner (LP) cash flows have turned deeply negative, with the gap between capital calls and distributions widening to levels greater than the observed in the depths of the 2008 global financial crisis.
The lack of liquidity has left LPs with limited headroom to make allocations to the next vintage of funds, with private equity fundraising cooling to its slowest rate in years, according to Pitchbook figures cited by Bloomberg.
The exit imperative: liquidity the priority for 2024
Looking ahead to 2024, the number one priority for the general partner (GP) community will be unblocking the fundraising bottleneck by getting cash back into the hands of investors, and the best way to do that will be to fire up exit deal value again.
According to Bain & Co analysis, buyout funds alone are sitting on an all-time high $2.8 trillion of unexited assets in their portfolios – more than four times higher than the thresholds recorded during the global financial crisis. Finding buyers for these assets and returning cash to LPs will alleviate the pressure on investor cash flows and get fundraising moving again.
Of course, the challenge for GP vendors during the last 18 months has been to find buyers willing to meet valuation expectations for assets. As interest rates have climbed, establishing consensus on pricing has become increasingly difficult. No GP has wanted to offload a good asset at bargain valuation at the bottom of the cycle, while buyers have found it very difficult to structure deals when there is limited visibility on future earnings and financing costs. The result has been M&A stalemate.
Creativity required
GPs will be exploring all options available to them for realizing liquidity and returning cash to investors in 2024 if conventional exit routes (strategic sales, secondary buyouts and IPOs) remain becalmed.
The market has already observed and tested what some of the options could be. More GPs are now exploring GP-led secondaries deals when planning exit routes, and are expected to continue doing so in numbers in the year ahead.
These structures, which see selected assets placed into continuation funds, give LPs the option to take liquidity or rollover their stakes in the asset into the continuation fund. For GPs with good assets, but under growing pressure to make distributions to investors, a continuation fund can provide tidy solution that allows for LPs to receive cash without managers having to sell off prized portfolio companies at bargain prices in bear market.
According to Jefferies, these GP-led deals account for 42 percent of overall secondaries deal value in H1 2023, which although down on the share observed in. the bull market of 2021, is significantly higher than pre-pandemic levels.
LP-led deals (where investors sell their stakes in funds to secondaries funds) will also be a key dynamic in the asset class in 2024. LPs have increasingly taken direct control of their cashflows by using secondaries deals to expedite routes to liquidity. LP-lead deals accounted for less than half of total secondaries deal value in 2021, but share has climbed to 58% in 2023, according to Jefferies.
Secondaries sales will remain an important tool for investors in 2024, especially when elite managers come to market with new vintages. LPs who don’t have immediate access to liquidity to allocate to these blue-ribband GPs will turn to the secondaries market to exit existing holdings in order to make commitments to their preferred firms.
Another route to liquidity GPs are exploring are NAV loans, where managers take out debt secured against the assets in fund and use the proceeds to make distributions. These arrangements are still relatively novel (and not without controversy, as distributions can be recalled if GPs can’t repay the NAV debt), but some high-profile private equity brands have put NAV loans in place to make distributions and others may follow suit.
Traditional exit routes: reason for optimism
There is growing, but still cautious, optimism that conventional exit routes will also start to unfreeze in 2024.
The outlook for interest is underpinning this sanguinity. After enduring the steepest pace of rate hikes in more than four decades central banks around the world do appear to have hit peak rates.
GPs would prefer rates to be lower than they are, but even if rates do stay at current elevated levels, there is at least some clarity in the market on what interest rate assumptions to build into deal models. This will go a long way to recalibrating buyer and seller pricing expectations, narrow the bid-ask spread on valuations and hopefully get deal markets flowing again.
After challenging year, GPs will be hoping that more landmark transactions will come to market in 2024.
Private Debt: outlook for 2024
Greg Myers Global Sector Head, Debt Capital Markets
What to watch out for in 2024:
Private debt is ideally positioned for a golden vintage in 2024 as high interest rates drive up yields and capital structures become more conservative
LP appetite for private debt exposure will remain strong as investors seek exposure to the asset class’s strong underlying fundamentals
Distinctions between bank and debt fund capital will blur as investment banks and Private Credit Managers build out their direct lending offerings
The resilience of portfolios will become a key differentiator in a market that will bifurcate
There haven’t been many asset classes that have benefitted from the current cycle of interest rate hikes. Private debt is one of them.
Despite volatile stock markets, a sharp contraction in M&A deal flow and stultified leveraged loan and high yield bond markets, private debt managers have continued to secure investor capital and find opportunities to deploy capital in a tough environment.
Steady distributions and attractive yields draw investors
The strong performance of the asset class in 2023 has positioned private debt to potentially deliver one of its best vintages ever in 2024.
As base rates are now sitting in the region of five percent, private debt managers can realistically expect to produce yields in the 10 percent to 12 percent range, according to analysis from Barings. The gap to equity returns is not very wide, and with private debt consistently delivering high, double-digit distribution rates, the risk-reward dynamics presented by the asset class w2ill be among the most compelling for investors in 2024.
Private debt managers will also continue to benefit from supply-demand dislocation in wider lending markets. Syndicated loan and high yield markets have been stung by higher interest rates and all but shuttered, with banks reluctant to take on syndication risk at such an unpredictable period in the credit cycle.
According to White & Case figures, leveraged loan and high yield bond issuance across North America and Western and Southern Europe over the first nine months of 2023 declined by almost a fifth year-on-year from $1.13 trillion in 2022 to $920.54 billion this year.
Tightening loan and bond markets and cautious banks have allowed private debt managers to cherry pick deals and issue debt not only at higher interest rates, but also with lower leverage and lender-friendly capital structures.
Reshaping an asset class
The strength of the $1.5 trillion private credit space will drive ongoing and significant evolution of the asset class, with 2024 shaping to be a groundbreaking year.
In the second half of 2023 a growing cohort of banks made strategic moves into private debt, either as cornerstone investors in private lending firms, as seen in Rabobank’s investment in sustainable private lender Colesco; through partnering with private markets platforms, as seen with Societe Generale planning to raise a €10 billion credit fund with Brookfield; or launching dedicated private credit managers inhouse, as Deutsche Bank has done.
More banks, nervous about losing lucrative streams of leveraged loan and high yield fee income to competition from private debt, are expected to make similar strategic moves and step into private credit in some shape or form in 2024. This will blur the lines between the two types of providers and reconfigure the way borrowers look at their financing options in the future.
Default risk looms
The one cloud that will hang over private debt in 2024, however, will be looming default risk.
Private debt as an asset class only really came onto the radar as a credible alternative to conventional bank-led lending after the 2008 financial crisis, when banks retrenched from the market to rebuild balance sheets and manage legacy portfolios.
Since then, private debt assets under management have expanded at pace, as managers seized the opportunity to fill the gap in the market left by the banks. The asset class, however, has never been truly tested through a downcycle and borrowers and investors will be watching closely to see how managers behave when portfolios do become stressed.
Bank of America estimates that the private debt default rate could reach 5% by early 2024, exceeding default rates for syndicated loans. From 2024 onwards, roughly a third of deals in debt fund portfolios will be maturing within 30 months, according to Bloomberg.
Many of these maturing credits would have been issued in bull credit markets and characterized by high levels of leverage and loose terms. Some managers, who were eager to gain market share and took on more marginal transactions with aggressive capital structures, will be particularly exposed.
Bigger platforms didn’t have to chase the market in 2021 and 2022 and are likely to have more resilient portfolios, as well as the resource to manage out any credits that may fall into stress. Newer managers with smaller teams will come under much more pressure if portfolios do become stressed.
This is likely to drive a bifurcation of the market in 2024, as top tier private debt funds take up a growing share of private debt deal flow and fundraising, while smaller firms find that their teams stretched as they try to shepherd current portfolios through distress at the same time as trying to originate new deals.
Evidence of this bifurcation has already started to emerge, with Pitchbook reporting that the number of funds new private debt funds closing has contracted by more than 25 percent, even though year-on-year private debt fundraising value has climbed. This signals that LPs have already begun to focus on relationships with fewer, bigger private debt funds, which are becoming increasingly dominant forces in the market.
Great opportunity lies ahead for private debt managers in 2024 – but there may be fewer managers around to take advantage of it.
Real Assets: outlook for 2024
Anita Lyse Global Sector Head, Real Assets
What to watch out for in 2024:
Interest rate stability will help revive real asset fundraising and deal activity after a difficult 2023
Bid-ask spreads on real assets should level off although the market will bifurcate according to asset quality and subsector
Fundraising will pivot decisively to established managers with larger platforms
Energy transition will be a key driver of long-term real assets growth
Real assets managers will be hoping that cooling inflation and interest rate stability improve conditions for fundraising and investment in 2024 after a difficult 12 months.
Real assets have felt the full force of geopolitical and macro-economic volatility. According to PERE, real estate fundraising contracted to $92.8 billion during the first nine months of 2023, a 38 percent decline on the $150.4 billion secured over the same period last year. The current run rate could see real estate fundraising come in at the lowest annual level observed since 2012. Infrastructure fundraising has slowed significantly too, with CBRE analysis of Infralogic data showing a decline to the lowest levels in more than a decade.
Hopes for stability
The headwinds that real assets investors have faced through the course of 2023 will persist into 2024.
In the real estate space higher capital costs and conservative underwriting will a remain a feature of the market according to JLL analysis, as companies reassess post-pandemic office requirements; logistics operators reconfigure warehouse portfolios amidst pressures on consumer spending; and investors take longer to make decisions when deploying capital.
In infrastructure, meanwhile, leveraged plays in sub-sectors such as telecoms towers and utilities will remain challenging. According to State Street, rising interest rates have made investments in competing, higher income asset classes more attractive than infrastructure plays, while climbing energy costs and falling global exports weigh on bottom line profitability. According to CBRE these dynamics have seen investors demur from committing to long-term, capital-intensive projects at a high point in the interest rate cycle.
There is nevertheless a degree of cautious optimism that the market backdrop for real assets investment strategies will improve in 2024, albeit below the levels achieved in the bull market of 2021 and early 2022. Interest rates will be the key barometer for a recovery in activity, with JLL expecting a steadier market to emerge should inflation continue its downward trajectory and interest rates stabilize. This could help to bring buyer and seller pricing expectations closer together following a period of volatile pricing shifts and limited deal flow on which to establish consensus on valuations.
Big platforms to dominate
In a trend that mirrors developments in other alternative asset classes, investors will commit the capital they do have available to bigger managers with large investment platforms in an effort to mitigate downside risk in a still choppy deal market.
Blackstone, for example, has raised at least €4 billion towards its seventh flagship European real estate fund since launching in April 2023, securing more than $3 billion of commitments in Q3 2023 alone. Copenhagen Infrastructure Partners (CIP), meanwhile, has raised €5.6 billion towards the €12 billion targeted for its fifth flagship, while Artemis Real Estate Partners closed its Artemis Fund IV on $2.2 billion, beating its $1.5 billion target.
Large real assets managers have also had the scale and resources to ramp up new strategies where they see opportunity and secure investor support. Real estate debt is one area that has seen a significant uptick in activity. Bain Capital and TPG are among the firms to launch new dedicated real estate debt strategies, while PIMCO closed its sophomore Commercial Real Estate Debt Fund on $3 billion to beat its $1 billion target.
Prolonged fundraising and reduced capital inflows in a slow exit market will also see managers across the board rethink their own operational models and running costs. Outsourcing back-office and middle office infrastructure will move firmly into the frame as firms prioritize reducing staff costs and other overheads.
Energy transition to drive long-term growth
One subsector that will animate real assets fundraising and deal activity for managers of all size is energy transition.
Delivering net zero emissions will require substantial investment, with McKinsey forecasting that $9.2 trillion of annual capital spending will be required between 2021 and 2050 to meet decarbonization targets.
Government and corporate commitments to securing the required investment to meet net zero target have insulated renewable energy and decarbonization projects from market volatility, with capital continuing to flow into these areas despite dislocation in other segments of the real assets space. The US Inflation Reduction Act and Europe’s Green Deal and REPowerEU initiative are among the global initiatives that have encouraged private sector investment into decarbonization.
For real assets managers these dynamics has driven substantial investor appetite for decarbonization and renewables investment strategies.
According to the Long-term Infrastructure Investors Association (LTIA), funds dedicated or partly dedicated to renewable energy have accounted for more than 90% of overall infrastructure fundraising since 2019. This secular pivot towards strategies with an energy transition theme has fed a swelling pipeline of renewable energy deal opportunities, with CBRE analysis of Infralogic data putting global live deal pipelines for renewables at around $3.6 trillion.
Real assets deal activity and valuations wills also become increasingly shaped by broader environmental, social and governance (ESG) concerns that extend beyond energy transition in wider areas of sustainability and energy and water conservation.
In infrastructure and real estate ESG has shifted from a “nice to have” to an essential part of a license to operate. Through the course of 2024 we expect ESG to become an important element of asset valuations, with widening valuation gaps between assets where ESG is embedded into operations and assets where ESG hasn’t been prioritized.
As market conditions improve through 2024 other areas of the market will rally, but energy transition and ESG will remain a key long-term driver for real assets fundraising and deal activity.
