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.

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“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.

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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:

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“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.

Read the complete article on the PEI website.

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What’s new across the world of capital markets? Alter Domus is proudly sponsoring SF Vegas yet again, this year running from February 25-28^th at the Aria Resort & Casino. The three-day event is the world’s largest capital markets conference for leaders within the structured finance industry.

Our team of experts will be there to share their knowledge and expertise with you. Be sure to stop by our booth to chat with the team and to learn about our complete range of solutions.

Our attendees include:

• Greg Myers
• Tom Gandolfo
• Lora Peloquin
• Devin Joyce
• Randall Reider
• Kennedy Glasscock
• Tim Ruxton
• Jennifer Jehle
• John Coviello

Get in touch with a member of our team ahead of the conference to set up a meeting. They look forward to seeing you there!

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.

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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?

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Learn more about Alter Domus’ AIFM Services and Private Equity Solutions.

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.

According to law firm White & Case, global buyout deal value has almost halved in 2023, falling to $442.2 billion over the first nine months of the year from $864.96 billion over the same period in 2022. The drop in year-on-on-year exit value has been similarly precipitous, contracting 51% to $240.75 billion over the same period.

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.

There are already early signs that a more stable outlook is opening up traditional IPO and M&A markets. In 2023, buyout firm GTCR went ahead with the largest deal in its history with the $18.5 billion carve-out of payments company Worldpay from Fidelity National Information Services, in transaction that enjoyed strong support from debt markets.

After challenging year, GPs will be hoping that more landmark transactions will come to market in 2024.

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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.

According to Pitchbook private debt delivered double-digit year-on-year fundraising growth in 2023, putting the market on track to deliver annual fundraising in excess of $200 billion for the fourth year in a row.

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.

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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.

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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

As demand for alternative asset services grow alongside 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. This shift is increasingly being observed among alternative asset managers responding to investor preferences for scale and stability.

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.

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We are proud to announce our sponsorship of the Private Funds CFO’s New York Forum on January 30-31. Join us at the event to gain valuable insights on the latest technology, tax reforms, regulatory updates, and ESG trends shaping the private equity industry. Connect with our team of experts, including Dean Schaffer, Tim Toska, and Ned Siegel, to learn about our integrated solutions for private equity managers.

Tim Toska, our Global Sector Head, Private Equity, will share his expertise on the “Refining data management and reporting practices to satisfy investors” panel on January 30 at 2:30pm EST.

Learn more about Alter Domus’ integrated solutions for private equity managers by connecting with our team ahead of the conference!

In a recent Preqin article, Alter Domus’ Tim Toska was joined by leaders from across the industry, including BlackRock, KKR and Schroders Capital, to give their expert views on deals, fundraising, and performance in the year ahead.

According to Tim, “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. 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. An increase in deal activity, and the continued development of liquidity strategies and more creative fund finance solutions, should ease the concerns of investors.”

You can read the full article on the Preqin website.

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Our very own Johnson Har will be attending the Asia Private Equity Forum is a leading annual industry event in the region, organized by the Hong Kong Venture Capital and Private Equity Association (HKVCA), Asia’s oldest and largest private equity industry group. The event will take place on January 26, 2024.

This forum brings together industry experts and practitioners to discuss the changes and challenges emerging within Asia’s private markets. With a focus on addressing the ongoing complexities, this event will cover a wide range of topics such as venture capital investing, private equity real estate, private credit, ESG, and regulatory matters.

Connect with Johnson ahead of the conference to network and explore how Alter Domus can help you navigate the complexities of Asia’s private markets and achieve your investment goals.

Alter Domus is excited to sponsor the 2024 Fondsfrauen Gipfel in Mannheim on January 23rd.
Our very own Angela Summonte will be joining a panel of experts from Hauck Aufhäuser, KENFO, and Golding Capital Partners to discuss the role of AI in asset management.

The future of finance is evolving rapidly, and AI is playing a crucial role in this transformation. How will it impact research, sales, and investment decisions?
Get in touch with Angela and our Head of Digital Transformation, Danilo to learn more about how Alter Domus is leveraging AI to drive success in the finance industry.

We will be attending the IPEM 2024 in Cannes from January 23 to January 25.
With private equity and venture capital projected to see declines of -40% and -60% respectively in deal values in 2023, “Getting Deals Done” has become the industry’s top priority, as LPs are eager to see their capital in action.

Join our Sales Director, Patrick Giovansily, and Director of Sales & Relationship Management, Enkela Kosturi, as they discuss how the industry is addressing these financing headwinds, sourcing lucrative deals, and innovating in deal structuring, portfolio management, and value creation.

Don’t miss the opportunity to connect with Patrick and Enkela in advance and schedule a meeting to discuss how Alter Domus can support your private equity needs.