A nuanced play

LPs interest in private debt is increasing....
Aivars Lode
  
Pension fund interest in private debt is increasing. But just how are these institutional investors allocating?


Pension funds are making growing commitments to private debt strategies, PDI hears. In the UK, one of Europe’s most active private debt markets, pension fund managers are attracted to the risk-adjusted returns of the asset class, we’re told It’s well-known that their brethren in the US are already allocating, but pension fund managers in the UK have been, shall we say, a little coyer. So PDI went to the National Association of Pension Funds’ annual investment conference in Edinburgh last week in search of clues that this might be changing.

With decreasing yields and increasing outgoings as pensioners live longer, how are pension fund managers going to meet future liabilities and are they considering private debt? Truth be told, they are considering many options, including invigorating their investment strategies.

Private debt is just one strategy to pique their interest, with key words like ‘infrastructure’ and ‘real assets’ frequently brought up during discussions too. ‘The Chinese are looking at UK infrastructure – why don’t we!’ to paraphrase one scheme manager in Edinburgh.

Amongst those to put their heads above the parapet in regards to private debt is local authority pension scheme the London Pensions Fund Authority (LPFA). It created a framework for procurement recently to secure the services of an alternative credit manager, a route not typically traversed by public pension funds when allocating to private debt.

Four managers - Apollo Global Management, Ares Management, Babson Capital and GSO Capital Partners - have been shortlisted to co-manage the LPFA’s £100 million to £150 million mandate.

Making the grade is quite a coup for these four manages given that within the new framework all 99 of Britain’s local authority pension fund plans affiliated via the Local Government Pension Scheme and overseeing roughly £180 billion (€249.2 billion; $267.4 billion) can appoint any of them to manage segregated accounts during the next three years. Whether they will or not remains to be seen, but the LPFA is expected to pick at least one by the end of March.

The chosen four have made it as a result of the multiple vertical strategies they offer, LPFA chief investment officer, Chris Rule said. And an impetus for investment from LPFA’s perspective is to learn more about the private credit asset class, he added.
This is food for thought, as it appears to confirm that pension fund managers are getting more hands on with their funds. The UK industry-backed Pensions Infrastructure Platform (PIP), which will invest £1 billion in UK infrastructure assets including debt, is another good example of this.

Many pension fund managers are familiar with private debt in the original sense - mezzanine and distressed strategies. But direct lending, particularly to corporates not backed by private equity sponsors, is a new idea. Direct lending falls somewhere in the middle of the private debt returns scale, between infrastructure on the lower end and more opportunistic investments at the higher, Gregg Disdale, senior investment consultant at pension advisor Towers Watson, explained to PDI.

How pension funds allocate depends on their specific circumstances. Some corporate pension schemes running large deficits are allocating to private debt, as they seek better returns on a risk-adjusted basis, PDI understands. The opportunity to gain exposure to lending in a region where banks are restricted is very compelling, as are the returns.
But far from reducing exposure to the low yielding public markets completely, at most a UK pension fund manager might make a new allocation of around 5 percent to the asset class, coming from both their credit and private equity allocations.

As always, illiquidity is an important factor for pension fund managers to get to grips with. It’s all about relative value. As Disdale puts it: “The critical question for us when assessing these ideas is are we being sufficiently compensated for locking up our capital. You need to believe you are being better paid per unit of risk versus other alternative credit investments.”
Surfacing data that will help UK pension fund trustees answer this question will ultimately decide how meaningful a role private debt will come to play in their portfolios.

- Private Debt Investor 

Is GP Restructuring An Emerging Asset Class?

As PE funds expire there is a restructuring of the industry coming....
Aivars Lode

A decade ago saw one of the boom periods for private equity with $1T of funds raised between 2005 and 2008. Now that most funds raised during that time are approaching the end of their 10-year contractual life, there has been a surge in GP-led fund restructuring transactions that has many in the industry looking at the space as an emerging and attractive asset class for investment.

“The restructuring of a PE fund is driven by LPs seeking liquidity in these older vintage funds and the tension with GPs who require more time or more capital to realize future value in its portfolio companies”,” says ICG Director of Secondaries Christophe Browne, speaking to Privcap at Hycroft’s 2015 Private Equity Conference in Miami.
“The structure of private equity funds doesn’t always mirror the right time to sell assets and realize maximum value,” he says.
The financial crisis pushed out the holding period for almost all PE-owned companies, and now a growing number of assets are now managed by GPs who ended up “underwater” on the economic incentives, which has caused some misalignment of interests between GPs and LPs.
For Browne, this type of crisis presents an opportunity for his team of specialist secondary portfolio buyout experts.
“When you look at the 2005 to 2008 vintage of funds that are now reaching expiration but have not performed, the management fee becomes the only incentive for the GP and LPs don’t have liquidity options,” he says. “That’s the perfect opportunity for us to go in and offer LPs a comprehensive solution by partnering with the incumbent GP to buyout all of its remaining unsold assets with a rollover option into the newly restructured vehicle”.
But the process of restructuring a PE fund is complex and requires a unique set of multi-asset due diligence capabilities and multi-party negotiating skills in order to complete a transaction in a relatively short amount of time.
Last year, Browne, along with ICG’s Global Head of Secondaries Andrew Hawkins, executed a successful restructuring of the 2005 vintage Diamond Castle Partners IV fund with a new $860M investment vehicle acquiring the portfolio of eight remaining companies and managed by Diamond Castle’s GP team.
“Diamond Castle was a classic example of a restructuring transaction, which had the challenges of a complex process and multi-party negotiation,” says Browne. “The fund was nine years old and there had been changes in the leadership partner group at the GP. Yet, there was still over $700M of net asset value remaining in eight portfolio companies.”
Browne adds that ICG’s job was to negotiate a satisfactory deal that would be accepted by more than 75 LPs, along with a partnership agreement with the GP to align interests for a new holding period. At the same time, they had to perform asset-level due diligence on eight companies in a matter of 45 days and be out with a tender offer to LPs in 60 days, he says. “It’s always a herculean task to get the deal done, but it’s great when it all comes together with a good outcome for all parties.”

By Mike Straka, Privcap