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

Specialization

Specialization: As the private equity environment gets more competitive, some firms are finding an advantage by specializing in specific sectors. And according to a new study from Cambridge Associates, their limited partners are benefitting from their specialization.

Sector-focused funds have returned an aggregate 2.2x multiple on invested capital and a 23.2 percent gross internal rate of return between 2001 and 2010, Cambridge said. That compares to the 1.9x multiple and 17.5 percent gross IRR returned by generalist funds during that time period.

Cambridge defines sector-focused funds as those that invest more than 70 percent of their capital in the consumer, financial services, healthcare or technology sectors.

“In an increasingly competitive private equity environment, a manager’s ability to demonstrate deep expertise in a focused field is a key differentiator,” Andrea Auerbach, global head of private investment research at Cambridge, said in a statement.

The challenge for LPs is to determine who is really a sector expert, Auerbach said in an interview.

Many firms claim to focus on several sectors, but it’s important to determine if they “live and breathe” the sector, or if they are simply calling themselves specialists “so the right sector banker can find you with their deal flow,” Auerbach said.

“You can have sector-focused individuals, or teams within larger firms who are ultimately competing against complete firms [where] that’s all they do is that sector,” Auerbach said.

PEHUB

SEC probing private equity performance figures: Reuters

The U.S. Securities and Exchange Commission is examining how private equity firms report a key metric of their past performance when they market new funds to investors, as the regulator boosts its scrutiny of the industry, according to people familiar with the matter. At issue is how private equity firms report how they calculate average net returns in past funds in their marketing materials, the sources said. Net returns, also known as the net internal rate of return (IRR) and an indicator of investors’ actual profits, deduct private equity fund investors’ fees and expenses from a fund’s gross profits. Private equity fees are not standard and different investors in the same fund can pay different fees. Fund investors such as pension funds, insurance companies and wealthy individuals – known as limited partners – pay the fees to the private equity firm. The private equity firm and its managers, called general partners, also typically invest some of their own money into the funds, but don’t pay any fees. Including the general partner’s money in the average net returns can inflate the fund’s average net performance figure, and the SEC is investigating whether private equity fund managers properly disclose whether they are doing that or not, the sources said. An SEC spokeswoman declined to comment. The SEC’s focus on the average net IRR disclosures, which has not been previously reported, marks a new phase in the agency’s efforts to regulate private equity and comes at a time when the industry is already under pressure from investors to simplify its fees and expenses structure. The emphasis on performance figures is likely to cause many buyout firms to review their regulatory compliance measures and force them to increase disclosures and make their numbers more intelligible to investors.There is no standard practice for calculating average net IRRs among the roughly 3,300 private equity firms headquartered in the United States. A Reuters review of regulatory filings and interviews with people familiar with different firms’ practices show the calculation varies widely even among the top private equity firms. Blackstone Group LP, Carlyle Group LP and Bain Capital LLC, for example, do not include money that comes from general partners in average net IRR calculations, while Apollo Global Management LLC does, the review shows. Fund marketing documents are not public, but the sources said all these firms disclose to investors whether they include general partner capital in the calculation or not. The SEC’s review comes after the agency put together a dedicated group earlier this year to examine private equity and hedge funds that had to register with it as part of the 2010 Dodd-Frank financial reform law, Reuters first reported in April. Much of the SEC’s focus so far had been on fees that private equity funds charge. In a May 6 speech, Andrew J. Bowden, director of the SEC’s Office of Compliance Inspections and Examinations, said more than half of the private equity funds the agency examined had inappropriately allocated expenses and collected fees. COMPLEX CALCULATION The average net IRR figure is crucial to investors’ understanding of their actual profits from private equity funds. To continue reading this story, please visit peHUB.com. By Greg Roumeliotis

Changes in Investment Needs to think about

Melbourne Mercer report deems Danish pension system best in world

Denmark has retained the only “world-class” pension system, while the Netherlands has fallen to third place behind Australia, according to the latest Melbourne Mercer Global Pension Index.

New European entrants include Finland, which came fourth and claimed the highest-ever integrity rating of 91.1, while Austria and Italy ranked 17^th and 19^th, respectively, behind France and Poland, largely due to the each country’s pension sustainability ratings.

The Index, in its sixth year and written by David Knox of the Australian Centre for Financial Studies in Melbourne, assesses pension systems on the three broad categories of adequacy, sustainability and integrity.

Italy set a record for the lowest overall sustainability rating, which takes into account coverage, contribution levels, demography and government debt, with a score of 13.4 in the category, slightly behind Austria’s 18.9.

The worst sustainability score to date was achieved in 2013 by Brazil, when it scored 26, a rating that this year improved marginally to 26.2

The final new European entrant, Ireland, ranked joint 12^th overall, the same as Germany.

Ireland earned a score of 62.2, with a higher adequacy rating than neighbouring UK but ranking significantly behind on sustainability.

Score of European countries within Index
Country (Ranking)	Score
Denmark (1)	82.4
Netherlands (3)	79.2
Finland (4)	74.3
Switzerland (5)	73.9
Sweden (6)	73.4
UK (9)	67.6
Germany / Ireland (12)	62.2
France (14)	57.5
Poland (15)	56.4
Austria (17)	52.8
Italy (19)	49.6

Denmark saw its overall rating increase to 82.4 due to improvements across all three categories and increased its lead over both second-ranked Australia and the Netherlands, with scores of 79.9 and 79.2, respectively.

The report praised the Nordic country for improving protection of benefits in cases of fraud or provider insolvency, but noted that the better score had been influenced by several minor factors including a higher savings rate.

Australia, meanwhile, was congratulated on increasing the rate of the mandatory contribution to Superannuation funds from the current 9.5% to 12%.

However, the Australian government last month announced that the current rate would be maintained until 2021, with the increase to 12% now occurring by 2025 rather than the initially planned 2019.

The Netherlands, which saw its score increase by 0.9 points to 79.2 compared with 2013, was praised for changes to the conflicts of interest policy.

Top 10 Countries within Index
Country (2013 ranking)	Score
Denmark (1)	82.4
Australia (3)	79.9
Netherlands (2)	79.2
Finland (-)	74.3
Switzerland (4)	73.9
Sweden (5)	73.4
Canada (6)	69.1
Chile (8)	68.2
UK (9)	67.6
Singapore (7)	65.9

It is unclear if the research was already able to take account of the recent changes to the financial assessment framework (FTK).

Knox stressed the importance of communicating clearly and concisely with fund members, as the effectiveness of a system was undermined by lack of community trust.

He also said the increasing importance of private provision over state pension payments meant communication would be key.

“This shift means communication to members has never been more important or come under more scrutiny from members, regulators, employers, consumer groups, politicians and the media,” he said.

France and Germany both saw significant increases in their overall ratings, with France’s 4 point rise to 57.5 credited to an increase in the minimum level of pension.

Germany, which saw a slightly smaller score increase of 3.7, nevertheless saw its grade improve from a C to C+, as its score rose to 62.2 due to changes to the provision of annuities.

Ireland was told it could increase its score by introducing a minimum level of contributions to occupational pensions, a move that would be made possible through the Irish government’s potential auto-enrolment reforms.

Auto-enrolment, and the rising contribution rates, benefited the UK, which saw its score rise by 2 points to 67.6, resulting in its overtaking Singapore and remaining ninth, despite Finland’s entry into the Top 10.

Poland slipped behind France to 15^th after its score fell to 56.4 after declines in both its adequacy and sustainability ratings, while its integrity rating remained unchanged over 2013.

The report urged Poland to maintain a “significant” role for the country’s second pillar – months after the state transferred all of the second pillar’s domestic sovereign debt to the Social Insurance Institution (ZUS) – and to allow at least part of the private savings to be drawn down as an income stream.

Sweden retained its strong position in the Index, increasing its overall rating and only falling to sixth due to the addition of Finland, with Switzerland’s rating remaining constant and also falling one spot to fifth.