Ainun Ayub, BBH’s head of alternatives in Europe, recently spoke at the annual Private Equity Europe Forum in London. The forum brought together more than 300 investors, private equity managers, and advisers to discuss the issues, obstacles, and emerging trends in the European alternative asset space. While many of the themes discussed have been mainstays in alts discourse for some time – portfolio liquidity, regulation, reporting — several new trends are emerging that should be on alternative market participants’ radar.
Here, Ainun shares a few themes that stood out.
Bridge loans on the rise. European private equity (PE) managers are more frequently using bridge loan facilities to fund investments and cover operating expenses. Here’s how it works: an asset manager would typically ask limited partners (LPs) for a drawdown of cash when they need financing for a new portfolio investment, as and when those deals are struck. By drawing on a bridge loan, asset managers can set a recurring investor drawdown schedule – often quarterly – and use the bridge loan to fund new portfolio investments or fund expenses until the full drawdown is collected on the allotted schedule. This can be a major boon to LPs, who may appreciate having a set capital disbursement schedule rather than “on demand.”
However, investors are on alert for the overuse of bridge financing; in an intensely competitive deal hunting environment, the temptation is great for some asset managers to use bridge loans to sneak in portfolio leverage to boost returns.
Asset owner ‘in-sourcing’ gains steam in UK. Some institutional asset owners that would typically outsource investment management are managing portions of their own portfolios in part to cut costs, and in part to accelerate the deployment of allocations to alternatives. We’ve observed groups of UK local and regional pension funds entering the fray by formally pooling assets and operational resources to create and manage their own private equity fund-of-fund vehicles. Internal management of certain slices of their broader portfolio (like their PE fund-of-fund allocation) can present cost savings opportunities through the simple elimination of a level of fees and sharing of operational costs. In-house fund management talent can be expensive. So far, however, fund sizes for these UK in-sourced fund-of-funds typically exceed £1 billion – and with annual captive contributions in the hundreds of millions from the pool of pension funds banding together, it stands to reason that we may see this trend continue.
Middle market top of mind. Middle-market funds continue to command the lion’s share of focus for European-based asset owners, for exposure to investments in small to medium sized enterprises that form the backbone of economic growth. Well-known asset managers with durable track records remain highly coveted for their ability to provide returns and recycle investment cash into new fund launches. As a result, fund sizes for these managers are trending larger and often over-subscribed, and for smaller asset owners, pooling assets may be necessary to access these highly sought-after managers.
Commingling in the co-investment space. Direct and co-investments by LPs has boomed in recent years, with large pension funds and insurance companies setting up in-house teams to source, filter, and execute on these deals, over and above fund investments. High net worth (HNW) and family offices have taken note, with many expressing desire to average down costs by investing directly. One problem: HNW and family offices typically do not have the bandwidth – experience, headcount, incentives – to properly vet and execute on co-investing opportunities. With these limitations in mind, a group of 20 HNW and family offices are banding together to support a global digital platform to access co-investing opportunities. The aim is to have a centralized network to source, conduct due diligence, develop relationships, and pursue global co-investment opportunities.
Heightened focus on Asia. In an increasingly competitive (some may say saturated) deal hunting environment in the US and Europe, many of the largest PE managers have shifted attention to Asia. In fact, deal making in Asia is tracking at near record levels with $34 billion in Asia deals in just the first five months of 2018.1 The growth appears to be two-fold: Global PE managers that were investing into Asia via satellite positions in their global funds are now setting up Asia-specific funds solely dedicated to Asia investments. Meanwhile, homegrown Asian PE shops have been able to raise larger funds as investors in Asia grow more comfortable with illiquid assets.2 And with these large players in the market effectively doubling down on their commitment to the region, we’ll likely see a lot more deal action in the years to come.
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© Brown Brothers Harriman & Co. 2018. All rights reserved. IS-04388-2018-10-09
2 McKinsey: Asian private equity: Defying expectations