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Fund finance - what will be key for GPs in 2021?
Jon Harvey from the Investec Fund Solutions team predicts what the key trends for 2021 will be for the fund finance and private equity space. He also analyses the key developments from 2020 and how they will impact funds going forward.
2020: Aligning with a changing society
Climate change, diversity and inclusion were huge parts of 2020 with movements changing the way society viewed these important issues. In 2020, investors committed four times the amount of environmental, social and governance (ESG) focussed funds compared to 2019, demonstrating investor’s appetite for ESG.
The Fund Finance market took note and developed ESG facilities. General partners (GPs) and their limited partners (LPs) liked the ability of a vanilla credit facility to help generate more economic benefits for their own ESG efforts. Get set for this to continue and GPs to be creative around how they tap into ESG facilities.
2021: Diversifying funding sources
Pitchbook forecasts a record $330bn of fundraising in 2021 in US private equity (PE) alone which is a c.4% increase on the previous high in 2019. A 4% increase in global PE fundraising capital in 2021 makes for a whopping $2tn+ of PE fundraising across the last four years. Capital call facilities needed in PE will likely be >$120bn on the 2021 vintage and when added to the prior three years (the period over which these facilities are most heavily used) this makes for <$450bn of credit lines! The strong performance of these facilities across a difficult 2020 backdrop, allied with the development of dedicated rating models, will attract institutional capital such as insurance and pension funds. GPs will see this as a way for growing more capacity for well-used lines across an ever-expanding platform of funds.
Sources: Prequin and Pitchbook
General partners and their limited partners liked the ability of a vanilla credit facility to help generate more economic benefits for their own ESG efforts. Get set for this to continue and GPs to be creative around how they tap into ESG facilities.
2020: GP led leads the rebound
GP-led processes drove a swift rebound in secondary deal flow in Q4. Financing has become a key component in these deals given the complex dynamics at play. Facility uses have varied from acquisition financing to follow on capital to bridging across a low money multiple position in the portfolio.
2021: Make sure the solution fits!
Creativity in the secondary market is increasing rapidly. Advisors and GPs alike continue to find innovative ways to put capital to work. Financing solutions need to keep apace and lenders will be asked for a range of different options for different portfolios and situations. From a first out tranche in a structured liquidity solution to a follow on capital call facility for a GP led secondary to a NAV financing on a secondary credit portfolio – these bespoke solutions will require flexibility, collaboration and experience. The Saville Row tailor vs the off the peg.
Financing solutions need to keep apace and lenders will be asked for a range of different options for different portfolios and situations. The Saville Row Tailor vs the off the peg.
2020: Acceleration of education and acceptance
The need for Covid liquidity showed the importance of NAV financing in the GPs toolkit. All NAV providers saw huge increases in deal flow and this accelerated the education of GPs and also, crucially, LPs. The multipurpose use of NAV lines and their ability to use in conjunction with subscription lines, to optimise the financing package, proved attractive to GPs. Lenders listened closely to the challenges of putting these lines in place and worked with GPs to create facilities that provided less friction and were more palatable to GPs and their LPs. Controls and covenant structures were the recipients of this development and helped fill the gap between NAV and preferred equity.
2021: Mainstream GP and fund tool
As we have seen with both GP-led secondary liquidity and the rise of subscription facilities, NAV financing is expected to become an established and understood tool for GPs. 2021 is set to see further growth in these facilities as they help provide both an alternative to portfolio asset recaps and a source of capital to fund exciting bolt-on opportunities. LPs and GPs in tandem will create a more clear control system to provide clarity and comfort around the use of these facilities and we will begin to see the growth of returns of those funds who have used NAV financing.
2020: Accessing inbuilt value
In a year when capital has been locked up due to Covid-19, GPs have tapped GP financing to generate their own liquidity. In many cases, the tumultuous environment has led to uncertainties around portfolio distributions and so financing has been used to counter that – an insurance policy if you will.
2021: An increasing set of options
The development of the fund financing market in other areas has provided a GP with more ways to access capital. With a forecasted record fundraising year of $330bn across PE, this range of options will be important as GPs look to capitalise on the opportunity coming out of the Covid crisis. Traditional GP financing will be supplemented by NAV financing, preferred equity, secondary and GP stake equity. Sophisticated private banks will also play a role.
GPs will then be able to pivot across different options depending on preference or situation. For example, do they sell an equity stake or rather use a credit facility? Do they attach the financing facility to the management company or a successful funds carry? Which is the optimum setup; a flexible facility borrowed by the GP or a Private Banking personal program where loans are made to individuals? Each has its merits depending on the situation and the flexibility needed. The most squeezed mid-market will be the biggest beneficiaries as many of these options have historically been focussed on large-cap managers. What’s for sure is that GPs recognise the value in their business, want to grow that and so a more flexible toolkit is a welcome addition.
Fund and GP Hedging
2020: Risk management back on the agenda
The Covid pandemic, Brexit speculation and US election have all contributed to big swings in FX markets, impacting funds that have foreign currency investors or those who invest internationally – GBPUSD has seen a 19% shift, EURUSD 15%. The convergence of interest rates across the UK, Europe and the US has also meant that the forward point ‘cost’ of hedging certain currency pairs has been greatly reduced. These two factors have led to GPs either increasing their levels of FX cover or putting in place a hedging strategy for the first time ever. As we moved into Q2, retaining liquidity was a key concern so managers sought out banking counterparties that could help them hedge on an uncollateralised basis, taking the pressure off LP capital and existing debt facilities.
2021: Added convenience for LPs
We’re seeing more GPs investigate share class hedging which aims to significantly reduce the FX exposure from the invested currency (LP capital) to the base currency of the fund – the added convenience of dealing in different currencies at a feeder fund / parallel fund can help managers attract a more diversified and, ultimately larger, investor base. Uncollateralised hedging will remain central to any FX strategy so that capital is used in the most efficient way possible.
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