Secondaries transactions are becoming increasingly complex and no two deals are the same. One of the most significant themes to emerge from Investec’s 2018 Secondaries and Fund of Funds Debt Seminar in London, was that financing solutions are becoming increasingly sophisticated to meet the needs of this evolving market.
Complex, GP-led deals, in particular, are on the rise. According to the pre-event survey, these transactions represented less than a third of secondaries activity last year. In 2018 that has grown significantly.
Guest speaker, Francesca Paveri Fontana, director at Evercore, also expects GP-led deals to represent an unprecedented share of record-breaking deal flow this year. “We expect deal value to hit $60bn, driven by the amount of capital out there,” she told guests at the seminar.
“The big trend is GP-led transactions. We are now seeing brand-name GPs entertain these solutions, which is bringing larger deals to market.”
The use of more sophisticated financing tools has increased sharply as a result. The survey found the uptake of capital call facilities remains steady at around 75 per cent and there has also been little movement on asset-backed lending. But the use of hybrid structures has doubled to 20 per cent from last year.
“It is interesting to see how the products we provide in each of these areas has evolved,” said Investec’s Global Head of Fund Finance Simon Hamilton. “We have moved from plain vanilla facilities to highly complex and tailor-made products, using existing solutions in ever-smarter ways.”
A pick ‘n’ mix approach: how fund finance is evolving
The pre-event survey conducted by Investec in the 3 months leading up to the conference, showed that returns expectations in the secondaries industry are falling, from 17.6 per cent last year to just 14 per cent. Given that pressure, it is more important than ever to implement bespoke financing facilities to enhance returns on a risk-adjusted basis.
Hamilton likened today’s fund financing market to a pick ‘n’ mix sweet shop, where managers can construct a bespoke solution, by choosing those elements that best fit their needs. And it is clear that a hybrid approach has become the popular choice.
“When it comes to GP-led deals, the majority of financing we've put in place has involved a hybrid structure,” said Investec’s Ian Wiese.
“When you're dealing with concentrated assets, you need a hybrid structure to justify the economics.”
But innovation in fund finance does not stop there. Investec is currently working with the fund of funds and secondaries communities to develop a number of new financing tools.
“Fund Unitranche Capital is a blend of preferred equity and asset-backed capital. This blended risk capital allows for a higher LTV, with more flexibility than debt but at a lower cost than equity.
The second area of innovation discussed at the seminar was the management fee swap.
Management fees continue to be a major point of contention for limited partners (LPs). This new solution allows LPs to swap the cost of the management fee for a share in the upside of that fund position.
“The underlying GP is agnostic to this trade. For them, the economics are the same,” explained Investec’s Matt Hansford. “The LP gets J-curve mitigation and only has a cost if the fund performs.”
In a market that never stands still, new uses for the nascent management fee swap are already being discussed. Some secondaries players have suggested it could be utilised as a fundraising tool. It could also potentially remove premiums in secondaries deals.
“The premium can be problematic because of the immediate J-curve hit,” said Hansford. “But if the fixed cost of that premium could be exchanged for a share of the upside that could be really attractive.”
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