The post-COVID slowdown in global capital raisings has driven a number of resourceful fund managers to embrace innovative financial strategies to shore up liquidity and strengthen the balance sheet.
The combination of high financing costs and slow fund inflows has prompted a wave of strategic alignments, with investors seeking to adjust their portfolios – whether to meet their own liabilities or upon completion of their fund’s term.
The timing presents a challenging yet manageable opportunity for fund managers navigating global macro-economic and geopolitical shifts.
GPs Facing Liquidity Constraints
According to the European Central Bank (ECB), at least 215 investments funds in the Euro area with net assets totalling €73,4 billion have temporarily paused redemptions between mid-February and end of March 2020. While most of these suspensions were brief, some funds took longer to adjust or were liquidated strategically.
Despite that, the requests for redemptions have continued. The ECB’s latest statistics show that gross redemptions (before the issuance of new shares or units) totalled €867 billion in the third quarter of 2023, with a continued elevated level of redemption activity carrying into this year.
The economic challenges have driven fund managers to adopt adaptive strategies to address cash flow constraints. Many have introduced temporary redemption limits to control outflows.
In some cases, fund managers offer investors distribution-in-kind, usually in the form of shares in an entity related to the management company. Others use borrowed capital for refinancing to fulfill investor payouts.
Use of Continuation Funds
Due to the complexities of the current market, some managers are exploring the use of continuation funds, as the prevailing conditions are less favourable for liquidating assets when a fund reaches the end of its term. However, investors are apprehensive regarding the way their fund’s portfolio is being assessed prior to its transfer into a new continuation fund.
Kumpulan Wang Persaraan (Diperbadankan) [KWAP], as an investor in global funds, has been closely monitoring and experiencing the evolving dynamics of the global funds management industry.
Exiting funds has become challenging post-COVID, particularly in the past 12 months, and has become a daily topic of discussion among investors who are facing delays in exiting funds.
“I see a lot of funds seeking to recoup the two years they lost during COVID – most LPs (limited partners or investors) have been – and still are – happy to give the managers extensions to allow them to wrap up a fund and generate liquidity for investors who want to exit,” says Muhammed Iskandar, Head of Portfolio Management, Private Equity at KWAP.
However, GPs are now starting to be more creative – at the expense of LPs.
“Exiting funds has become challenging post-COVID, particularly in the past 12 months, and has become a daily topic of discussion among investors who are facing delays in exiting funds. We understand the market stalled during those two years, so we gladly agreed to a fund extension to recover lost time,” he adds.
The fall-off in transactions has meant that more managers are considering rolling their funds over into a new vehicle, known as a continuation fund, to open a liquidity window for investors who must exit.
LP Concerns: Structure, Valuations & Discounts
Several transactions involving continuation vehicles have raised concerns, particularly regarding the independence of valuations and the discount rates applied. In some cases, the scheme is designed to take over the portfolio of an existing fund, yet the structure itself may be questionable.
Iskandar expresses strong reservations against selling a portfolio at a discount of more than 50 per cent of its book value, although he acknowledges that investors must accept a haircut in order to exit a fund. Ultimately, it comes down to fairness. “I would prefer to see a trade sale and a clean exit,” he states.
He further adds that LPs in PE funds are at a disadvantage because of the lack of price signals on the value of assets in private, unlisted markets.
“There have been instances where GPs have booked the transferred numbers (valuation of assets), but when we eventually exit the real returns are often lower than expected.” Iskandar explains.
There is a strong emphasis on having more transparency in the relationship between GPs and their LPs, who are often given “highly sanitised” information.
The relationship is built on both trust and commitment. Trust in the absence of commitment does not reflect on a true partnership.
“LPs must actively engage with GPs regarding any issues that arise. We appreciate a heads-up, as we don’t want surprises or things coming out of nowhere. The relationship between GPs and LPs is two-way; if there are problems requiring LP intervention, let us know – even if it’s not outlined in the LP agreement, as we’ve invested our capital,” he concludes.
The relationship is built on both trust and commitment. Trust in the absence of commitment does not reflect on a true partnership. Similarly, commitment without trust is equally concerning, especially since you have already committed to an investment but does not have enough trust in the manager.
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