This article is sponsored by Apex Group
What will the fundraising environment look like for private equity in the year ahead?
Henk Pieter van Asselt: Investors normally look to allocate around 60 percent of their funds to public markets and 40 percent to private markets, but as public markets devalued this past year, that balance has shifted. From a risk management perspective, some investors are now in an undesired situation and so private equity firms will face fundraising headwinds as a result.
It is likely to be the mid-sized market that suffers most. Larger managers are unlikely to encounter problems raising capital and will probably increase fund sizes based on their previous track records.
There is a tremendous amount of dry powder in the hands of private equity firms and we expect there to be significant investment activity in 2023. Given speed to market, those funds that require special purpose vehicles to be set up need restructuring, or there is regulatory reporting to be done fast and efficiently. This is driving an uptick in demand for support from specialist service providers.
Georges Archibald: We are going to continue to see fundraising activity, but that is going to be dispersed across opportunity sets within closed-end investments, including infrastructure, buyouts, growth equity, real estate and private credit. Critically, the demand side of the equation continues to be quite high, so we are bullish on the closed-end segment, subject to various degrees of slowdown in those sub-segments as a result of cyclicality.
How are CFOs calling on service providers to assist with capital raising?
HPvA: From an EU perspective, we have seen the bigger funds leaning less on service providers for capital raising, while the mid-sized and smaller funds want more support. Apex Group has invested in a digital solution to support fundraising called Profilir, which connects LPs and GPs during the capital-raising process. We also acquired a company called Context365, which provides technology and events to connect alternative asset class investors with managers. In addition to this, we are seeing CFOs reaching out to providers for support with more traditional means of fundraising.
A lot of US funds coming to the EU need a European structure to invest into, and that is something service providers can set up. The US and the Cayman Islands are generally not the preferred jurisdictions for European investors, which tend to prefer to see structures in jurisdictions such as Luxembourg, the UK or Ireland. CFOs want to establish a proper foothold within a country like Luxembourg, and want assistance with an office, and the recruitment of non-executive directors, front-office staff and local partners.
GA: If you think about the stakeholders involved, they all want a degree of trust and transparency from their GP, and the GP in turn needs a fund service provider that can deliver. Importantly, that transparency needs to be part of the fundraising journey, so we partner with managers to ensure we give them a robust reporting and data package so that they can deliver for their current and prospective LPs.
How do you see investors engaging with managers to accelerate progress on DE&I? Are regulators driving the conversation?
GA: We are seeing more questions coming from LPs around topics such as the composition of boards, senior management teams and middle management. The challenge is to capture that data. We are increasingly seeing this form part of the LP engagement process.
We all want a more engaged model, and that requires more data. We are not only providing ESG data to managers as they look to invest themselves, but also so that they can take that data back to engage with their investors in a more transparent and meaningful way.
This is a great example of the regulatory environment and the private markets aligning. Everyone is rowing in the same direction to drive change, creating benefits not only by doing what is right but also by increasing investor returns.
HPvA: ESG and diversity, equity and inclusion are topics that are on the agenda for every LP and every regulator. We are helping GPs respond, and take another look at their current policies, presenting them with benchmarks for the industry and supporting them in remediating any gaps.
This is also something that we have been looking at as a business for some time. Peter Hughes, our chief executive and founder, is very much driving the ESG agenda throughout our organisation and we have really focused on diverse representation in senior levels of our business in the last few years.
What criteria are LPs now focusing on when weighing up prospective GPs?
HPvA: LPs continue to focus heavily on track record, fast and flawless execution of their demands, and the reputation of the firm. Investors have also realised they want to work with managers that have a healthy appetite for regulation and compliance.
“LPs continue to focus heavily on track record, fast and flawless execution of their demands, and the reputation of the firm”
Henk Pieter van Asselt
GA: Key here is how you differentiate yourself as a manager and the tools that are out there to help you do that with better scale and better processes. You need to think about the LP’s own constituency and what its investors want in terms of transparency and reporting. If that is important to the LP, then the GP needs to be aligned. The manager, as well as the providers it partners with, must have a good understanding of what is required by the stakeholders and what their priorities are.
A newer issue that is becoming very important for LPs is how funds deal with ESG, and this is another area where we are helping particularly US managers that are less familiar with the European market. Often, they need help complying with the regulations, so we have expanded our ESG ratings and advisory service as part of our single-source solution for clients.
Which geographical markets are currently attracting the most investor interest?
GA: The simple answer on geographies is: it depends. If you sit with a Brazilian onshore manager, they are looking at Luxembourg as a parallel structure, maybe the Channel Islands, and potentially Canada, Delaware or the Cayman Islands. Managers want to know more and understand the regulatory landscape, the benefits of having substance and the ability to create substance in each jurisdiction, and then be able to execute with the particular mechanisms that matter.
For us, the critical component is taking a thoughtful approach to understanding what the manager is looking for. That includes understanding the timeframe, the idiosyncrasies of particular jurisdictions, and most importantly how much each option will cost.
HPvA: When it comes to where LPs from the US invest their money in Europe, Luxembourg continues to attract the most interest. The UK is seen as a growing alternative to Luxembourg, but the combined elements of Luxembourg, including the tax regime, mean that it is still a more attractive hub that has now proven itself as a private equity centre of choice.
“You need to think about the LP’s own constituency and what its investors want in terms of transparency and reporting”
I expect Luxembourg will continue to thrive, with the UK picking up from a regulatory perspective. For the Cayman Islands, I would say the outlook is a bit gloomier – while US funds continue to use it, those with European investors are moving away. We will see the likes of Ireland, the Netherlands and Singapore gaining in popularity as the faster-growing jurisdictions.
When it comes to the entities below those funds, my view is that there are going to be fewer structures but more demands around those structures. There is now so much regulatory and compliance pressure on funds that sometimes the costs of running the structures outweigh the benefits. Over time, we will likely see more high-quality work for a smaller number of structures.
A lot of funds set up an SPV for each portfolio company, so they can end up dealing with 15 different service providers in 10 different countries. Service providers can offer fund administration services and set up SPVs in all these countries, and we are working with CFOs, legal and tax counsels to create international structures of entities to drive efficiencies around this.
What are the principal drivers pushing managers to use third-party providers, and what are they looking for in an outsourced solution?
HPvA: Managers want providers that can set up their operations and create efficiencies. Increasingly managers need SPVs and bank accounts too, so they are looking for providers that can deliver those efficiently in all the fast-growing markets. They want a global presence, multiple products and providers with established reputations across their three lines of defence on risk and compliance.
GA: The principal drivers are trust, transparency, guidance, strategy, value for money and unlocking scale. The new products on the horizon will be ones that can transform the way managers think about technology inside their businesses and deliver scale over the next three to five years. Managers are looking at what to do from a transformational perspective, like what we currently are seeing in the data environment. The focus will be on extending all the research and development that the fund service providers have developed into the client environments for their benefit.
Henk Pieter van Asselt is global head of corporate product and Georges Archibald is chief innovation officer and regional head of North America at Apex Group