Preferred equity issuance shot up during the worst of the pandemic. Fifty-six percent of buyers surveyed in investment bank Evercore’s H1 2020 Secondary Market report said they offered preferred equity during the period compared with 21 percent at the end of 2019, as secondaries firms aimed to take advantage of general partners’ need for liquidity to support struggling assets or make acquisitions brought about by the covid-19 crisis.
Getting those preferred equity deals across the line, however, remained challenging. Of the almost two-thirds of the 30 largest buyers who offered preferred equity solutions, only 33 percent closed on their transactions.
Some of the largest secondaries firms – notably Carlyle Group subsidiary AlpInvest Partners, Goldman Sachs Asset Management and HarbourVest Partners – got sucked into preferred equity because the conventional secondaries market was closed.
In July 2020, HarbourVest was reported to be in talks with Ottawa Avenue Private Capital, the family office of the DeVos family, to invest in a portfolio of LP stakes. The firm was looking to invest up to two-thirds of the total $1.5 billion it was aiming to deploy on a preferred equity basis.
In August the same year, Goldman invested $200 million in a preferred equity structure into a portfolio of five underlying investments managed by affiliates of Colony Credit Real Estate’s manager. The firm was anticipating a particular opportunity in preferred equity as GPs sought capital to strengthen their portfolios in light of covid-19, managing director and global head of private equity secondaries Harold Hope told affiliate title Secondaries Investor at the time.
Then, in September 2020, AlpInvest closed a $360 million multi-asset recapitalisation on Kinderhook Capital Fund III. The deal was structured during the crisis as a preferred equity deal that could turn back into a recapitalisation if economic conditions improved. Improve they did, and the preferred equity tranche was duly rolled into the continuation vehicle.
As the pandemic continued, participants wondered whether this model would remain attractive after markets rebounded and normal secondaries deals started again. After all, the risk/return profile of preferred deals is different to that of a secondaries fund, so there is a limit to how many such deals a typical secondaries fund can do.
The question was, will people raise dedicated funds for these deals? Now, the answer appears to be yes.
AlpInvest is set to extend its investment platform with the launch of a preferred equity fund, the Strategic Capital fund, Secondaries Investor reported in December. The fund, which is due to launch early this year, will focus on preferred equity, NAV-based lending and funding GP commitments, following the path forged by strategic capital deals the firm has already backed from a $1 billion pool of separately managed accounts.
It is not alone in focusing on the opportunity. In May, BC Partners appointed Tom Glover, who was head of North America fund finance at Investec, as operating adviser to help develop a GP and NAV-based lending strategy.
“Covid has undoubtedly brought NAV lending to the fore,” Doug Cruikshank, head of fund financing at Hark Capital, part of Aberdeen Standard Investments, told Private Equity International in February 2021. “But concentrated NAV is not the product of covid. This is a natural progression of liquidity provision across the life of a fund. I have no doubt that it is an enduring trend.”