The financial impact of recent lockdowns and subsequent economic upheaval has been well documented and current inflationary pressures and recessionary fears cast shadows across the wider financial world. As longer term investors will tell you though, some of the greatest opportunities arise in times of uncertainty or market dislocation. For emerging managers this may prove to be that exact point in time.
Although it may seem incongruous, uncertainty often represents fertile ground for managers, and a review of the larger macro picture hints at this. Fundraising in 2021 and into the start of 2022 benefited from initial lockdowns with overall fund sizes increasing in both the private equity and private credit sectors. Not only staggering in size, these commitments also demonstrate investor appetite.
While market sentiment remains high and the push for further democratisation of the markets continues, many LPs are apparently running up against their own manager exposure limits. With most, if not all, of the established market participants having completed their flagship fundraises LPs may need to diversify their portfolios from a relationship perspective with additional capital earmarked for new firms.
Appetite for specialisation in certain distinct sectors also appears to be increasing with acquisition processes resulting in specialist managers gaining the upper hand providing more specific and attractive options. Larger established managers have launched more sector-focused funds, which broadens the scope of target companies rather than being restricted to larger cap deals. In addition to sector specialisation there are also signs that local knowledge and access is becoming key. With opportunities becoming more competitive, knowing the local market may well be beneficial to the manager and thus investors.
One of the great drivers for the emergence of new managers, of course, is regulatory change. The UK government has been extremely vocal about encouraging growth through private markets and open to private investment. Although proposed legislation does not create the self-regulating freedom that some may have expected, the introduction of certain elements such as Qualifying Asset Holding Companies offer up potential tax incentives for UK structures and, potentially, UK managers. The Long-Term Asset Fund structure, mirroring the European Long-Term Investment Fund in many regards, may also provide optionality for new managers to differentiate from existing offerings, albeit take up of these structures appears to be slow.
Proposed changes to Solvency II may also encourage new managers should the envisioned loosening of restrictions result in insurers seeking new investment opportunities. As noted above, many established managers have undergone fundraising recently and with investment periods locked in, LPs may be reluctant granting approval for additional raises. This, like opening private markets to retail investors, will likely necessitate additional investment vehicles from managers more minded to these types of investors.
Over the past few years the costs, timing and uncertainty of regulatory licencing and the subsequent on-going compliance burden, has led to a raft of emerging firms sacrificing independence for the speed to market and the efficiency found by leveraging the licence of a regulatory hosting platform. Platforms with strong governance, appropriate resources and effective risk management provide a valuable service but anticipated tightening of this regime may well encourage some managers to consider the direct licensing route.
The hosting sector is braced for greater accountability, increased regulatory reporting, potential business limitations and stringent monitoring of its clients. Some of the resulting burden and bureaucracy will necessarily be pushed down to hosted firms making the solution, for some, less attractive. Going it alone may then not seem so burdensome.
History shows us that the emergence of new managers is cyclical and whilst there is no one specific indication that a stream of new managers are about to burst onto the scene the aforementioned factors may indicate the start of a new cycle.
As reporting requirements become more onerous, and ESG considerations further entrenched, newer, flexible, smaller and entrepreneurial managers may be the greatest beneficiaries of this uncertain market.
Adam Palmer is a partner at governance consultancy ACA Group responsible for leading the UK Regulatory Consulting division in London. He manages a team of consultants providing Financial Conduct Authority and US Securities and Exchange Commission compliance support to UK-regulated companies. Andrew Poole is a director in the UK Regulatory Consulting division with governance consultancy ACA Group. He provides FCA compliance support and consulting services to a portfolio of clients, focusing primarily across on the private markets.