13 minute read
funds trends
As change grips the financial world, the future of funds is not immune to progress. So what’s hot and what’s not in the funds world, where is investor interest headed – and what does it mean for Jersey and Guernsey?
The future of funds
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Words:
David Burrows
THE FUNDS ARENA has seen some notable trends in recent times, not least the global appetite for access to alternative assets, which continues at pace.
In the Channel Islands, there has been a huge increase in the net asset value of funds focused on private equity and venture capital in the past five years. Figures recently published by Jersey Finance show that in Jersey alone there has been a 249% increase. Guernsey is seeing growing interest, too.
Malcolm Macleod, Head of Funds and Institutional, Jersey, at IQ-EQ, explains: “This demand is not only from institutional investors, but increasingly from highnet-worth individuals (HNWIs) and family offices, who are diversifying their asset allocation away from traditional investments towards alternative assets.
“While some HNWIs and family offices choose to invest directly, most prefer to use a private fund structure in order to access talented asset managers with strong track records in high-quality deal origination.”
Mike Johnson, Chair of the Jersey Funds Association and Group Head of Institutional Services at Crestbridge, takes a similar view.
“Undoubtedly, the upward trend for investors globally to allocate to alternative asset classes is a sustained one, with Preqin forecasting total global alternative assets topping £17trn by 2025, up from just under $11trn in 2020,” he says.
“That trend has been mirrored in Jersey, with the total value of funds serviced in Jersey growing by a fifth over 2021, driven by a rise in alternatives – predominantly private equity and venture capital.”
Indeed, Preqin analysis – which offers an in-depth breakdown of trends across the sector – supports the view that the private infrastructure asset class is experiencing an ongoing fundraising furore.
Infrastructure fundraising has maintained an unprecedented pace, according to its analysis, with as much capital raised in the first six months as one would expect in a record year.
But deployment is what matters, and with large deals falling over due to overpricing, Preqin says the deals market needs to find an equilibrium for the recent raft of mega funds to get capital to work.
For venture capital, Preqin suggests activity in the industry is holding up comparatively well, but it remains to be seen how much of that was already in the pipeline. It forecasts slower deal activity going forward as the market begins to adjust to lower valuations.
The Russian invasion of Ukraine and the ensuing sanctions on Russia have left a massive gap in global commodities markets, particularly energy. Preqin reveals that, against this backdrop, natural resources funds raised $51bn in Q2 2022, almost $20bn higher than in Q2 2021.
The latest performance data shows stellar returns for the asset class. However, given that this is geopolitically driven, such performance may not represent a long-term trend.
EYE ON THE FUTURE
Looking forward, Johnson argues that economic recovery around the world is going to need significant amounts of private capital to support business and infrastructure growth. He believes Jersey is well placed to support that in terms of expertise, experience and structures.
Macleod believes debt funds will also become more popular in this high inflationary environment.
“Rising prices, supply challenges and an excess of cash in the economy driven by pent-up consumer demand during the Covid-19 pandemic have all contributed to rising inflation. In response, interest rates are increasing globally,” he says.
These macroeconomic factors are influencing asset allocations, he explains. “Although private equity continues to drive growth, some investors could be
tempted away from potentially volatile PE investments or fixed-rate bond investments, which could leave them out of the money as interest rates continue to rise.
“Instead, they are favouring debt funds, where returns are linked to floating rate loans within the funds’ portfolios, which can generate increased income as interest rates increase.”
Johnson also believes that hybrid funds will significantly increase in popularity, with the turbulent macroeconomic environment and rising interest rates also driving their appeal.
“These are private investment vehicles that have attributes of both hedge and PE funds – thus offering investors the diversification that comes with exposure to public and private markets, with the flexibility to invest in a range of assets and deliver various liquidity options,” he adds.
Fund managers are turning to hybrid funds as a way to innovate and offer sophisticated investors a greater degree of choice, flexibility and returns, according to Macleod.
Meanwhile, a wider range of investors are showing interest in hybrid funds as they seek access to the higher risk-adjusted ▼
Fund managers are turning to hybrid funds to innovate and offer sophisticated investors greater choice
returns generated by private market assets. According to data from Preqin, tech companies have accounted for more than half of the total public-to-private deal value in the past 18 months.
Top of the shopping list have been business-to-business software companies Citrix, Anaplan and Zendesk.
Alex Henderson, LP Partner at Mourant, agrees that technology as an asset class is flourishing. “We are not just talking about pure software companies, but any portfolio company operating in an industry that can use technology to become more efficient.”
So is technology almost a defensive play now? “Yes and no,” responds Henderson. “Market conditions have made it harder for companies to create value, and private equity firms have perhaps moved away from the traditional model of cutting costs to be more efficient.
“Technology can actually create significant value in numerous sectors, so there are good opportunities there.”
Henderson echoes Macleod’s point and he notes that larger institutional investors have exposure to both public and private markets.
“It’s not an either/or option for institutional investors; private capital exposure forms part of their diversified portfolio,” he explains. “Private markets offer an opportunity for strong returns but also some protection from the market volatility that can accompany listed investments, so can’t be ignored by those managing a large portfolio.”
There is a more challenging listing climate right now but, as Henderson explains, when public markets struggle, there is an opportunity for companies to be identified as undervalued, attract PE interest and go private again. Essentially, the markets can feed off each other.
Ross Youngs, Group Commercial Director at Belasko, also sees opportunities for private capital on a turnaround agenda. “When I talk to special situations managers, they tell me that market volatility and geopolitical uncertainty is creating stress within corporates,” he says.
“There are opportunities for private equity to come in and support these companies. I think 2022/23 will be quite an interesting year for new capital raising.”
Youngs says venture capital in tech has been super-strong over the past few years but, unlike Henderson, he sees things cooling off a little.
“Tech is at a crossroads now – it has certainly been hot, but I believe we are in a change period,” he says.
Youngs sees cryptocurrency as an interesting proposition. “I think exchangetraded funds are a safer entry into crypto – and there are still a lot of people supporting this space.”
SPACS COOL-OFF
As to what is definitely not hot right now, Youngs picks out special-purpose acquisition companies (SPACs), which he says have suffered a massive uphill battle on recent valuations.
The SPAC boom was fuelled by an extended period of low interest rates, which drove investors to riskier areas of the market to seek higher returns. Last year, the SPACs market was flying, but the economic landscape has changed since.
The real estate market will continue to attract investor interest, according to Henderson, although this interest might come from different sources.
He stresses that while the residential market for homebuyers is a different matter altogether, commercial property and specific prime-location investing will likely see good business volumes.
“Even if interest rates continue rising and suppress some demand, overseas investors with a long-term investment horizon might see lower valuations as a good opportunity rather than a cause for concern, particularly if exchange rates are in their favour,” he explains.
Henderson adds that there will likely be an increased focus from property fund managers on specific investments in the sector, such as data centres and large warehousing facilities.
JURISDICTION OF CHOICE
Looking at jurisdictions rather than products, Johnson explains why the Channel Islands continue to have such strong appeal.
“The combined appeal of stability, certainty, experience and premium service quality have all combined to create a really compelling proposition for managers and investors,” he says.
“It’s about being entirely comfortable with domicile choice – and there’s no doubt that Jersey offers the reliability and peace of mind that managers and investors want.
It’s about familiarity too, Johnson argues. “Once managers have established their first funds in Jersey and they have been a success, we’re seeing them come back for second, third and multiple fund launches, and that sort of confidence seeps out across the industry. It’s a reputational dividend.”
But he adds that it’s also about staying relevant and innovative – and the Jersey Private Fund (JPF) is a great example of that, he says.
“This year marks the fifth anniversary since the JPF was launched as a structure for limited numbers of sophisticated investors,” he says. “Since then, it’s grown to become really the vehicle of choice for institutional investors and a great vehicle for co-investment among family offices.
“It’s a fantastic example of Jersey showing innovation to meet a very real demand in the market.”
Meanwhile, Johnson adds, the incentive is to maintain that approach in the ESG sphere, with Jersey Finance launching its sustainable finance strategy last year and the Jersey Financial Services Commission introducing new codes of conduct around disclosure and reporting to combat greenwashing.
“It’s a clear indication of the islands’ intent in the growing ESG space,” he concludes. n
Period of uncertainties and reflections on debt instruments
Belal Al Bonni, Senior Manager in Audit & Assurance at Deloitte Guernsey, takes a look at how debt managers are responding to a period of uncertainties – and the implications for investors
THE WORLD IS experiencing a sharp increase in inflation rates, with Covidrelated supply shortages and the turmoil of the energy market being cited as two key contributors to the rises.
Monetary policies have been tightened across the world, and the collateralised loan obligation (CLO) market, as well as the stock market, have witnessed a deterioration in prices over the past several months.
So are we experiencing ‘the period of uncertainties’?
The mantra in financial markets for the past 40 years has been ‘don’t fight the Fed’. Currently, the US market is experiencing the biggest interest rate rise in almost 30 years; Australia, India and many other countries have similar instances of rising interest rates; and the European Central Bank is not immune.
On 22 June, the Bank of England stated: “Since December 2021, we’ve increased our key interest rate, Bank Rate, from 0.1% to 1.25%.” So is the ‘easy money’ period coming to end?
HOW HAS THE DEBT MARKET RESPONDED TO THESE UNCERTAINTIES?
The debt market continued to perform strongly in the post-Covid-19 recovery period – during the fourth quarter of 2021 through to early February 2022, when these uncertainties started to crystallise.
The European corporate bond market had a strong performance during 2021, with 1,322 deals being closed with an aggregate value of more than €800bn.
This was also the theme for January 2022, when fundraising exceeded the same month in 2021.
However, in February 2022 there was a significant drop in fundraising activities, followed by a swift rebound post-February, with a shift in the type of debt instruments from high-yield to investment grade as a short-term response to the uncertainties.
The private debt sector had a similar experience, with very strong fundraising activities during 2021. Like the bond market, there was a deterioration on fundraising activities during the first quarter of 2022.
However, Preqin predicts that private debt assets under management will rise to $2.69trn by 2026, achieving a compound annual growth rate of 17.4%. This would make private debt the fastest growing asset in private capital.
HOW HAVE DEBT MANAGERS RESPONDED TO SUCH UNCERTAINTIES?
During a rising interest rate environment, savings products such as high-yield savings accounts or certificates of deposit might look more attractive to risk-neutral and risk-averse investors.
In contrast, investors seeking more risk/ return would require higher returns to compensate for the level of risk taken on top of maintaining the real value of their investments.
As witnessed in European corporate bond market activities, there was a shift in fundraising activities during the current period toward investment grade bonds and less on the high-yield bonds.
But will this shift be for the short term or the longer term?
Inflation is most damaging to the value of fixed rate debt instruments because it devalues interest rate payments as well as repayments of the principal. If inflation exceeds the interest rate, lenders are losing money in real terms.
Looking back to historical information and comparable inflationary periods, most of the outperforming risk-averse asset managers and hedge funds avoided investing in fixed income instruments during such periods. On the flip side, fixed income instruments were the favourite of risk-seeking managers, who invested in high-yield instruments, including distressed debts, to compensate for the underlying risk as well as the nominal inflation rate.
Preqin predicts that private debt assets under management will rise to $2.69trn by 2026 – making it the fastest growing asset in private capital
IMPLICATIONS FROM AN ACCOUNTING PERSPECTIVE
• Debt instruments at amortised cost:
In a rising interest rate environment, it is more likely for debt instruments to be held to maturity rather than being prepaid/ refinanced by borrowers.
This might not be consistent with the forecast cash flows’ timing when the instrument was originated – which could lead to changes in the amortised cost value because standards require these to be dealt with prospectively as a change in estimate.
Higher interest rates also affect impairment reviews of debt instruments. There will likely be an increase in the probability of default, as well as the discount rate in determining the exposure at default and the loss given default.
• Debt instruments at fair value:
Generally, the fair value of a debt instrument is determined by discounting future cash flows that are expected to be received from the instrument by the relevant market yield to maturity.
The market interest rate is one of the key factors in determining the market yield to maturity. Generally, increasing the interest rate will increase the market yield to maturity and ultimately decrease the fair value of the debt instrument.
On floating rate debt instruments, future cash flows are updated to reflect the changes in interest rates similar to the change in the market yield to maturity and, as such, the fair value is expected to be at or close to the principal amount.
However, on fixed rate instruments, future cash flows are not expected to change, with an increase in the related discount rate to reflect the market changes that will usually lead to a decrease in the fair value of the instrument. n
DELOITTE’S DEBT FUND SERVICES
Deloitte’s Debt Fund Services team spans audit, advisory and tax experts in the Channel Islands, the Isle of Man, Gibraltar and Deloitte’s NSE network.
Deloitte is the winner of the 2019, 2020 and 2021 Alt Credit European Awards for Best Audit Service.
The award-winning team has developed a level of competency, experience and expertise which is unique in the financial services market, and our client experience and technical knowledge of all debt asset types means we can deliver an expert and insightful audit.
Deloitte’s market-leading reputation is grounded in marquee debt sector clients including LSE and TISE listed debt funds.
