Recent Developments in Global Private Investment Funds

Originally published in Israel Desks International Legal Guide 2018.
Co-authored by Mourant Partner Hayden Isbister, Clifford Chance Partner Michael Sabin and Senior Associate, Alex Chester.

Story of Two Markets

The past year has seen record breaking amounts of capital raised in global private fundraisings. Top fund managers with strong track records have been hugely successful, achieving premium terms and rapid fundraisings, often spending just a few months on the road and wrapping up in  "one and done" single closings.

However, behind this is a story of two markets. A number of prominent investors have become more selective about the managers they invest with and have been consolidating their relationships. This has meant that managers with weaker track records, or who are raising their first fund, are often struggling.

More Capital

Record amounts of capital have been directed towards investment in private funds. As public markets have risen, investors have had to commit greater amounts to private funds in order to balance their allocations. Existing fund investors are receiving steady flows of distributions from existing funds, which are being reinvested into new fundraisings, and the number of investors committing to private funds has grown. For example, family offices are increasing their exposure, smaller Asian investors are now seeking to deploy capital internationally and, based on recent press reports, a number of the largest sovereign pools of capital (e.g., sovereign wealth fund of Japan) are opening up to investments in private assets. Overall, this has translated to significantly more available capital for investment in private funds.

Expansion of Strategies

The range of strategies offered by private funds continues to grow. This phenomenon is primarily driven by existing managers expanding their businesses to offer new strategies rather than first time funds. For example, growth in credit funds has been particularly strong, driven by an ongoing demand for non-bank lending and the fact that they offer investors attractive risk-return profiles. In addition, we have seen greater use of existing platforms and relationships to expand to a new asset class may provide efficiencies and smooth start of a new business from the outset. Various managers have started offering longer-term lower-return funds (with average fund life in excess of 15 years vs. more typical 10 years in a private fund) alongside their main offerings and this has been particularly notable in the private equity and core real estate sectors.

Increased Sophistication

The private funds market has become increasingly sophisticated.

Co-Investments. Investor demand for co-investment alongside the main fund vehicles, and typically on a no-fee basis, has continued to rise, and managers have developed increasingly complex co-investment arrangements. This has resulted in the growth of formal co-investment frameworks and top-up funds.

Secondary Transactions. Fund restructuring is the type of transaction where sponsors reorganize an existing fund vehicle, provide a liquidity option to existing investors and inviting new potential investors to buy into mature assets. Almost non-existent 5-7 years ago, restructurings have become mainstream transactions. Meanwhile, the mainstream secondary market for limited partnerships stakes in existing funds has become increasingly mature, with specialized secondary funds taking a key role in creating exit options for existing investors, including through more complex transactions, such as tender offers.

Subscription Facilities. Credit facilities secured by investor capital commitments to funds continue to be attractive for managers in a low interest rate environment. Loans under these facilities are remaining outstanding for increasing periods of time, with some managers rolling loads for over twelve months. This is an area that has been subject to growing investor scrutiny, as investors are looking more closely at the benefits of managing capital calls through such facilities against concerns that managers could use fund facilities to improve their own economics.

Fund Terms. Increased demand from investors has put managers in a strong position when negotiating fund terms. "Early bird" discounts for investors have become less common and certain managers have been able to achieve improved terms, such as premium carried interest.

Expansion of strategies has also impacted fund terms. First, there is an increased willingness to enter into strategic relationships where investors commit across multiple funds, rather than single products, in exchange for consequently better terms. Second, provisions on exclusivity, allocation of investment opportunities and restrictions on raising successor funds have become more relaxed to accommodate the wider range of products offered by managers.

Regulations Stay. Following the financial crisis of 2008, the global private equity and investment management industries have become subject of a tide of rulations that requires the registration of almost all private equity managers with the U.S. Securities and Exchange Commission, restricts the ability of U.S. banks to sponsor private funds and imposes detailed registration requirements on the marketing of "alternative investment funds" (i.e.,private funds) in Europe. There has been little deregulation of these rules in the U.S. and the European marketing rules are also here to stay.

Leading Offshore Jurisdictions. The world's leading fund sponsors have been using sophisticated "offshore" financial centers, such as Jersey, Guernsey and the Cayman Islands, for the establishment of investment fund structures for a number of years. Jersey has developed a respected funds sector that offers a broad range of fund regimes, from regulated options through to the more sophisticated and institutional end of the market. The industry has a net asset value of 291 billion and has a total of 1,104 regulated collective investment funds established.

Guernsey is a leading location in which to conduct investment fund business, and in particular alternative investments, with its decades of experience in dealing with a variety of asset classes. It has also an excellent reputation with the development of more esoteric investments and a prominent international centre where innovative fund products can be successfully launched.

The Cayman Islands is one of the world's leading offshore jurisdictions for the establishment of private equity funds. The term "private equity fund" for Cayman Islands purposes commonly denotes a closed-ended, non-retail fund investing in illiquid assets and it covers a range of funds, including real estate funds, venture capital funds, infrastructure funds, credit opportunity and other debt funds, secondary funds and funds of funds.

The Cayman Islands is an attractive tax neutral jurisdiction and there is also a sophisticated and stable legal regime in place that is based on English common law principles. The local judicial system provides significant legal certainty to market participants and the Exempted Limited Partnership Law, the principle law applicable to private equity funds in the Cayman Islands, was overhauled in 2014 to make it more compatible with the Delaware limited partnership regime and to deal with other points relating to the private funds market. In addition, the Cayman Islands introduced a new limited liability company vehicle in 2016, which has been used as a general partner, joint venture and downstream investment vehicle, making the jurisdiction even more attractive for sponsors and their advisors around the globe. Together, these factors have led to considerable growth in private equity funds and related downstream deal work in the Cayman Islands.

Conclusions

The private fund market has seen two major trends over the past year. Firstly, top managers have been raising record amounts of capital, both quickly and on good terms. Secondly, the market has been increasing in sophistication, for example, in terms of co-investment, fund restructurings, secondaries and new strategies.

Since global private fund raising gives a clear advantage to size, Israeli private fund managers are only starting to enter the global market, in lockstep with the increasingly high importance of the Israeli economy to the world. Choosing the right fundraising strategy and working with the right financial and legal advisors is especially important for funds that have only limited experience working with international institutional investors.