The growing trend in secondaries trades via fund restructurings should be more popular with investors, writes Ashley Marks, director at CAPRA Global Partners.
Purchasing a portfolio of real estate assets via acquiring fund units or special purpose vehicles is not a new concept, though it is one that seems to be more prevalent over the past three years as a proportion of the funds that were (relatively easily) raised between 2006 to 2009 reach a fork in the road: extend or wind up.
It is these expiries which are increasingly creating opportunities for different types of buyers that traditionally would not be competing against each other, namely indirect buyers like pensions or insurers, secondaries specialists and other fund managers.
A fund restructure can be defined as a major change in its investor base, manager or terms, and there are typically up to four groups involved: existing and new investor(s), the existing fund manager and sometimes a replacement fund manager.
Incumbent investors in a fund can see a restructure as an opportunity to exit quickly and efficiently (six months versus two to three years for a typical wind-up), while new capital often finds a fully seeded portfolio as an exciting prospect, albeit one delivered in an uncommon process. Managers with funds nearing expiry, however, view a restructure in different ways. For some, it is an opportunity to retain the management of the vehicle for several more years. For others, it is a method of achieving the objectives of their investors.
Perhaps the ideal reason for a manager attempting a restructure and to remain is because the assets may have moved down the risk curve, from a more opportunistic strategy to core, meaning the fund needs repositioning.
There are many other justifiable reasons why an incumbent manager would pursue a restructure; not least that although the manager may have been in place for the past seven years, it might not employ the same individuals. These new individuals may want to draw a line in the sand, essentially hitting the reset button on the fund to ensure alignment with the investors.
The tightrope that a manager must walk when entertaining a restructure typically revolves around balancing the interests of their investors and their own. This is not always a simple process, especially for smaller fund managers with few funds under management (both in terms of assets under management and total number of funds). Those with less to lose (for example those with little difficulty in raising additional capital) will find it easier to put their investors first.
However, investors are a little like elephants: they never forget. Indeed, there are some cases where investors have sworn to never recommit to a manager due to the way the manager has approached its intent to retain control of assets, so self-preservation can be a false economy. Managers who successfully navigate conflicts of interests are often the ones that investors will be more attracted to for the next fund.
Invariably, whether a restructure is attempted or completed, the focus will center on pricing and the nature of the assets will be central to this. The other highly relevant ingredient will be the nature of the purchaser; be it a pension fund, a fund manager or a private equity or secondaries market specialist. The investors with typically the lowest cost of capital tend to be the ones least equipped to underwrite a fund restructure.
I was fortunate to be involved with a German retail fund restructure earlier this year. Despite several typically indirect investors confirming their interest to recapitalise the fund and retain the well-regarded manager, one by one they fell away from the process. This was due to insufficient resources, a lack of expertise and inflexible deal requirements.
Eventually, a fund manager saw the opportunity, packaged the deal appropriately and leveraged their relationship with one of their own pension fund clients to take over the entire vehicle; both the equity and management. The deal happened at a significant premium to the prevailing net asset value – albeit lower than what the related agents were anticipating. The existing investors were delighted to exit and at what they considered to be an attractive price rather than waiting for another two years as the manager sold assets one by one.
One important observation to take away from the experience was that the investor and manager were underwriting the opportunity at core-plus returns. The more opportunistic secondaries market specialists and private equity fund managers, on the other hand, were closer to opportunistic levels and could not compete with the end purchaser due to their lower cost of capital. It begged the question: why are there not more investors pursuing this as an investment route to assets?
This story first appeared in sister publication PERE‘s secondaries supplement.