Securitisation: opening up private equity

Singaporean state-owned investment firm Temasek’s issuance of $510m in private equity-backed bonds allowed the firm to extract liquidity from its portfolio through a partial sale, similar to a secondaries deal. PJT Partners/Park Hill’s Larry Thuet and Pablo Caló recently spoke to Secondaries Investor about how collateralised fund obligations can open up private equity to a wider investor base and how insurance firms can use the tool to reduce their risk-weighted asset exposure.

Are we seeing more appetite for deals like Temasek’s recent bond issuance?

Thuet: There’s definitely market interest in these deals. The press coverage has sparked interest among holders of private equity and new investors in the asset class.  Strong demand for the notes proves that private equity provides a quality cashflow stream to securitise.

Various owners of private equity fund interests are natural sponsors of collateralised fund obligations (CFOs), but for many others they can provide an alternative to plain vanilla leverage or the means to make their balance sheets more efficient from both a return and a regulatory capital standpoint.

Why is securitisation something the industry should pay attention to?

Caló: A securitisation in essence is tranching the cashflows of a diversified portfolio of any sort of assets. What this does for private equity is that it enables a diverse set of investors to participate over time and across a broad selection of risk-return profiles and tenors.

It adds new capital to the industry, simplifies the securities the investors can hold (in the case of note holders) as opposed to having to become a limited partner in a fund.  Furthermore, it provides liquidity to investors in case they want to sell such notes which can be freely tradeable, in contrast to the complexities of selling a limited partnership interest in a fund.

More importantly, securitisations of private equity provide a insight into an asset class that may not otherwise be visible to most non-specialist investors.

In Astrea III, the portfolio consisted of 34 mature private equity funds each with particular performance, draw-down and distribution patterns based on its maturity, terms and market conditions, but in the aggregate generating a relatively smooth cashflow curve.

[quote]Private equity was an asset class for institutional investors; suddenly it can become available … to high net worth individuals and institutions that need easy purchase and monetisation.[/quote]

Private equity was an asset class for institutional investors; suddenly it can become available, if not yet to the masses, at least to high net worth individuals and institutions that need easy purchase and monetisation. It opens up private equity for a completely different investor base, and this is a net benefit not only to the sponsor or the issuer who holds the assets and tranches them, but also to the underlying fund managers and the industry as a whole

“Supporting materials provided in the documentation and rating agency analysis [of such bonds] provide further support and transparency to a little understood asset class.”

How does investing in CFOs differ from investing in listed private equity?

Caló: One, you are differentiating risk, and the equity, which is more similar to listed private equity, is now a levered equity base. It’s very different from a structuring standpoint – while [listed private equity] is plain vanilla, this is structured.

Two, investors can buy the notes and they know exactly what they’re buying because it has a fixed interest.

Three, investors in private equity are faced with market volatility and the market perception of private equity. Listed private equity has tended to trade at a discount and that has very negative implications for raising capital. These notes are fixed income instruments so by definition you know what you’re buying.

Thuet: What you’re taking is a portfolio of private equity which is illiquid, with a single type of cashflow and a single stream of cashflow which is return of equity. You can turn it into two, three, four, five or six forms of cashflow with different return profiles, different risks and different returns. That’s a very compelling feature.

Astrea III has 34 funds and more than 590 portfolio companies. How important is diversity in the underlying portfolio?

Thuet: That’s a very diversified portfolio with limited idiosyncratic risk or concentration, which is important to create the different tranches of debt and important to getting them rated. Diversification is a requirement but not a catalyst.

Caló: It is important to construct a portfolio that generates the right expected cashflow curve. You need diversification to build and to be comfortable with the distribution pattern from the portfolio.

How can insurance firms benefit from securitising their portfolios?

Thuet: For regulated financial institutions holding risky assets, it is the cost of the risk as much of the risk itself that needs to be considered.  They’re required to hold back a significant amount more capital if they invest in equity versus debt. It’s about the regulatory regime in which they operate and the efficiency in which they can deploy the capital.

Larry Thuet is the head of Park Hill’s secondaries advisory group and is based in Chicago and New York, and Pablo Caló is a managing director in the group, based in the firm’s London office.