Points for fixed life alternative funds to consider in light of ongoing market disruption

We have set out below some points for fixed life alternative funds to consider in light of the current market disruption.

Background

The current Coronavirus disruptions will be impacting the day to day marketing and investment activity for many alternative funds. It is currently unclear how long the disruption will last, but it seems inevitable that we are looking at additional months, rather than days. Fixed life funds typically operate on the basis of assumptions as to how long certain activities will take, from marketing, through investment and then wind down, and what proportion of committed capital will be deployed at each stage. A significant period of stalled, or redirected crisis management, activity can drive a coach and horses through such assumptions.

Terms to review

Fund managers and investors may therefore want to review the terms of their "live" funds to see whether they wish to go back to investors to build in a little flex. In particular:

• After a first close managers typically have a further 12 to 18 months to bring in additional investors to reach their target fund size. Marketing may be materially hindered by the current lock-down. Funds who are early in the process may wish to consider seeking an extension.
• Late investor equalisation payments are not always redistributed to earlier investors. Some funds retain these in the expectation they will be fairly swiftly deployed in making investments. If funds anticipate a material slowdown in investment, managers may wish to consider returning such retained amounts, subject to recall in the future. Where funds wish to retain such amounts, investors may wish to review the manner in which they may be invested.
• Investment periods are typically fixed, running from either the first close or the first investment. Where periods have already commenced prior to the commencement of lock down in relevant markets, managers may want to review their right to seek extensions to ensure they have adequate time to build portfolios when activity can recommence more normally.
• Some funds will have caps on the amount of follow-on investment which may be made after investment periods expire. Managers may want to review these. Many investee businesses will be undergoing stress and may require assistance to navigate back to normalisation.
• Funds in disposal and wind down may also need to look at extended lifespans to allow time for exit markets to normalise.

Impact on fees

Investors and managers may also wish to discuss what expected management activities and attendant costs will be during and after lockdown and the extent to which managers will realistically be able to benefit from government assistance. It may be that some adjustment in fees will be appropriate, recognising that

• funds in their early stages may have scope to reduce costs if activity may be suspended
• funds at a later stage, with investee companies experiencing material distress and scope for exit reduced or delayed, may incur greater costs than would usually be envisaged in the later stages of a fund

Impact on carry

The last global crisis saw a number of funds fall "under water", with carried interest hurdles becoming incapable of being achieved. This placed strain both on investor relations but also internal dynamics within some fund managers as a result of generational differences in exposure levels to affected funds. It is too soon to tell whether we will be encountering the same dynamic at play, but during any periods of enforced inactivity firm leaders may wish to play through possible scenarios for consideration.

Key Person Exposure

It is not a comfortable thought for any team, but all businesses need to consider the business and operational impacts of staff illness at all levels. Managers often have (and if not may wish to seek) the power to add additional Key Personnel with approval from their LP Advisory Committee, to build a known support and transition team, in advance of, as well as in response to, a Key Person Event. This builds confidence in a broader team and reduces the scope of hair trigger terminations in the event of loss of one Key Person. Honest discussions with investors around internal resilience and succession can build, rather than undermine, confidence.

Keep communication flowing

One of the strongest lessons that emerged from the 2008 market disruption was that funds that were honest and open with their investors, and kept a good dialogue going, fared better than those who closed in on themselves.