A wide-ranging discussion on best practices for credit managers – from managing firm finances and operations to compliance and investor reporting – at the first-ever PDI CFOs & COOs Forum showcased the dynamism of the roles dealing with those issues.
As the asset class continues to grow, so does the complexity and breadth of the chief financial officer and chief operating officer roles, and the acumen needed to succeed in those positions. From evolving fund structures to expertise needed to support the range of different debt strategies, some attendees grappled with vague answers and grey areas of the job.
“It’s not getting simpler,” one attendee lamented.
As the alternative asset space, particularly private credit, becomes more intricate, limited partners become more aware not just of deciphering investment performance but also the policies and procedures a firm has in place for ensuring ethical investment and financial management.
Some of the more spirited debates centred around the valuation of illiquid credits and how firms can successfully expand their alternative asset management business to include a private debt strategy. The event had specific panels dedicated to the topics, but the issues arose on multiple occasions.
Talking about valuation, a senior executive at a large asset manager said timeliness and accuracy are among the key factors to zero in on, a point broadly agreed on.
However, the conference-goers and speakers disagreed about the best procedure for valuing assets. One senior professional for a large investment firm said his firm taps its portfolio managers, while another suggested involving the deal teams.
Another long-time valuation expert sounded a more sceptical note, however: he’s never met an investment professional who believed a deal he worked on should be written off. This can be important when dealing with portfolio companies that have hit operational or financial snags, this person said.
Another aspect of the valuation process debated concerned when to value the portfolios of private vehicles versus public vehicles, such as business development companies. Should private funds be valued quarterly just as BDCs are? The unanimous answer from panellists: the rigor of public funds should be applied to private funds.
Keeping away from conflicts
Multiple private equity firms beyond the massive publicly traded alternative asset managers have added credit strategies over the past several years, which has thrown the inherent conflicts of interest into the spotlight.
When launching a new debt platform alongside an existing private equity product, the firm must consider whether it should help bankroll their own leveraged buyouts and other equity deals.
The topic was divisive: one investment professional said this person’s firm stayed away from it, while two other senior executives said their firms would participate in any private equity transactions their counterparts may be involved in, but they were limited to a role as a passive investor in the credit securities.
Another conflict of interest a consultant touched on stood squarely within the debt realm. How does a firm manage deals where the firm holds debt in multiple positions in the capital stack? The conflict presents a unique challenge in a workout scenario: one optimal workout plan for say, a senior debt position, may not result in the best possible treatment for a junior debt investment.
LPs dialing up scrutiny
As finance, operations and compliance professionals grapple with the growing intricacy of their firms, investors are becoming ever savvier about private debt. They are sifting through claims every general partner seems to make and asking for granular information.
A case in point is the assertion that a given firm has proprietary dealflow. It’s hard to verify that, one investor noted, but this person had several guidelines.
If a GP lists its current pipeline in a pitch deck containing the same deals another credit manager lists, there’s a chance neither of them get advance looks on transactions or see deals not widely shopped.
If a firm has trouble deploying capital, there is a chance that GP may not have proprietary dealflow. If a firm consistently exercises one-year extensions on its funds, it is possible that asset manager might not be on the speed dial of private equity sponsors and various advisory firms.
A consultant noted verifying the proprietary dealflow claim could be as simple as examining an investment professional’s frequent flier miles – did the person jet set around the country, or even the globe, to look for potential transactions, scouring high and low, from a nation’s large metropolitan areas to its rural corners?
Limited partners are asking about policies for asset allocation among different vehicles the given GP manages as well as digging into how credit firms are valuing their assets, one CFO said. Say a firm decreases a position’s valuation from 98 cents to 92 cents on the dollar, it may face questions about how and why it made that certain mark.
What’s more, investors are also querying managers about their fees and expenses. Previously, a second CFO said, they would ask what your headline expense ratio number was; now LPs ask to have that figure broken down into six or seven different parts.
They are also beginning to ask about fees for third-party service providers that might work on the fund, according to a third CFO. Some LPs have viewed it as a charge disguised as an addition to the fund’s management fee.
Regulator watching fees
In addition to more investor scrutiny, the Securities and Exchange Commission continues to be vigilant about excessive fees, one executive told attendees. The regulator can be very exacting, as the individual gave a rather specific example: the SEC may view that dinner with a client could be registered as a fund expense – but not after-dinner drinks from a hotel room minibar.
Aside from the specific nature of the charges, the federal agency also keeps a close eye on allocation of fees across different investment vehicles. For instance, if a firm registers a travel expense associated with monitoring a portfolio company spread across multiple funds, the GP cannot allocate more of the cost to the fund that has performed better.
As the conference ended, it became clear that establishing a world-class credit platform not only requires an insightful and knowledgeable investment staff. It also demands a rock-star team of finance, compliance and operations professionals.