Feature: This season’s colour – evergreen

From the perspective of the fundraising merry-go-round, the idea of raising money just once and recycling it, must be enticing. Indeed, the permanence of permanent capital vehicles is highly attractive, several managers of such vehicles explain to Private Debt Investor

The ability to raise capital once and then get on with investing has convinced several managers to launch vehicles while others are examining their options for structuring such permanent capital. In the US, business development companies are the most obvious form of permanent capital. PDI took an in-depth look at the sector in last month’s magazine while the focus here is on evergreen vehicles in Europe and UK investment trusts, in particular. 

NEW KIDS ON THE BLOCK

This year, two US-based managers have listed investment trusts in the UK focused on investing via marketplace lending platforms. In mid-March, Victory Park Capital’s VPC Specialty Lending (VSL) raised £200 million ($315 million; €281 million) from its London Stock Exchange (LSE) initial public offering. It revealed that the capital was around 70 percent deployed in mid-May and, based on the plans outlined in its prospectus, it seems likely that the firm will soon raise fresh capital in the form of a C share listing. One of the benefits of investment trusts is that additional capital can be raised relatively easily by issuing new C shares.

Asked why Victory Park Capital opted for a UK-based investment trust, Brendan Carroll, partner and co-founder of the firm, says that it just made sense. “Like anyone else, we like diversifying our own investor base. Could we have gone back and raised a private vehicle? Yes. But we have our own experience to draw on and did a lot of research ourselves. We also took advice from investment bank Jefferies and on the investor side we were seeing a lot of demand,” he explains.

The firm also looked into the US BDC structure but found that under those rules, marketplace lending would all be classified as a single investment type – no matter how diverse the focus of the underlying origination platforms. And BDCs are restricted from having more than a one-third exposure to a particular category, Carroll notes. 

VSP was shortly after followed by Ranger Direct Lending which is managed by Ranger Alternatives, a subsidiary of Texas-headquartered Ranger Capital Group. It raised £135 million and was admitted into trading on the LSE on 1 May. 

Both vehicles will invest in credit assets generated from a number of online lending platforms. VSL has relationships with 14 different platforms in the US and the UK. It takes a passive approach, usually taking a slice of the loans generated by the platform. It has a dividend yield target of eight percent. 

Ranger DL has relationships with seven US-based lending platforms across a range of niche sectors including SME, invoice financing, real estate and equipment finance. It is also in the due diligence phase with several other platforms in other jurisdictions, Bill Kassul, a partner with Ranger, outlines. The vehicle is actively managed (selecting specific deals from the platform it invests via) and targets a dividend yield of 10 percent. 

Whitewood REFF, which was seeking capital to pursue a real estate debt strategy in the Benelux region of continental Europe, failed in its bid to raise £125 million in permanent capital via a London-listed investment trust. The vehicle, which was set to be advised by Whitewood Group affiliate Whitewood Capital REIM, published its intention to list in March. The IPO was dropped and the vehicle is pursuing other means of capital raising, as PDI reported in June. 

Whitewood may not have been successful but among the 20 or so debt-related investment trusts, as identified by trade body AIC, a couple of the real estate offerings stand out for their success, as measured by the above target dividends for investors. Cheyne Capital’s listed offering Real Estate Capital Investment reported strong results in June with a net asset value total return per share of 12.3 percent with a dividend per ordinary share of 10.8p. ICG-Longbow, the real estate debt arm of London-based Intermediate Capital Group also has a listed entity and while it warned that competition could drive yields down in the future, it met its 6p dividend target for the year to April. 

And while this year, a lot of attention has been given to the new marketplace lending investment trusts, there is also CVC Credit Partners European Opportunities Limited. It offers retail and institutional investors restricted to public markets access to CVC Credit Partners mid-market corporate debt investments, the sector which is by far the largest private debt strategy and which most BDCs focus on. 

The investment trust structure beats the traditional closed-ended vehicle on a number of counts, explains Ranger’s Kassul: “[With a closed-ended fund], you raise what you need over a few years and then there’s a drag as you deploy. And if you want to do another [fund], you have to pay for it again.”

Closed-ended funds are also expensive to raise and with permanent capital it’s possible to top-up, note both Victroy Park’s Carroll and Kassul. Adds Carroll: “The other thing for us was having asset/liability concerns basically solved. Our private equity-style vehicles are long-lock six to 10-year type vehicles. So I'm investing in a platform business that's making two/three/four-year loans to a consumer or small business, I'm not a hedge fund, I don't want to have to worry about the underlying liquidity of the end investment so that's one of our selling points to our investors.”

LISTING LIABILITY

While evergreen vehicles may do away with the liability mismatch, if listed, they do introduce a different inherent mismatch – that of liquidity. Listed vehicles are at least notionally tradable and liquid but the underlying assets are illiquid. Exiting those instruments ahead of maturity is likely to come at a loss if it’s even possible.

So investors take a clear risk when using a liquid structure to invest in illiquid assets. This has caused problems for many BDCs in the US. When their stock price trades below net asset value, investors are unhappy.

Buy in at a discount and trade out at a premium and the investor is happy, they get the dividends from the cash coupon thrown off by the underlying loans and a bump in principal at the end. Reverse that though, and you get losses and disgruntled investors. Go further and raise fresh capital when the stock price is below NAV per share and you get angry shareholders.

“There’s always somewhat of an arbitrage – be it good or bad – when you go via public structures into inherently illiquid assets,” says chief executive officer of ESO Capital, Alex Schmid.

MISMATCH V TAX

ESO Capital is raising its sixth fund focused on providing growth and rescue financing for lower mid-market companies. It is also in the process of establishing a limited company that Schmid plans to grow into a full speciality finance business. The new permanent capital vehicle will initially have a similar strategy to that employed by VSP and Ranger DL. Earlier this year, ESO signed an initial £50 million underwriting agreement with ThinCats, a marketplace lender that provides secured loans to SMEs. ESO agreed to underwrite large loans originated by the platform (the first deal was a £1.2 million loan for a wind turbine project) with ThinCats’ other registered lenders able to sign up for a slice of the deal via its standard auction process.
ThinCats’ secured loans are complementary to what ESO does already albeit at the much smaller end of the market and below ESO’s typical lending threshold. But the relationship will just be the start of the new evergreen vehicle, explains Schmid, adding that the firm is in negotiations with other niche strategies to invest with them too. 

ESO’s existing investors have provided the capital to back the new unlisted entity. Schmid hasn’t ruled out listing the business eventually, but it is not a given he says, adding that developing the business and building a dedicated team is his priority. The firm dismissed the investment trust option as too limiting in scope. “In an evergreen vehicle, I can evolve my strategy by learning more, knowing more, hiring better people, growing and changing with the marketplace,” he argues. 

And while corporation tax is a severe disadvantage of the structure ESO is establishing, Schmid says that for a speciality finance strategy, having permanent capital and being able to build the business steadily, overcomes that disadvantage.
For the lower mid-market corporate investments that ESO has made since 2006, the closed-ended GP-LP structure is still the best option, he argues. 

MARKETPLACE MIDDLEMEN

The money raised for evergreen vehicles in Europe is dwarfed by the capital being raised for private debt strategies. But there is clearly interest, both from managers as well as investors, with much of that directed towards marketplace lending.
Investors spy an opportunity in supporting the start-ups that are attempting to disrupt banks. While marketplace or peer-to-peer lending is still tiny in comparison to bank lending, these platforms are making headway and offering investors cash yield.
Ranger’s Kassul notes that institutional money is key to the sustainable development of marketplace lenders. “It’s finding unique deals and unique niches and coming in with these established players that are not start-ups, they’ve got established management teams, proven underwriting models and verifiable track records that we can look at, and then work with them to help them grow their business and finance their book.”

The equation is pretty simple with huge demand for capital from SMEs on the one hand and with an insatiable appetite for cash yield among investors. That, Schmid says, combined with the structural changes in the lending landscape is key. “The general theme that everyone is trying to get to is disintermediating banks taking away market share and taking away earnings power. And if you look at banks, those are permanent capital vehicles,” Schmid concludes.

BUYER BEWARE

“If you have an evergreen set-up, you need a new structure with exit gates and more limited liquidity. Investors need to be able to uninvest,” was the conclusion of Karl Happe, Allianz Global Investors’ chief investment officer for insurance-related strategies, when asked about permanent capital vehicles for debt investments. 

From the investor point of view, that seems more than reasonable. With an illiquid underlying base, if everyone starts rushing for the door, they don’t just get stuck, the door disappears. And while the UK’s investment trusts offer some benefits, and are notionally tradeable, in practice, there is not much trading in the stock. 

The benefits of evergreen for managers are relatively clear. Ranger’s Kassul even notes that the reporting requirements, because they are standardised, make it easier to share information with investors – a process that can be more ad hoc in a closed-ended fund. 

In the end though, it is investors who will have the final say on permanent capital vehicles. For now, the yield on cash is clearly attractive enough for many. 

But the underlying risks of a fundamental mismatch built into listed permanent capital structures remain – not something easily dismissed, even almost seven years on from the global financial crisis. And investors should definitely bear in mind that for managers, there’s pretty much only upside.