How to cope with growing pains

Our inaugural CFO/COO event recognised the way operational issues have come to the fore in the asset class. Andrew Hedlund took notes

A wide-ranging discussion on best practices for credit managers – from managing conflicts of interest to investor reporting – took place at the first-ever PDI CFOs & COOs Forum, showcasing the innovation and dynamism required to deal with these 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. Some attendees grappled with grey areas of the job.

“It’s not getting simpler,” one attendee lamented.

As the alternative asset space, particularly private credit, becomes more specialised, limited partners are more aware not just of the need to carefully decipher investment performance, but also the policies and procedures a firm must have in place for ensuring ethical investment and financial management.

Keep 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 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 their firm stayed away from it, while two others said their firms would participate in any private equity transactions their counterparts may be involved in, but were limited to a role as a passive investor in the credit securities.

Another conflict of interest a consultant touched on was 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.

Closer LP scrutiny

Investors are becoming ever savvier about private debt. They are sifting through claims every general partner makes and asking for granular information to back it up. A case in point is the assertion that a given firm has proprietary dealflow. It’s hard to verify that, one investor noted, although they 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 an advance look 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 it might not be on the speed-dial of private equity sponsors and various advisory firms.

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 to 92 cents on the dollar: it may face questions about how and why it made that change.

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 for that figure broken down into six or seven different parts.

Private credit will likely continue to grow as the firms active in the space mature; managers will expand their investment products to add more strategies and funds.

All this brings more responsibilities under CFOs’ and COOs’ purview, creating more opportunities for firms to flourish – but also more potential headaches.