Were you surprised by the fund's ultimate size?
Yes, it came as a surprise to us that we were able to raise $2.7bn. We had broad support from both institutional investors, family offices and Goldman Sachs employees, who together with the firm committed 32 per cent of the fund's $2bn in committed equity capital [the fund is levered of an additional $700m of debt]. But I think there were several reasons for that. One was that this was our third fund in the mezzanine space, and we had produced good returns on the two previous funds, so the track record was good. Also, the fund is well suited to an environment of low interest rates and volatile equity markets. On a risk-adjusted basis, investors found the product attractive, enabling them to get a mid- to high teens returns at less than equity risk.
The fund's investment approach has been described as ?active? – can you explain that?
We definitely want to play an active role where that is something that everybody wants. But we also want to work very closely with the commercial banks in the market, because they are hugely important clients. We source a major component of our deals through the banking community, and we don't want to do anything that would jeopardise that. We're happy to let them arrange a transaction for a fee and take the mezzanine risk off their hands.
What is your relationship with the firm's direct investment arm, GS Capital Partners: will you be investing alongside each other?
Historically, we have not crossed the funds. I think it is theoretically possible that if we were a small co-investor in the equity of one of their investments that we would also go into the mezzanine. But in our 36 mezzanine investments so far, we have not done this. The purpose of GS Mezzanine Partners is to finance other buyout firms' transactions and other people's deals.
You recently invested in the buyout of Bertelsmann Springer. Is that the kind of transaction you're looking to go into going forward?
Yes. The mezzanine tranche in that deal was €265m, of which we invested €115m, or 43 per cent. We also bought some equity, which the fund has the flexibility to do. Because we are buying assets for ourselves, we can structure these investments any way we want. We can work with the equity sponsors to custom-tailor a transaction, and unlike a commercial bank underwriting a mezzanine loan, we are not having to make a judgement of what we can sell in the syndication market. We're making a judgement of what we like and what we're prepared to do from a credit perspective. Warranted or unwarranted, secured or unsecured, cash pay or no cash pay, senior mezz versus junior mezz – we can play anywhere in the structure.
You are investing the fund in both North America and Europe. Where do you see the greater opportunity at present?
So far we've deployed about eight per cent of the fund in two deals, Bertelmann Springer and Frans Bonhomme, both of which were European. We expect Europe to be approximately 50 per cent of the fund, but we wouldn't be surprised if it was more, and we have the flexibility to invest it all in Europe if we want. We see the two markets as quite different though. Europe is characterised by large transactions, where the mezzanine pricing umbrella is Libor-based, the product is second-secured, and the return expectation for us is somewhat lower than it is in the US, since we are dealing with large, less risky companies.
In the US, we tend to be operating more in the middle market, where companies have encountered difficulties in accessing the high yield market for issues of less than $150m.. There the product tends to be fixed rate with warrants and unsecured, with call protection, and the returns tend to be higher. Investing in both markets gives you a very complementary, balanced portfolio.
Do you see further institutional appetite for mezzanine funds going forward?
There will be further demand, but we think there is a limited number of fund managers with sufficient track record to attract investment. We definitely see the market starting to distinguish between large, long-established mezzanine houses and others. Manager selection will be critical for investors going forward.