Module 4: Supporting client needs through public-private solutions 4.3 Manager due diligence and assessing product fit

In this video, you’ll learn how to perform your due diligence when choosing public-private funds, including considerations for the governance, fund profile and financial considerations.

Eddie Welch

Public private solutions sales specialist at Capital Group

3MINVIDEO

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Eddie Welch, Public-private solutions sales specialist at Capital Group

 

As private markets become more accessible through public-private solutions, one of the most important responsibilities we have as financial professionals is pursuing the appropriate fit for investors. Comprehensive due diligence, particularly in this emerging space, is an important step before making investment recommendations to clients. It helps ensure a thoughtful approach that prioritizes alignment, applicability and service.

 

The manager you select matters, so when you are recommending a private market fund, consider closely its governance. Some questions to consider are, do they have a long track record investing in public and private markets? How are they bringing that into the fund? Are they buying, building or partnering with a private markets specialist? What is their overall approach and how do they address the unique risks associated with private market investments? Your choice of manager can drive the difference between client outcomes. 

 

Another thing you might want to keep top-of-mind is the profile of the fund. When you dig deeper, look at what types of private market sectors the fund focuses on to understand how these exposures can complement other strategies in your portfolio. You should fully understand the liquidity profile of the fund. This will be important to help balance the liquidity needs of your client with the pursuit of potentially better investment outcomes. 

 

There are some other considerations too, like the particular risk of the fund’s individual investments, the impact of leverage on the fund’s returns and who is eligible to invest in the fund. Essentially, “know what you own.” And of course, there are financial details. Make sure to have a clear understanding of the fund fees - inclusive of any performance fees - and how the manager approaches fund dividends so you can clearly answer your clients’ questions.

 

There are plenty of things to think about as you serve your clients. Remember to start by aligning your client’s financial plan with the manager and solution that you believe can help support their long-term goals. Then, sizing exposures thoughtfully and blending private allocations with more liquid public assets that seek to achieve these goals.  

 

Success with these investment opportunities can come down to really knowing your manager and your client. When those things are aligned, you cannot only create portfolios that help investors pursue their long-term goals, but you can develop stronger, longer relationships with your clients.

 

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Comprehensive due diligence in this emerging space is necessary for financial professionals before making any investment considerations. Knowing who to partner with is just as important as knowing what investment strategies to offer your clients.

 

Understanding who’s managing the funds you’re considering and being transparent about the ways public-private solutions can fit into a portfolio ensure a thoughtful approach in discussions with your clients.

 

When researching potential investment opportunities that may be appropriate for some of your clients, it helps to keep these things top of mind.

 

Fund governance

 

  • Who is the fund manager?
    • Do they have a long track record investing in public and private markets?
    • Has the manager invested adequately in the technology and human capital required to successfully execute the fund strategy?
    • What is the manager’s experience overseeing assets at scale?

 

  • How is the fund managed?
    • What is the fund’s objective and how is the mix of public and private assets structured to align with this objective?
    • How transparent and understandable is the fund’s investment process, holdings and underlying exposures?

 

  • What is the manager’s approach to private market investing?
    • How does the manager get access to private markets exposure: directly, through a partner/subadvisor or a fund of funds?
    • How does the manager address the unique risks associated with private market investments?
    • What sort of ongoing relationships do the fund managers maintain with their borrowers throughout their lifecycle?

 

Fund profile

 

  • What are the sector exposures of the fund?
    • What types of private market sectors does the fund focus on?
    • What are their risks and how does this compare to other public and private markets? (e.g., public equity vs. private equity)
    • What balance of public vs. private assets does the fund target? With what degree of flexibility can the fund deviate from the targets?

 

  • What is the liquidity profile of the fund?
    • How often does the fund offer liquidity? I.e., how often can an investor request to redeem or how often is a repurchase offered? Similarly, how often can investors purchase shares in the fund?
    • What is the limit on redemptions in any period? What is the frequency of the repurchase offer?
    • Is the fund vehicle and liquidity structured in a way that allows for the orderly and consistent management of the underlying public and private assets?

 

  • What are the risks of the fund investments?
    • How is the overall risk of the portfolio managed?
    • What are the best and worst environments for the mix of underlying fund assets?
    • How are the private assets priced and how frequently?
    • Does the fund use leverage? If so, how much?

 

  • Who is eligible to invest in the fund?
    • Are there eligibility requirements to invest in the fund? Does an investor need to be an accredited investor? Or a qualified purchaser?
    • What type of documentation is required to invest in the fund?

 

Financial considerations

 

  • What are the fund fees?
    • What are the total fund fees including incentive fees, if applicable?
    • How are the fees of underlying managers or third-party vehicles in the fund reported?
    • How do the fees compare to other public or private offerings?
    • How do the fees compare to the expected returns?

 

  • How does the manager approach fund dividends?
    • Does the manager expect to make regular fund distributions?
    • Are there tax implications for those distributions?

Checkpoint

Now that you have completed this lesson, you should be able to confidently:

 

  • Conduct  due diligence on public-private investment solutions by evaluating fund managers, governance and operational transparency.
  • Analyze fund structures, risks profiles and eligibility requirements in order to explain these factors to your clients considering new investment options.
  • Compare fees, expected returns and tax implications across public-private solutions to help your clients make informed decisions.

Takeaways

Due diligence checklist

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End of lesson

The next lesson you will learn more about how to address questions from clients.

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For Public-Private Credit+ Funds:

- Bond investments may be worth more or less than the original cost when redeemed. High‐yield, lower‐rated, securities involve greater risk than higher‐rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not.

- The funds may invest in structured products, which generally entail risks associated with derivative instruments and bear risks of the underlying investments, index or reference obligation. These securities include asset-based finance securities, mortgage-related assets and other asset-backed instruments, which may be sensitive to changes in interest rates, subject to early repayment risk, and their value may fluctuate in response to the market's perception of issuer creditworthiness; while generally supported by some form of government or private guarantee, there is no assurance that private guarantors will meet their obligations.

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- The fund invests in private, illiquid credit securities, consisting primarily of loans and asset-backed finance securities. The fund may invest in or originate senior loans, which hold the most senior position in a business's capital structure. Some senior loans lack an active trading market and are subject to resale restrictions, leading to potential illiquidity. The fund may need to sell other investments or borrow to meet obligations. The funds may also invest in mezzanine debt, which is generally unsecured and subordinated, carrying higher credit and liquidity risk than investment-grade corporate obligations. Default rates for mezzanine debt have historically been higher than for investment-grade securities. Bank loans are often less liquid than other types of debt instruments and general market and financial conditions may affect the prepayment of bank loans, as such the prepayments cannot be predicted with accuracy.

 

For Public-Private Equity+ Funds:

- The fund also intends to concentrate in the financial services group of industries, and to invest at least 80% of its assets in securities issued by companies based in the United States.

- K-PEC and co-investment risks: The fund's investments in KKR Private Equity Conglomerate LLC (“K-PEC”) and co-investments alongside K-PEC or one or more other KKR vehicles that pursue private equity strategies entail additional risks. Private equity investments are typically illiquid, speculative, and difficult to value, often requiring multi-year holding periods with returns generally realized only upon sale or refinancing of a portfolio company. These investments depend on access to financing, and market disruptions or increased competition may limit opportunities and affect performance. The fund's significant investment in K-PEC creates concentration risk and a decline in K-PEC's value could materially impact the fund's returns. Co‑investment opportunities are competitive and limited and there is no assurance the fund will receive allocations or comparable terms and will generally have less information than for public companies. Through its investments in K-PEC or other KKR Vehicles and co-investments, the fund may have exposure to portfolio companies with limited operating histories, evolving markets, unproven technologies, and inexperienced management, which may require significant capital and create heightened vulnerability to downturns. Most holdings are illiquid, subject to resale restrictions and may require consents or be sold at a discount. Costs associated with investments in private equity are generally greater than those of investments in other asset classes. In addition to bearing their portion of the fund's fees and expenses, shareholders in the fund will indirectly bear a portion of the asset-based fees, incentive fees and other expenses incurred by the fund as an investor in K-PEC or other KKR Vehicles and in co-investments. Incentive fees are paid to KKR when the fund's investments in K-PEC or other KKR Vehicles and/or co-investments deliver returns in excess of a specified hurdle; when paid, these fees reduce the net realized returns of such investments.

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