While buoyant fundraising continued in the global funds and asset management sector through 2022, challenges linked to ongoing economic and regulatory uncertainty have been a growing feature through 2023. Geographically, fundraising remains firmly concentrated on North America and funds came back to market so quickly during 2021 and early 2022 that LP pipelines have been under pressure. The tougher macro environment, with declines in public markets and rising inflation, as well as the geopolitical dynamics is causing fundraising to be more subdued globally.
Strong outlook for Gulf SWFs
In the Middle East, however, which is being supported by elevated oil prices and an ongoing post-pandemic recovery, the alternative asset management market looks set to benefit from relatively good conditions through 2023 and 2024. Middle Eastern sovereign wealth funds (SWFs) and other institutional investors continue to seek to build robust portfolios of alternative investments in a quest to generate returns and drive their economies’ non-oil growth.
We see significant interest across the region in new distressed debt, special situations and dislocation funds, as well as successor funds in private equity, growth capital and private credit. There is also growing demand for Shari’a compliant funds with a range of structures being developed.
Middle Eastern SWFs more than doubled their investments in Western economies between 2021 and 2022, with deals up in value from USD21.8bn in 2021 to USD51.6bn last year, according to Global SWF's 2023 Annual report. Gulf SWFs made successful bids to acquire assets ranging from New York-based asset manager Fortress Investment Group to British carmaker Aston Martin.
While they have historically scouted out attractive opportunities in times of volatility and low valuations, a key difference this time is the shift toward sectors like technology, healthcare, logistics, renewables, broadband, and digital infrastructure assets. Gulf SWFs are also backing private equity firms and leveraging relationships with established managers to do co-investments and/or more direct deals. We are also seeing Gulf SWFs taking stakes in the general partner/manager of a fund.
As funds grow and diversify, the need to establish appropriate legal functions must not be overlooked and many will be working to identify the best structure for their legal functions in order to remain nimble and responsive. We predict the use of interim legal resources will be invaluable in helping managers navigate that journey.
The forecast ahead
Looking forward, a number of hot button fund terms are in the spotlight as the uncertain market environment gives institutional investors greater influence. There is more institutional investor focus on the investment strategy, the fund’s term and investment periods, follow-on investments, the ability to recycle distribution proceeds and limitations on borrowings in 2023, while management fees remain under pressure.
Considering the competitive fundraising environment, the market continues to be creative and managers are focusing on innovative models to attract institutional capital. Interests have heightened in a range of structures including co-investments, separately managed accounts, funds of one, long-term strategic partnerships, and hybrids across these various options.
The world’s largest institutional investors have used their clout to invest differently, with some now making as much as half of their private markets commitments outside fund structures, either directly or as co-investors alongside a fund in which they may also have a stake. Managers need to develop their own strategies to respond to this evolving demand dynamic.
There is also a growing appetite for continuation funds and for secondaries, which are now the number two long-term strategic preference of institutional investors after mid-market buyouts, according to Montana Capital Partners’ Annual Investor Survey.
Emerging priorities for managers
There is a general upward trend when it comes to fund finance activity in the MENA region, with subscription-line and hybrid facilities increasing in popularity. Preqin expects the use of alternative fund finance structures to almost double by 2027, with the Middle East likely to follow other regions with a growing interest in net asset value (NAV) financing and other solutions.
The combination of the global Covid-19 pandemic and more challenging macro and geopolitical conditions have sharpened a growing focus on liquidity from managers across the industry. More lenders have come into the market to provide subscription lines and NAV facilities, and these are being tapped by managers more frequently and earlier in their funds’ life cycles.
We have seen private credit funds and insurance companies showing much greater interest in fund financing transactions too. The NAV lending market in particular has been developing at a furious rate, aided by the introduction of credit ratings for these loans that have given insurance companies and institutional investors the assurance to enter the market.
ESG and social impact investing is now a key item on every fund board’s agenda in this region, particularly as managers grapple with the additional disclosure and transparency requirements rolling out across the European Union under the Sustainable Finance Disclosure Regulation (SFDR) and the EU Taxonomy Regulation. These rules have a reach far beyond Europe, highlighting a need to standardise fund processes to meet investor demands for ESG-aligned products around the world and requiring compliance from any manager seeking to market in the EU.
ESG investments in the Middle East have boomed since the pandemic, with the total value of green and sustainable bond and sukuk issuance in the GCC exceeding USD8.5bn in 2022. This is likely to remain a key feature of the market for at least the next decade. Social investing is being pushed forward by investors who want long-lasting, sustainable contributions left behind as their legacy and, at the same time, environmental investments present a huge opportunity for the Middle East, especially with the region hosting both COP27 and 28.
The rise in the global popularity of ESG investing presents a unique opportunity for asset managers and banks in the GCC to offer more green Islamic investment products to attract investment from a broader pool of ESG-conscious investors. Additionally, while green investments that tick the boxes of ESG and Shari’a compliance may currently be limited, the gap can be bridged by innovative structured solutions that allow for exposure to certain ESG investments that would otherwise not be Shari’a compliant. These are increasingly being used by family offices, regional banks and institutional investors.
Another key shift in the funds area is a growing focus on the behavior and culture at firms, driven not only by regulatory scrutiny but also by large institutional investors that now expect their managers to report diversity data and explain their initiatives and strategies in detail. We also see an increasing focus on the ‘G’ in ESG, driving the need for good governance, proactive management and more complete, consistent and reliable sustainability information.
How A&O and Peerpoint can help
As the alternatives industry carries on evolving at pace in response to regulatory pressures, fundraising challenges, liquidity issues and investor demands, managers continue to strive to run lean and focused operations. With so many pressures on internal legal and compliance resources, and fierce demand for talent, interim access to a top-level skills base can provide invaluable support.
Right-sizing the legal team is a challenge for a number of alternative investment firms, particularly across borders, so flexible resourcing options are a useful aid to that scaling process, proving the case for permanent recruitment as well as bridging gaps in busy areas at peak times.
If you’d like to find out more about how we can support your business then do get in touch with either kamar.jaffer@aoshearman.com or azara.digan@aoshearman.com.
For more information about Peerpoint and how it can provide the perfect solution for your team, please visit their website.
