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Private Funds 2018: Trends & Conclusions

So far this year private funds and private capital have continued to benefit from a recently buoyant fundraising climate – which has meant good news for managers, investors and lawyers. In a market where the traditional vehicles for raising money have become less certain, new investors have looked to private funds as a way of ensuring steady returns. Once the preserve of massive funds and investment vehicles, now even “ordinary investors” in the form of high-net-worth individuals are getting in on the act. With a proliferation of investors following a proliferation of regulations and compliance issues, the legal work involved in funds has only continued to expand.

New tricks

According to Prequin, as of 2015, private funds constitutes a US$4.2 trillion industry – not exactly small beer for investors or the lawyers that facilitate fund raising and advise fund managers. In Q1 2017, 253 funds closed raising a collective US$156 billion. Given that total funds raised in 2016 reached US$669 billion, alongside accounting for the fact that all of the data is not yet available and a typically slower first quarter, it looks like fundraising for this year is set to meet and possibly even top that of last year. The number of funds that have surpassed US$1 billion in investment during the past 10 years is impressively high, particularly in the infrastructure sector where it accounts for 85 per cent of all aggregate capital raised.

This success is not altogether surprising, but is perhaps made more impressive given the big internal hurdles that the market has seen over the past few years. One of these is a growing need for transparency. Due to rules contained under the Markets in Financial Instruments Directive (MiFID II) declaring that fund managers must present clients with clear budgets for research, big funds such as Hermes Investment Management and Jupiter have stopped passing on the cost of external analyst research to their clients and have instead decided to pay for it themselves. While this is partly being done in order to circumvent what might be considered pesky compliance obligations, it is perhaps also recognition that staying in step with, and ahead of, the market has now become so important that it warrants being paid for directly from the fund’s budget. Those that have decided to cull researchers are no less concerned about the coming changes; big data and data analytics are replacing traditional methods as a significant part of research for funds.

“Things are less cookie-cutter,” one lawyer told us, “and remain busy across the board.” Credit funds and alternative asset management look to be here to stay, and, although the governor of the Bank of England, Mark Carney, insists that such “fault lines” as shadow banking have been fixed, one source was keen to tell us that this is now “a post-banking era”. That said, some jurisdictions, notably Ireland, relaxed their requirements for loan originators, in order that they could lend directly to investment funds.

The global funds landscape is mainly unchanged; Ireland and Luxembourg are still the jurisdictions for UCIT funds, while London and New York remain highly favoured by funds and investors. Offshore, the Cayman Islands and British Virgin Islands continue to see good levels of inbound work flow, and Singapore and Hong Kong are also active. In Africa, Mauritius is becoming a place that funds consider a great springboard for agricultural and mining funds, in what is increasingly a fledgling continental economy.

The long arm of the regulators

Regulation has been the watchword for financial authorities everywhere since the credit crisis, but the funds space has seen a considerable ramping up of what was traditionally a famously unregulated space. This is in large part thanks to the European Union. The long-awaited MiFID II, due to come into force in January, currently stands at 1.4 million paragraphs long – and is still growing. Every regulatory funds lawyer in Europe told us it was near the top of their workload.

In addition, the EU Market Abuse Regulation (MAR) represents the EU’s attempt to stop insider dealing and market manipulation, issues that private funds have dealt with throughout their history. While such regulation is almost certainly good for funds and for everyone else, it does mean that fund managers will have to keep an ever-closer eye on the actions of their funds and the requirements of regulators.

A greater need for compliance also means greater costs to funds, and in an increasingly globalised industry, cross-border funds will need to comply with multiple regulatory regimes. While the US Securities and Exchange Commission is keeping an eye on all this, no other part of the world is matching Europe for its desire to create a coordinated, transparent market. This means that lawyers in these jurisdictions must continue to be dynamic in how they provide solutions for their clients, but it will also likely answer the question as to whether investment funds consider the size of the European investment market to outweigh the amount of red tape now involved in doing business there.

“Hedge isn’t dead”

While never able to match traditional private equity funds for their sheer ubiquity, hedge funds have endured through dizzying ups and downs in the last 20 years alone. As one source told us, “Hedge isn’t dead.” Many investors at the end of 2016 said that their portfolios did not meet expectations, but according to Prequin the industry has only made one monthly loss since March 2016. Event-driven strategies and emerging markets, in particular, have yielded good returns but no new fund of funds vehicles were launched in Q1 2017. As a demonstration of how stable the players at the top of the market remain, the three largest fund managers as of 31 December 2016 are Bridgewater Associates, AQR Capital Management and Man Group, all founded in the last century and two of which are over 30 years old – seasoned outfits for a market that really only blew up in the late-1980s.

This gives hedge fund lawyers reason to be cheerful, partly because the space represents one of the most resilient markets out there – meaning that legal work will keep on coming. Hedge funds are still one of the most lightly regulated investment vehicles on the market – again, this is outside of Europe, which attempted to rein such funds in with the Alternative Investment Fund Managers Directive (AIFMD) – and are keen to keep wearing that badge. They will no doubt look to lawyers to ensure that they can do what they have always done, to the horror of financial authorities: roll the dice with startling alacrity.

Conclusion

With the funds space generally appearing to be on the up, managers can envision bright futures, thanks to regulations that can be tackled by good lawyers and emerging markets that can yield sizeable returns. Undoubtedly the legal community is busy processing these new changes while dealing with their day-to-day funds work. The industry’s days of near-total deregulation seem to be over. Whether that turns out to be good for fund managers, investors and lawyers will no doubt be the story occupying the final years of the decade.

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W11 1QQ, UK