US alt IM investment valuations recover amid record fundraising

Rebounding equity markets and credit spread tightening led to meaningful sequential-quarter recoveries of fund performance and balance sheet investment valuations for alternative investment managers (alt IMs) in Q2 2020, with the correction in liquid markets bolstered by unprecedented Fed stimulus, Fitch Ratings says. 

However, underlying portfolio company fundamentals remain suppressed by the economic fallout from the pandemic-driven recession, which could create investment opportunities over the medium term, depending on the speed and path of recovery.

Despite rebounds in fund performance, some firms recorded impairment charges on investments in energy and other sectors heavily impacted by Covid-19. Still, returns on current vintage investments could be substantial, given investment opportunities provided by the current market dislocation. Alt IMs generated some of their best returns in vintage years following the global financial crisis, riding out negative valuation marks on existing investments, given the locked-in nature of fund structures.

Investment opportunities pivoted away from liquid strategies in 2Q20, focusing instead on private credit solutions. The pace of deployment is expected to accelerate over the next 12 months, as private equity (PE) deals take longer to materialise due to an inability to conduct traditional due diligence, as well as divergent bid-ask spreads. Investment activity totalled USD44.5 billion for the rated peer group in Q2 2020, down from USD50.3 billion in 2Q19.

Investors searching for yield amid persistently low interest rates led to record fundraising for alt-IMs in Q2. Several firms logged their best fundraising periods on record - Apollo's inflows were primarily driven by transactions in its insurance platform, without which inflows would have still totalled a strong USD16 billion in 2Q.

Other record capital raises included BAM at USD23 billion, which included Oaktree's USD12 billion fundraise for its next flagship distressed credit fund, and KKR at USD16 billion, including approximately USD9 billion raised for its Asia PE strategy. Ares had one of its strongest fundraising quarters, at more than USD9 billion, including a first close on its sixth flagship PE fund along with capital raised across several credit strategies. Record fundraising drove aggregate fee-earning assets under management growth, which were up 9.1 per cent QoQ after falling 1 per cent sequentially in 1Q20.

Strong demand and solid long-term investor relationships have allowed alternative IMs in Fitch's peer group to further scale their platforms during this crisis. Debt/fee-related EBITDA (FEBITDA) margins remain strong and are supported by recurring management fees, locked-in fund structures and a largely variable cost base, which can protect margins in downside scenarios.

Average leverage increased for the peer group, as some firms took advantage of favourable market conditions to raise debt capital and enhance liquidity to fund potential investment opportunities, while KKR raised debt and equity capital to fund its acquisition of Global Atlantic Financial Group Limited.

Fitch believes its rated peer group maintains ample liquidity at the firm level to fund general partner commitments, new investment opportunities and debt maturities, which are minimal in the near term. Ratings stability is expected in the near term, given the long-term investment horizon, locked-up nature of capital and recurring management fees of alt IMs, which largely insulate credit metrics from market volatility.