A big question for investors, especially in planning whether an alternative investment secondary market sale will eventually be necessary, is whether there will be a spike in capital calls.
Some industry observers expect capital calls to drop precipitously because managers won't need the cash since most new transactions were put on hold due to recent extreme volatility. A recent study by London-based alternative investment research firm Preqin and risk management firm FRG, Cary, N.C., said a surge in capital calls is not expected until 2021. The study analyzed funds from vintage years 2017 to 2019, which it said represent 72% of the $2.63 trillion in global alternative dry powder. Assuming a brief but significant recession, the study concluded that general partners will sharply reduce capital calls and distributions in the first half of 2020 and generate more distributions than capital calls in the second half of the year. Capital calls will then rise in 2021 as transaction volumes and asset prices rebound, the study said.
CEPRES GmbH, Munich, an alternative investment research firm, said in an April 2 news release that it expects LPs will receive less capital in distributions than what they will provide in capital calls until the fourth quarter. After that, CEPRES anticipates distributions to be reduced by as much as 50% through the end of 2021.
CEPRES also expects up to 50% fewer capital calls than typical for the next six months. While CEPRES also expects managers to make new investments, the firm expects alternative investment managers to seek capital to increase their own liquidity and build cash reserves.
So far, a few real estate investors have asked GPs not to call capital right now due to liquidity constraints, said Robert Kohn, partner at real estate placement agent and secondary market adviser Park Madison Partners LLC, New York.
Asset owners and consultants say they have seen a handful of large capital calls by managers seeking money to pay down their subscription lines of credit, and they expect more to come.
"Subscription line lenders get nervous when investment values drop precipitously," said David Fann, New York-based vice chairman of alternative investment consultant Aksia LLC. "Since the LPs are the backstop, the quandary is whether LPs will fund capital calls — effectively spend good money after bad or default and just walk away."
Over the past several years, managers investing in the secondary markets have used substantial amounts of leverage, including special-purpose vehicle deal-level debt, seller financing and subscription lines of credit, said Jeff Diehl, managing partner and head of investments at private markets investment firm Adams Street Partners LLC, in an email.
" As a result, investors in these funds should expect an uptick in capital calls as these funds de-lever to minimize potentially negative fund net (internal rates of return) and to avoid potential lender 100% cash sweeps of distributions," Mr. Diehl said. Cash sweeps are when up to 100% of potential distributions to secondary buyers are used to pay off lenders.
"Investors in secondary funds that have employed deal-level leverage should anticipate their distributions may lag secondary funds that have not done so due to potential higher (special purpose vehicle) cash sweeps by lenders," he said.