Managers scramble to launch captive equity funds as they become best route to market

John Goldfinch, partner at law firm Milbank, says the firm is seeing around a dozen of these ‘funds’ at varying stages of being set up. “Mostly, managers have figured out what the structure looks like, worked through tax and regulatory issues and chosen jurisdictions, but not a lot of people are pulling the trigger and incurring the cost of actually establishing them, or engaging in active marketing,” he says.

There are three basic types of retention/equity fund, explains London-based Goldfinch.

The first are captive equity funds that provide the risk retention piece or even all of the equity, for a single manager’s deals (such as Cross Ocean).

The second type are true third-party vehicles that provide the retention (and potentially more) equity to multiple managers. Both types of funds are required to invest in other assets as well, often running a loan trading business alongside investing in mezz or other CLO tranches (for instance, Chenavari/Taurus).

Finally, there are collateralised manager vehicle (CMV) structures that raise retention equity much like the first category, but which are themselves the contractual manager of the relevant series of deals (such as Polus).

The fundraising environment across all areas of credit has become challenging. Sources say capital for these new CLO funds is largely raised through existing LPs on a firm-wide basis.

In addition, sources say some large investors who committed to several CLO risk retention vehicles pre-Ukraine are no longer active in the space, which is taking a toll on capital-raising.

“Sometimes new managers can bring equity to the table and, given the current market environment, this puts them in a much stronger position than if they were competing with more established managers in an environment where third-party equity capital was easier to come by,” says Goldfinch.

“If they are willing to accept lower equity returns for the first couple of deals, they may be in a position where they can effectively buy market share.”

While some large European CLO managers (such as PGIM, Spire, BlackRock and CSAM) have not struggled to attract third-party capital, this may change if equity investors move up the capital stack to double Bs, Gupta says.