Karl Bradford on COVID-19 vs fund managers

Hi everyone. You're listening to The Alternative Series podcast by IQ-EQ. I'm Hugh Stacey, Head of Investor Solutions, your host for today. And I'm pleased to welcome Karl Bradford, a legal director at Foot Anstey in the UK. Karl has particular expertise in the structuring, establishment and running of private investment funds. We are here to discuss with Karl about the impact of COVID-19 on fund managers and the four areas for them to consider in the light to the pandemic. Hi there, Karl.

Hi Hugh. Great to speak with you.

It’s a pleasure – thanks for sparing the time for the call today. Right, we'll kick off with the first question if that's okay.

Yes. Great. Please do.

So, Karl, in your recent article published on the 18th of March this year, you mentioned that investor due diligence meetings are likely to be delayed leading to a ‘wait and see’ approach on the part of investors. With greater travel restrictions now in place, are there any workarounds to in-person due diligence exercise that the industry is actually considering?

Um, yeah, I think that's right. We're still seeing that kind of ‘wait and see’ approach as people are getting used to the new normal. But I think as people realise that it's ongoing, it's clear that we do need to have workarounds and people are really starting to look at ways that they can do that now. And I think it is actually a really good time to be carrying out due diligence at this stage because there is more time – well, for some people there's more time, not for everyone. Um, but it may mean you can make a deeper dive into some of the due diligence materials that fund managers have. So I think fund managers are likely to see a rise in the questions asked by investors as those investors do start to take a deeper dive into the information they're provided because they can't have the face-to-face meetings.

And so they’re going to actually really look at the detail now, especially around track record, existing portfolios, the pipeline, both pre-COVID and also the resilience of the pipeline now in this new system that we're working to. Also I think investors will be thinking about some of the operational systems that the fund managers have in place to see how well they are positioned to weather these kinds of storms that we're seeing. And so I think actually, although there will be a wait-and-see in terms of actually making an investment, now is the time where people will really start to carry out that due diligence and really focus on it.

Um, I think in terms of actual workarounds, obviously people are starting to embrace the technology that we have available. Telephone conferences, obviously, like we are having now. It's easy to jump on these kinds of calls and also video conferences. They're definitely becoming the new norm. And although I think in terms of, you know, it's always nice to have an in-person meeting, the platforms that are available and just the fact that everyone's having to do it means that everyone's getting used to it and that it will get embraced more and more. And also, you know, a lot of those platforms have various presenting options. There's virtual breakout rooms so that you can have side conversations and then come back into the main conversation. So in a way it can be very much like having a face-to-face meeting. Interestingly, what we're seeing as people do adopt, you know, meetings by telephone and video, is that it’s actually often a lot easier to arrange because people are ultimately in their office, in their house or flat. And so it can be easier to arrange those meetings because people aren't traveling between meetings or longer travel than that.

So, I think, those workarounds we're definitely seeing. I mean, what I would advise is that when those video conference and teleconference meetings are being set up, is that it's really important that they are a well thought out meeting. Because you'll have so many people speaking, it's really important to have a clear agenda, some ground rules, to make sure that the call is managed in the right way and to make sure that people have a designated time to make questions because it wouldn't be the same as in a face-to-face where, you know, you can tell the body cues of someone wanting to ask a question or putting up their hand or, um, really reading the room. So you therefore have to have a lot more structure in these kinds of calls so that they go in a more orderly way. Um, but I think, you know, that's where the service providers can really help. They can help to manage those kinds of calls to make sure everyone gets a chance to speak in the right kind of forum.

Yeah, Karl, thanks for that, I couldn't agree more. We've seen a massive uptick in terms of our Investor Solutions portfolio monitoring, you know, where a lot of people are looking at how they can do more due diligence and, um, monitoring and tracking of their underlying companies and the performances and the risk exposures. And I suppose, to your point in terms of workarounds, the very fact that I'm sitting in my study in London and you’re at home in, I think it’s Bristol isn’t it. You know, we're able to do this. So, yeah, with every crisis there's obviously ways in which people can be quite innovative in how to overcome that.

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So yeah. Great! Thanks very much for that. Umm, so, with high levels of dry powder in the private equity industry, you noted that fund managers could face issues deploying capital within the investment periods, as identifying the right acquisitions could prove a challenge. On a positive note, the PE industry is an unprecedented position to make investments in social and environmental causes that reflect changing market expectations in the backdrop of COVID-19. What are your views on how fund managers can turn this challenge into an opportunity?

I think that's a great point and, you know, as you've pointed out, environmental, social, governance – ESG elements – have really become an increasingly important part of making investments and will do so especially with the EU directives coming out on the taxonomy and disclosure regulations that will come in force next year. And so it really is becoming a huge part of the investment universe. I think what we're seeing with COVID-19 is a real example of how large-scale global events can really bring everyday normal life to complete standstill. And I think people recognise now that the potential next crisis could be climate related, you know, the climate emergency. And so I think, you know, ESG elements are really going to stay in the fore.

Um, and that actually sort of plays out in lots of different ways. ESG has so many parts to it. I think this particular crisis is going to throw a huge spotlight on the social element – the ‘S’. Obviously that piece, as I'm sure you know and have had to deal with, is really hard to define and I think fund managers have struggled in the past in terms of how to really capture what it means to deal with the social aspect. But in something like COVID-9 where it's having such an impact on employees and the wider society as a whole and across all businesses and communities, it will be become very important – especially you know, where fund managers want to look at protecting the brand reputation within their portfolios.

Karl, that’s really interesting you say about the ‘S’ in ESG because what we're finding, with our portfolio monitoring platform, we’re actually adding an ESG dashboard to that because we're getting such an increased demand from clients to be able to report on these matters and feed it out to their investors. But what I see – and it sounds like you’re seeing the same thing – is that the ‘S’ in ESG is coming to the fore as you said, because, you know, you've got the management company or, sorry, the management teams or the underlying companies having to put the employees’ welfare as a massive priority and making sure that, as you said, the brand isn't being tainted at all. But at the same time you've got to ensure that the company is performing as well as possible in terms of its financial performance and potential dividends to shareholders. So, Karl, would you say that there's almost a power struggle when it comes to the social part of ESG between the management team of the underlying portfolio and the private equity investors?

Um, that's an interesting point. I think in the long term it will all be– how it's dealt with now, how the ‘S’ is dealt with now, will really have an impact in the long term. Because, like you say, it's all about brand reputation and the long-term impacts of that. And so, although there might be a bit of a power struggle a little bit at the moment payment because you've got to balance these things up, a lot of studies have shown that, you know, ESG considerations in a portfolio do have a positive impact on the returns of the portfolio. We're obviously in really uncharted territory here, but I think if the whole ‘S’ part is managed really well and that brand is kept, we'll see a bounce for those companies and those portfolios that are really able to ensure that they've dealt with it in the right way. Um, and so there are obviously, yeah, competing thoughts on that, but I think it is going to be really important to do.

And I think that's a really interesting point you make because it's about the duration and people always say private equity investment is a long-term investment. And I think what we'll find with COVID-19 – and I'd be interested to hear your thoughts – is that you will find out whether investors really are a long-term investor or whether they just want to have a quick win.

I think you're right. I think there has to be a longer term play here. We're in a sort of suspended animation almost at the moment, and although there's lots of things that need to be done and that we can do, it will push out the returns. We're going to see some form of impact and so returns are going to take longer to come back. And I think those that can employ the longer term strategy, and also make sure that they capture all of these ESG parts, will really have a stronger portfolio going forward. And therefore, in the longer term, will definitely have better returns. Um, but it will be a ‘wait and see’ and it won't necessarily come out straight away, so there will obviously be – because of other factors and some people being under pressure to, you know, make an investment work quicker – that that will add other pressures. But I think we'll definitely see an extension of the investment horizons.

I think now is also a really good time for fund managers to carry out a review of the fund, the ESG policies that they have in place. Um, they need to ensure that they're up to date, obviously with the latest laws and regulations, but also that you do sometimes see a lag with what was agreed in the fund documents, the final fund documentation and any side letters with individual investors, and actually the fully baked ESG policy. So it's a good time to ensure that that's all together. And again, I think service providers can really assist fund managers in this and making sure that they are compliant with everything. Um, and also, you know, as we've talked about, ESG is so important for a lot of investors that they're going to see a lot more in terms of regular audits.

And so, as investors drill down into those ESG scores, I think the fund managers really need to take that time to look at the policies and how they're coming up with those scores. Make sure it's all in good order. And it's obviously going to be more important now as we see a lot of these factors playing out, how they're dealt with. Um, I think another point maybe to just cover in the ESG aspect is that it covers so much and, I think, one of the most important things is that communication. Really building strong internal relationships, but obviously also business relationships with suppliers and service providers, and community relationships to help enhance the brand going forward. And I think it will be those fund managers that are able to do that, and portfolio companies, that will find themselves in a strong position as deals come back to the market. And also, they’re going to be the fund managers that will find themselves in good demand when they go to raise their next fund because investors in the future will be looking to see how these fund managers weathered this particular storm.

Karl, that's a really interesting point about ESG and, you know, those managers who really embrace it in reports and get some ESG scoring using specialist providers for that. All of that will have some impact though on the returns for the investors. Do you feel that the investors find this is such an important aspect to report on that they will be okay with any sort of dilution of performance or returns in return for getting a good ESG report from their fund managers?

Yeah, well I think there's a few points that. I think, yes, ESG will continue to be important and for some investors it's going to be more important than others. So I guess different investors will take a different stance on it. But obviously, you know, where an investor has investors itself that require that transparency of scores, then they need to make sure it goes up the chain and I think over time what we'll see is more efficiencies built in about how these scores are generated and how the due diligence is carried out and reported on and the audits are done. And so, it won't, I think, in the long run be a real cost to the fund. It will actually enhance the fund and enhance the investments as it develops over time. Especially as, you know, we've got the European directives coming in next year.

Yeah. Okay, great. Thanks for that. It's good to get your insights and thoughts. As you highlighted in your article, MAC clauses and seller disclosures are more important than ever before. What are some risk management measures that fund managers are advised to adopt in the context of live sale and purchase agreements?

For those transactions in the early stages, there's going to be a lot more focus on due diligence and then identifying the gaps and the risk areas and how those have developed in the new world order that we're in. And then it will be about building in more protections to protect that risk that's been identified. And I think we're going to see probably more negotiated terms around key customer supplier provisions, escrow arrangements and probably a more detailed consideration of earn-out provisions. And then I think sort of in the more, you know, the live sale and purchases, it's important to identify the risk areas with two key questions in mind, I think. The first question being: what has changed? For example, are the warranties still correct? Has there been any material adverse change? You know, whether it's in the financial position or otherwise, and whether the obligations or conditions that remain active within one of the transaction documents can be met within the required time, because they’re usually time specific. So, what has changed is the first question. And then the second question is then, what is the position in relation to points that have changed? So you know, how fundamental is it that that warranty is no longer correct? Or how fundamental is it in terms of agreeing that change? Is it a material change or is it just a smaller change in the financial position? And then you have to look at how can that could be cured and defaults and waivers and what the outcome could be for the various parties. That will obviously will be very specific to the individual transaction that there is. I think, you know, we are seeing – just in the last week or so – people, a lot of queries coming up about the earn-out provisions in documents because these earn-outs usually are around a year or so, and so earn-outs that were put in documents a year ago, they suddenly look very different in this new world order. So we're getting a lot of queries about those and how they can be interpreted and things. So you'll see a lot of that going forward, I think.

Um, and then, you know, I think there's a few practical considerations just in terms of actually how you bring all these documents together. The practicalities of signing the documents now that people can't all just get into a room and sign and also even just witnessing documents because everyone, there's social distancing so they're having to sit individually in their houses. Um, certain transactions require notaries, and there's also filings to me made with regulators and tax authorities, which is obviously harder now, although there is good guidance out there, but much harder now with social distancing and just people not being able to move and send documents, et cetera, as easy as they could pre COVID-19. So I think, yeah, each transaction is different. Um, and obviously legal counsel can guide fund managers on the best course of action, but I think wherever those documents are in the transaction, there needs to be detailed thought on how COVID-19 impacts on each of those provisions. And it might be in ways that weren't expected.

So Karl, it sounds like there's going to be a lot more work for the likes of lawyers like yourself?

Haha! I think lawyers we'll be busy in terms of, yes, reviewing the provisions. Um, I think it is a time when lawyers really need to work with fund managers to assist them in the best way forward because it's such unprecedented times. And so, yeah, I think it will be busy times for everyone, but hopefully a collaborative approach and making sure that, you know, these transactions can stay on course as much as possible because ultimately everyone wants to try and minimise the economic impact of this.

And have you seen an increase in queries around this in the last, sort of, three or four weeks?

Yes. Initially there was a bit of almost a lull because everyone was getting used to working from home and what it meant and there was a lot of scrambling around and just dealing with the then and now. And now we are seeing, in the last few weeks we've been seeing a lot more, umm, that agreement that got agreed a year ago, this obligation still remains, but what's the physician and how should we deal with this? Those kinds of questions are definitely coming up more and more. And we are looking back through documents to identify those risks and really working with fund managers to work out what the risks are, how it's changed, but what we can do really going forward.

So the next question is something which we've been heavily involved with and we’ve definitely got a slant and a say on this, but it's around communications and, in the backdrop of COVID-19, how significant those communications and the frequency, bearing in mind, you know, the ability to physically touch base with investors is obviously no longer there. So what are some of the measures that fund managers should be putting in place to circumvent this?

Oh, I 100% agree in terms of communication being so important. It's time for fund managers to really look to strengthen business relationships, stakeholders, investors, suppliers – as we talked about before around the ESG elements. And I think, when there is a crisis, the most important thing is about how that crisis is managed and then communicating that clearly with investors. Everyone's nervous about what's happening at the moment in the market. Investors are going to be particularly nervous about the impacts of COVID-19 on their investments. And it's really important for fund managers to be in regular contact to explain, you know, the impacts and the measures being taken to mitigate any of those impacts. Ultimately fund managers are working round the clock at the moment on their portfolios and working with their portfolios and putting in place all of this framework and due diligence on what's happening and speaking with their service providers.

And so, you know, you really want your investors to know how much work you're putting in to protect their investment. And, you know, it's really key that they do know. We've worked with a few fund managers on those updates to go out, because I think it is important probably not just to bombard investors on a daily basis with everything that's happening. It needs to be thought about in a way that's useful for an investor to make sure that, you know, they get the information they need clearly and concisely. Or whether it's used in something else, like a portal or some other online tool. Because everyone's working at different times now because everyone's having to manage their own particular circumstance there, they want somewhere that they can go to find the information when they need to rather than sort of searching through emails or, or calling up a fund manager.

So, we have seen a huge spike in interest in our portfolio monitoring platform. You know, initially we thought it was just going to be used for an internal analytical tool, but a lot of our fund manager clients are now asking us to open up to their investors so that they can give their investors real time access on a dashboard type environment so they can get the latest information updates from the underlying portfolio companies. So I actually think this is going to perhaps change the way fund managers are reporting to the investors in the future.

Yeah, I think that's brilliant. And as you know, yeah, previously it's been that information will go out on a monthly or quarterly or annual basis and there will be timelines around that built into the fund documentation. But if now actually investors can go into a portal in real time to see what's happening with their investment, I think that level of transparency is going to be really good for investors and how they feel about the investment going forward and their faith in the fund manager.

I've definitely seen that and definitely concur with that one. Um, so it might not, my next question really is touching on the ‘S’ and ESG and something we were discussing earlier about this, sort of, potential for the employees’ welfare in the underlying portfolio companies and also management and performance of the company. So, you know, as more and more economies engage in strict measures to prevent the transmission of COVID-19 – from curfews to full lockdowns – how can fund managers ensure work disruption is minimised even as the health and safety of employees is given the importance it deserves?

Yeah so it’s real tricky one. Um, I think fund managers are actually in a really unique position here because they can help coordinate across their portfolio companies to really sort of help with what assistance is out there, you know, whether it's government schemes or loans or anything like that that’s in the relevant jurisdiction and can really help coordinate that. So yeah, there's a bit of an efficiency there, rather than each company having to go out and do it on its own. I think the current crisis has really seen the vulnerability of certain systems. And so, again, kind of going forward, fund managers can speak with their portfolio companies about what can be put in place going forward to ensure that if something like this happens again, that there's less of a disruption. I mean, we actually had a client that had only stand-alone desktop computers rather than laptops for their entire office, so when the office went to work from home, everyone basically had to get in a taxi and take their entire computer home with them – this massive computer. Whereas other firms have got really good systems in place and laptops and basically it didn't matter where they were working from. And so people had to really play catch up. So I think, you know, investing now in the future is going to really help.

And using, you know, we've talked about some of the tools that are out there. I think there are some really interesting tools out there that can be used in new and interesting ways. One that we saw in the real estate sector is 3D mapping tools. You know, that that tool can be actually operated completely just by one operator. So social distance can, you know, if this carries on, that's possible. And then once you've got the data – and it's really high quality data – that 3D mapping tool can be used for virtual tours of buildings, architects can use it to review schemes and surveyors can actually take measurements from inside the tool. And I think those kinds of tools will be utilised by fund managers going forward.

And all of those tools really help make sure that people can do their job without having to go into the office or to a site. And so, if there is another lockdown, it just means that business continuity continues, which protects the employees as much as possible because you are just restricting the amount of contact with other people. Obviously, not everything can go online and it would depend on the portfolio of companies, but there are going to be obviously a lot of people that need to keep going in and in those kind of cases it's very important I think that there's clear policies in place – whether there's sufficient equipment, masks and visors, that kind of thing, to be given out to employees to ensure their health and safety.

So I think, you know, for reasons that we spoke about earlier, Hugh, regarding ESG, fund managers really need to look consistently at applying their health and safety policies across the portfolio and use best practice, not just what they can get away with, in effect, in certain jurisdictions or situations, you know. The law and policy is very much playing catch-up at the moment because it's such a new and ever changing kind of new world order that we find ourselves in. So yeah, it's about making common sense judgments and, really, best practice in the spirit of the guidance that's currently available.

Um, I think one of the big things that's going to start to become a much bigger issue in the next few weeks is really the mental health of employees. Because a lot of the current focus has been on the physical health and safety, making sure people don't get COVID. But now people have been in prolonged lockdown, that's really going to start taking its toll on the population at large. But you know, it will impact certain people more than others. And I think, where there are employees involved, fund managers should really look at ways that they can make sure that there are processes in place to help those employees as much as possible in that regard.

Yeah, I think there's huge challenges for the HR departments of fund managers and the like. From IQ-EQ, on a lighter note, we've been just doing some smaller things, light-hearted, to sort of ensure that people's welfare is taken seriously. So we're doing virtual drinks on a Friday, we're doing quizzes, tips to help people in terms of home schooling. So there's lots of little things that people are doing to sort of help the mental health of their employees.

Yeah, and I think that's great and we're doing exactly the same sort of thing. I hear the same from lots of friends and, and contacts that work in other organisations. There's lots of ways that you can help support each other and, like you say, virtual pop quizzes and things is a great way.

So my last question is, you know, as deal flow slows dow and the everyday sort of activities are reducing, is it the right time for fund managers to focus on operational efficiency?

I mean, that's a really good question. I think operational efficiency is an important aspect of fund management at any time really, you know, no fund manager wants to eat into their returns unnecessarily. Um, I think now the initial hiatus has passed to a degree, it would be, yeah, a good time for managers to start looking in more detail at a top-down review of, you know, evaluating all of the operations in the fund and working out whether there are any efficiencies to be had. And I'm sure there will be, again, you know, using service providers to help or looking at the data more and really drilling down into that. I'm sure there's going to be definitely some easy wins in terms of cost and time saving efficiencies. But there could be sort of much bigger operations that can be either outsourced, you know, to a firm that might have the resources and that can assist, that can add the business continuity. And so, I think, yeah, now would be a great time to start looking at the options available.

Oh yeah. I can completely concur coming from a service provider. So yeah, we're going to be on that one!

Well I thought ultimately you're a service provider and, although there's something in it for you, actually what you can provide is something that is more efficient than someone being able to do that internally. If, you know, it's all about economies of scale, isn't it? So I think, you know, it is great and there are lots of service providers out there doing different aspects and being able to collect data in different ways. But it's about using that data in the right way. And it's about having the right, uh, operations for your fund. And the way that that fund, you want that fund to work.

I think that's the key point, that you can gather as much data as possible but it has to be consistent, it has to be useful and you have to be able to turn that data into intelligence. And there's lots of ways of doing that. But uh, yeah, you know, just having a software platform doesn't necessarily mean that you're going to get any better intelligence necessarily. You just have to ensure you're using in the right manner.

Exactly. And it's about some of that software as well, being able to talk with other software that you might be using. So yeah, if you've got data here, if it's just in one table format, it could be useless. But if you can use that and extrapolate, like you say, that data in the right way for what you need for the fund, it can really enhance what the investors are getting in terms of transparency.

Yeah. And from speaking to a lot of fund managers in terms of our portfolio monitoring solution, you know, I think days are gone now where that people are using Excel and using tabular format. People want to see pictures, graphs, um, to ascertain that information quicker, if that makes sense.

Yeah, definitely. I mean it's that dashboard isn't it? You have a dashboard and then if you want you can click down through into the data, but ultimately you get something that's much more user friendly that you can, as an investor or as a fund manager, you can go into and use that data in the way you need to.

Yeah, yeah. No, completely, I'm seeing that a lot at the moment. And eh, yeah, if you ever get bored of being a lawyer, Karl, you can come be one of my sales directors.

Haha! Thanks very much.

So thanks very much, Karl, for being our guest speaker today on our podcast. And actually thank you the listeners as well. Um, you can read the full interview on the IQ-EQ website, on iqeq.com. So thanks very much and stay safe everyone.

Thanks Hugh. Yep, agreed, please stay safe and well.