The Future of Funds by Maples Group

THE FUTURE OF FUNDS

Essential Insights from Maples Group’s Insights Investment Funds Forum

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Executive Summary By Adam Donoghue and Harjit Kaur

Hedge Funds: Challenges and Opportunities By Dan Beckett

Private Assets: The State of Play By Michelle Barry

ESG Investing: Where Next From Here? By Ian Conlon

About the Maples Group Funds & Investment Management Practice

December 2023

EXECUTIVE SUMMARY Adam Donoghue

Co-Head of Practice | Funds and Investment Management Maples Group Dublin

Harjit Kaur

Head of Practice | Funds and Investment Management Maples Group London Throughout 2023, the funds and asset management industry has navigated various local market forces, revealing some consistent global themes. Firstly, the macro environment has underscored our vulnerability to political and worldwide events. Notable developments including the on-going Ukraine crisis, the slowdown in China, the surge in energy prices and persistent inflation and interest rate increases have all had diverse and significant impacts on performance, products and fundraising efforts. A prominent theme this year has been liquidity. At one end of the spectrum, we have seen a trend towards closed-ended products to access illiquid private market strategies, secondaries and infrastructure funds, in particular. At the other end, the rise of ultra-liquid exchange-traded funds (ETFs) continues at pace. While sustainable finance is rapidly advancing, asset managers are already grappling with big challenges, from inconsistent data and disclosure obligations to the looming threat of greenwashing litigation. Despite these hurdles, the opportunity remains that there is a vast amount of capital that needs to be deployed to finance the climate transition agenda.

Regulatory adaptation is a constant factor in our industry. The SEC’s new private funds rules could have a significant impact and the upcoming amendments to the AIFMD regime are likely to have implications for delegation models in EU funds, as well as for credit managers engaged in loan origination. As returns in traditional asset classes become more muted, we have seen increased interest in offering retail investors exposure to alternative products. In Europe, we are excited about the prospects of the upgraded European Long-Term Investment Fund (ELTIF) regime as a means of connecting retail capital with long-term, lessliquid assets. So how is the industry confronting these challenges and opportunities? In Q3 2023, we gathered some of the sector’s brightest minds at our Insights Investment Funds Forum to find out. Eimear O’Dwyer, the co-head of our Dublin Funds & Investment Management team, also spoke to James O’Sullivan, Head of Funds Authorisation at the Central Bank of Ireland about the regulatory climate in 2023 and beyond. Here are the insights we gained.

HEDGE FUNDS: CHALLENGES AND OPPORTUNITIES Dan Beckett

Partner | Funds and Investment Management Maples Group London

“The superior man, when resting in safety, does not forget that danger may come. When in a state of security he does not forget the possibility of ruin. When all is orderly, he does not forget that disorder may come.” -- Confucius With high interest rates and inflation creating a challenging economic environment, what effect have trading conditions had on managers and in particular, in-house legal counsels? “It can have a knock-on effect with new fund formations, side letters and funds of one. Good performance brings increased interest in what we provide and last year was no exception.” -- Panellist We then discussed the pressure on fees and retaining talent. Given the regulators’ focus on fees, how are hedge funds tackling the hiring challenge? It was interesting to hear agreement that you cannot solve this perennial problem simply by throwing money at it. Compensation is important, but so too are development, support and coaching. “We offer a highly collaborative working model and we hope we attract people who want to come and work with and learn from others – it’s a model that has stood the test of time.” -- Panellist

But in a candidates’ market, hiring and remuneration costs will inevitably go up. If hedge fund managers are becoming more expensive, what does this mean for investors? For our panel, it means an increase in two things: diversification and communication. On diversification, a bifurcation of fee models is allowing funds to cater to all investor attitudes. “More commoditised product has put a downward pressure on fees. On the other hand, you can command higher fees for premium products. We address both ends of the spectrum.” -- Panellist When it comes to communicating higher fees to investors, the key is clarity. Disclosing a pass-through model up-front, for example and explaining the benefits of the approach are paramount. “The narrative to investors is, ‘We want to get you the best talent for the best performance, and this is how we’re doing it.’ Provided you’re clear as to your model, it’s for investors to decide if they want to get on board.” -- Panellist We then discussed the pass-through model, which has been muchpublicised and endlessly-discussed. In our panel’s experience, is it something investors have been happy to put in place? The sentiment was that if performance is good, the pass-through narrative makes sense. And generally, the conversation with investors around the potential for higher fees has been positive. “Thanks to the success of the multi-manager model, passthrough is acceptable now in a way it wasn’t 10 years ago. Investors will give you an opportunity to show you can deliver and pass-through is not a red line for very many investors.” -- Panellist Shifting focus slightly, I asked the panel for their initial reaction to the new SEC Rules for Investment Advisers. One panel member admitted to breathing a sigh of relief when the standard of care proposals were dropped but remains cautious on preferential treatment and the definition of ‘similar pools of assets’. Another panellist was optimistic that European managers, having gone through AIFMD and “the pain of preferential treatment and disclosures”, will deal with whatever the new rules throw their way:

“There may be considerations around whether disclosures will have to be a lot more specific. But on some of the calls I’ve been on recently, US counsels sound quite upbeat. So I’ve got my fingers crossed that the earlier pain (of AIFMD) will serve us well now.” -- Panellist As the rules had only just been published, we were all reluctant to say with confidence what their impact would be – but it was good to hear that they may have the potential to generate some positive outcomes. Sticking with the regulatory theme, the Financial Stability Board is preparing to update its recommendations on liquidity management. IOSCO is also updating its guidance on anti-dilution tools. How did the panel feel about the prospect of additional regulation? Our panel felt that funds have been on top of planning for ‘stress situations’ for some time and that the regulators, particularly during new fund set-up, are much more on top of this now too. As one panellist put it, this is essentially about internal risk management: stresstesting, monitoring and reacting. It is a question of institutions applying the tools and resources at their disposal. “When you create the product you have to make sure it has the right tools and liquidity means to deal with a stress situation, and this is much more front of mind now than it was 15 years ago.” -- Panellist Changing tack, I was interested to know what drives the choice of jurisdiction for a new fund. Is it purely investor-driven? For our panellists, it is simply about what will work best. There are strong speedto-market and quality-of-advice considerations. Well-trodden, frictionless routes will always be revisited. But investor preference is important and again communication plays a vital role. Where previously a fund targeting US investors would almost certainly need to be Cayman Islands-registered, for example, things are different today: “US investors are more comfortable with other jurisdictions now. There are commonly tax or market access reasons why you want to register the fund in Ireland, for instance. And that’s what would drive the conversation with investors: the desire to get them the best returns.” -- Panellist

To round out a thoroughly enjoyable session, I asked our panellists and our audience: what will be the biggest challenge for hedge funds over the next 12 months? Unsurprisingly, compliance was front of mind. There is a concern around the SEC rules bringing an increased workload on disclosure and reporting and on internal education and monitoring also.

What will be the hedge funds industry’s biggest issue over the next 12 months? Compliance with new regulation

37% Trading conditions

24% Capital raising

37% Preventing outflows

13% Staff retention

Source: Audience poll conducted during the session (78 responses).

A fascinating session and since I let him set the scene, I could not resist letting Confucius draw it to a close:

“It is easy to hate and it is difficult to love. This is how the whole scheme of things works. All good things are difficult to achieve; and bad things are very easy to get.” -- Confucius As we continue to chart a course through these uncertain times, can the hedge fund industry keep making the hard decisions? And can we avoid making the bad, easy choices?

PRIVATE ASSETS: THE STATE OF PLAY Michelle Barry

Partner | Funds and Investment Management Maples Group Luxembourg To kick off our private assets panel, I jumped straight in with private debt, which is an essential source of financing both for companies and the real economy. So, how is the landscape in 2023? One panellist called this a “golden age” for private credit, a claim the rest of the panel were quick to agree with. High interest rates and high yield potential have brought a spike in investor interest over the last couple of years: “We’re seeing a tremendous opportunity to achieve equitylike returns in the direct lending space with a senior creditlike risk. From a fundraising perspective, it’s an intensely competitive space. I spend half my time just focused on direct lending products.” -- Panellist While this has generally been seen as a positive, an “incredible deal flow” and “deep bench of available deals” have given rise to a crowded market where the balance of power increasingly lies with the borrower. As one panellist put it: “The feedback from our teams is that they’re passing on loan opportunities because there are so many bidders. Borrowers see that as an opportunity to pit lenders against each other and we’re having to choose our deals more carefully.” -- Panellist Next, we turned our attention to the broader topic of fundraising. Amid a reported slowdown across different private asset classes in 2023, how are funds finding their way? What was interesting about our panel’s response here was how different the perception is at fund level, compared with the broader external narrative. Investor demand feels robust, they said, albeit with more of a “micro focus” on specific assets, as opposed to the total lack of interest that the cold, hard numbers might imply:

“There always seems to be someone interested if you drill down close enough. In credit, for example, maybe there’s more interest in whole loans to mid-market companies than in trading distressed. The feedback we’ve had from investors is that they’re focussed on very specific assets or asset classes, rather than having no interest in fundraising at all.” -- Panellist So, overall, perhaps the fundraising picture is more positive than the headline figures suggest. As one panellist summarised: “Points of interest for investors have changed, but there’s still interest.” Having predicted that robust investor demand will continue, what else did the panel expect from private assets in Q4 2023 and beyond? One prediction united our panel here: investor demand for customisation will be huge. One panellist described a “groundswell of bespoke mandates” from investors who “want something different”. Acknowledging an ongoing trend for customisation, another panellist said they are paying close attention to investor demands and incorporating their learnings into investment strategies: “Unlike in the hedge fund world where investors are looking at total returns or just big asset classes, in the private fund world investors are looking at the individual names of underlying investments. Almost all our conversations are around personalised or bespoke mandates.” -- Panellist For the asset manager, this can be extremely interesting work. The concern is it can also be extremely time-consuming, not to mention a “bucketing” nightmare. With so much customisation on the mandate, the lines between buckets are beginning to blur: “Buckets are colliding and that takes a lot more time internally. If you’re not just taking their last loan document and scratching out the dates and refinancing – there’s a lot more work. It’s an exciting time but it requires a lot of effort from legal and compliance.” -- Panellist Next, I wanted to hear the panel’s thoughts on the topic du jour: the retailisation of private assets. Is this something they are investing significant time in? Here we heard some markedly different experiences, with panellists split according to size. For larger firms, the opportunity is huge and the resourcing investments have been commensurate.

For smaller firms, the trick is figuring out how to compete when you have 100 employees and your competitor has 3000. It is a puzzle they are still trying to solve, as one panellist explained: “We’ve spent a lot of time looking and learning and watching what everyone else is doing. We haven’t really jumped in. The lift involved is high when it comes to compliance, operations, investor relations. To do it well you have to add headcount.” -- Panellist Even if you can handle the lift, retailisation is not pitfall-free. Our panellists described a cultural shift for both investor and manager, one that will require a great deal of education to get right General partners who are used to calling and deploying capital whenever they need it will have to adjust to having far less control over their capital inflows. For limited partners, understanding liquidity is key: “[It’s about] explaining to retail investors that these are semi-liquid products. That these are asset classes that may or may not be able to provide liquidity on any given day, that’s important… The sheer volume of people you need to make it work is astounding.” -- Panellist For now, this remains an attractive proposition that smaller managers will happily take advantage of – if they can overcome some pretty significant cost and resourcing hurdles. It will be interesting to watch this play out, particularly in Europe with the recent ELTIF revamp. Moving on, and with one eye on the day’s upcoming ESG session, I asked our panel: how have you been affected by the increased focus on sustainability? One panellist said they had funds for which environmental, social, or governance factors were a core part of the mandate but was unequivocal about their ultimate aim: “Our goal is to maximise risk-adjusted returns for investors, full stop… It’s about marrying them [ESG factors] into the fund’s strategy in a way that’s consistent with what the investors have signed up for, rather than doing it for the sole merit of considering ESG factors.” -- Panellist A gradual increase in anti-ESG sentiment throughout 2023 has left funds catering to clients at either end of a broad spectrum as well as all those who sit somewhere in between. One panellist sees an opportunity for investors who are willing to look beyond a headline and consider ‘good companies’ that have been given ‘anti-ESG’ labels that do not tell their full story:

“In private credit, one of the best opportunities is where the banks will no longer tread. It becomes an opportunity if you have dry powder that’s not hampered by any particular restriction or industry, or any other mandate.” -- Panellist Wrapping up, I asked our panel and audience about the likely impact of the SEC’s new private funds rules. How do people expect the new rules to affect the industry? Once again, our panellists were neatly aligned: they just do not know at this stage. A lot of time and effort has been invested in trying to interpret the rules, but a lack of clarity remains particularly around what constitutes a ‘similar pool of assets’. This sentiment was also reflected in the results of our audience poll, with 47% of voters expecting the new rules to increase investor costs and curb competition and 41% expecting them to usher in more fairness and transparency.

Do you expect that the SEC’s new rules around private funds... Will increase costs for investors and curb competition

47% Will result in greater transparency and fairness in the private funds market

41% This is the first I’m hearing of these new rules and as such I have no expectations

12%

Source: Audience poll conducted during the session (51 responses).

“We don’t believe we’re treating investors unfairly, but some investors have specialised reporting rights precisely because they came with a very bespoke mandate. If that has to be expanded out to more generic pools… it could be a big headache.” -- Panellist Given the current challenge to the SEC’s new rules by various industry bodies, a ‘wait and see’ strategy feels like a sensible approach.

ESG INVESTING: WHERE NEXT FROM HERE? Ian Conlon

Head and Partner | ESG Advisory Group and Funds & Investment Management Maples Group Dublin The value of EU sustainable funds has hit €5 trillion¹, accounting for 45% of the entire EU fund universe². Global assets under management (AUM) in ESG products is expected to hit $34 trillion by 2026³, and investor sentiment for ESG and impact strategies remains strong. Against this backdrop, what does the future hold for ESG investing? Firstly, I wondered what the industry is doing to funnel private capital to the places where climate adaptation programmes are most urgently needed. ? One panellist described a “huge mismatch” between where funds are going and where they are needed, noting that the vast majority of investment is going to developed markets when “60% of future emissions” are expected to come from emerging markets. Interestingly, when we polled our audience on this theme, two thirds of respondents felt regulatory intervention would be needed to accelerate this reorientation of private capital.

What is most likely to accelerate the reorientation of private capital to meet our net zero objectives? Political and/or regulatory intervention / incentivisation

62% The profit motive

34% The moral imperative

Source: Audience poll conducted during the session (74 responses).

¹ https://www.morningstar.com/en-uk/lp/sfdr-article8-article9 ² https://www.efama.org/sites/default/files/files/EFAMA_MKT%20INSIGHTS%2312_final.pdf ³ https://www.cityam.com/global-esg-funds-set-to-hit-34tn-by-2026-says-pwc/

As far as strategy goes, one panel member said they will continue to invest in development bank-originated projects – but also look to self-originate mitigation and adaptation projects in emerging markets. They also shared this fascinating insight from their own research: “We think if we, collectively – as pension funds, private investors and insurance businesses were to invest less than 1% of financial assets currently outstanding in climate change mitigation and adaptation, it would be sufficient to tackle the challenge.” -- Panellist Businesses that need the most help to decarbonise are often excluded from investment on environmental criteria. How can we engage rather than exclude high-carbon companies? One panellist pointed to the Nordic region as a potential standard-bearer. Once seen as the pioneers of fossil fuel exclusion, firms in that region are now looking to stay invested in carbon-intensive companies and use the tools of engagement to move them along. Underpinning this, they added, is a cultural shift from making investment decisions based purely on one volatile, heavily-estimated metric: carbon emissions tonnage. “We designed an indicator that’s multi-dimensional… looking at the quality of [the company’s] commitments, its decarbonisation strategy as a whole, its commitments to green capex. We think that’s the way forward.” -- Panellist How do we avoid pulling essential capital away from companies that, on paper, do not look best in class but are actually on the right path? Answering this question will be vital for meeting our climate goals. BlackRock’s Larry Fink says he is no longer using the term ESG because it has been “entirely weaponised” by both ends of the political spectrum⁴. Did our panel agree? In transpired that there was complete agreement with Mr. Fink, with panellists describing different aspects of the confusion surrounding the topic. For one, clearer distinctions between fact and prediction are urgently needed: “We really need to make sure that we know what the data is and that the data is right, and that we make the distinction between science (and economics and finance is not science) and somebody’s assumptions.” -- Panellist

⁴ https://www.reuters.com/business/environment/blackrocks-fink-says-hes-stopped-using-weaponised-termesg-2023-06-26/

For another of our experts, there has been a ‘complete conflation’ of the terms ‘ESG integration’ and ‘sustainability impact’. This has led to accusations that ‘sustainability outcomes’ are being imposed on investors, and sparked a backlash against individual managers deemed guilty of it: “ESG integration is simple. We’re trying to mitigate the financial risks associated with ESG factors. We’re not trying to impose any type of outcome… we’re just trying to limit the risks on their capital. In Europe we understand the differences between the concepts, but it’s less well-known in the US. I don’t see it abating until we get the results of next year’s election.” -- Panellist We have seen greenwashing fines increase in recent years and a new definition of the term from ESMA. Is the clarification welcomed and how can firms mitigate greenwashing risks? On mitigation, one panellist felt the starting point has to be legal and compliance policies that “have teeth and buy-in” across the firm – so the impacts of disclosures and monitoring are understood. External support has a key part to play in this infrastructure too, with many firms looking to pair outside ESG legal advisers with their own (often newly-hired) inhouse specialists. In terms of ESMA’s greenwashing definition, one panellist welcomed the clarity but felt asset managers should not have been surprised by anything it contained. For them, the industry’s lack of alignment on greenwashing is the real issue: “From my research on peers, everybody is miles apart… they’re coming at it from different directions. We get different legal advice depending on who we talk to. It’s been a real headache, a real challenge. The volume of time and resource needed to ensure we don’t fall into the greenwashing trap – it’s tough.” -- Panellist While strong policies and procedures were seen as essential, we also heard that mitigating against greenwashing is fundamentally about delivering on your initial commitments: “What’s important is not making misleading statements. ESG rests on making statements of ambition. Saying, ‘We’re not doing this now, but we’ll get there.’ You need to make the scope of the ambition clear, to say how you’ll get there and how you’ll report. You wouldn’t market an impact fund that says it’s going to do X, Y and Z – and then doesn’t deliver.” -- Panellist

In closing, I asked our panellists to make a wish for the ESG investing space over the next 12 months. What were they hoping for? Unsurprisingly, regulation and the regulators were recurring themes. We heard a call for better interoperability between regulators and for industry practitioners to get a seat at the regulatory table – particularly in the context of SFDR 2.0. And while they felt we were unlikely to see total convergence between US and European ESG regimes, one panellist hoped we might at least see some alignment on data: “There’s a huge challenge in getting any kind of data in private markets and it would be helpful to converge around what that data is – as well as how it gets packaged up, marketed and reported on.” -- Panellist

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