posted 10 Aug 2007 in Volume 10 Issue 3

Country report: Permanent-capital vehicles – here to stay

By Benjamin Wrench, senior associate, Ozannes

It seems that KKR is rarely out of the headlines, firstly with their innovative “permanent-capital” fund structure, which facilitated the successful raising of US$5bn, then by the disquiet caused by partnership interests in the fund trading at a discount, and more recently of course in respect of their takeover of Boots the chemist.

All this activity has produced more heat than light on the fund structure that KKR blazed a trail for, so perhaps now is the right moment to assess the rationale behind the structure.

Why permanent-capital?

One of the characteristics of a permanent-capital vehicle is that the proceeds, and hopefully profits, of the realisation of the fund’s investments are reinvested; instead of being returned to investors, as would normally be the case with a private-equity limited partnership investment vehicle.

For investment managers this has distinct advantages: not least because their fees are calculated on the basis of assets under management. The ‘rolling up’ of profits, and their automatic reinvestment, means that not only can the manager increase its fees but it can also save the time and cost of raising more money to fund the later investments.

It is not a surprise therefore that KKR Private Equity Investors LP was followed swiftly by AP Alternative Assets LP (managed by Apollo) and others.

Both these private-equity limited partnerships used a similar structure in which limited partnership interests were listed in order to provide liquidity. Many institutional investors prefer to invest in securities that are listed on an EU-recognised exchange, and it was to satisfy this demand that KKR and Apollo settled on Euronext.

For such large funds it would have been natural to list on the London Stock Exchange (LSE). However, partnership interests cannot be listed in London. KKR and Apollo were keen to reflect the traditional private-equity limited partnership structure, and were therefore reluctant to establish their respective funds as corporate vehicles. Nevertheless, corporate vehicles would also have faced difficulty in listing on the LSE because, among other things, an LSE-listed fund is not permitted to take legal or management control of investee companies. It must also have a board that is independent of the manager and it is prohibited from concentrating more than 20 per cent of its portfolio in any single investment. The permanent-capital vehicles also include provisions that disenfranchise the partnership interests from voting rights. The listing rules of Euronext are more flexible in respect of all of these aspects than the equivalent LSE rules.

Moreover, the continuing obligations of Euronext are less onerous than those of the LSE and have no portfolio-reporting requirements; no restrictions on cross-holdings; nor requirements to gain shareholder approval before altering the investment policy.

Why Guernsey?

Guernsey was perhaps a more natural choice of jurisdiction than Euronext may first appear as a choice of listing. Many of the private-equity managers have extensive experience of operating private-equity funds through Guernsey. Being offshore, Guernsey provides tax neutrality, and its relatively close physical proximity to London enables the fund’s board of directors to demonstrate more easily that the “mind management and control” of the fund is located in Guernsey rather than anywhere else. As Guernsey is outside the EU, it is also the case that value-added tax is not chargeable on services provided to the fund (including management fees). Also, Guernsey does not levy stamp duty on the transfer of either shares in companies or interests in limited partnerships.

Guernsey was particularly favoured as an offshore jurisdiction because the Authority for the Financial Markets, the Dutch Securities Regulator, recognised Guernsey as a jurisdiction that applies an “appropriate level of regulatory supervision” over funds established there, with the consequence that the Dutch authorities are prepared to grant a listing to most Guernsey funds.

The future of permanent-capital

The permanent-capital structure also has advantages for fund managers outside the private-equity arena. Hedge-fund managers prefer the permanence that comes with a closed-ended fund in which there are no redemptions to cause a fluctuation in the assets under management.

Following on the heels of KKR and Apollo, in the autumn of 2006 two permanent-capital hedge-fund vehicles were launched (respectively by Boussard & Gavaudan and by Marshall Wace), both of which took the form of closed-ended Guernsey companies listed on Euronext in Amsterdam. Between them they raised over US$2bn.

As with the private-equity vehicles of KKR and Apollo, these funds intended to invest in underlying funds that were already managed by the manager of the permanent-capital vehicle.

Even though it would have been possible for these two funds to list on AIM, in the manner in which New Star Absolute Return Fund PCC Limited did in mid-2006, the Euronext route had been given a great deal of momentum by KKR and Apollo.

The corporate permanent-capital vehicle has certain advantages over the limited partnership version, especially where, as in Guernsey, the company can hold shares in treasury in order to manage any discount to net asset value in the price of shares. This is perhaps where the future lies.

Benjamin Wrench is a senior associate at Ozannes. He can be contacted at benjamin.wrench@ozannes.com