ICG plc (ICG) Earnings Call Transcript & Summary

Hello, everyone, and welcome to ICG's 2020 Year-end Results Presentation. [Operator Instructions] So without further ado, I can now hand you over to our Chief Executive, Benoît Durteste. Benoît?

Thank you, Ian, and thank you all for making the time and joining us for our results presentation. I do hope that you and your families have stayed safe and healthy during the peak of the pandemic and hopefully that you're starting to feel the progressive easing of restrictions. Some highlights for the year. This COVID crisis create significant uncertainty, and we will be discussing what this means for ICG going forward. The year to March 2020 has been another strong year for us. It was a record fundraising year with EUR 10.2 billion raised and a 22% growth in assets under management, reaching just in excess of EUR 45 billion. This has led to a 27% increase in Fund Management Company profit to just over GBP 183 million. Unrealized losses incurred as at the end of March have translated into a GBP 72.3 million loss for the Investment Company. This brings overall group profit to just under GBP 111 million. We have EUR 11.4 billion of capital available across our funds both to support portfolio companies through and post crisis and to take advantage of market opportunities. We also benefit from a strong balance sheet with EUR 1.3 billion of liquidity and low gearing. For those of us who remember the GFC, ICG is in a very, very different position, a much stronger one, not only to prove resilient, but to come out of the crisis in an improved competitive position. Final ordinary dividend is 35.8p per share in keeping with our dividend policy. Total ordinary dividends in the year are up 13% to 50.8p per share. It's worth highlighting that this double-digit increase, which results from the continued growth of FMC profit, comes after a year in which we had increased full year dividends by 50%. What's been our response to the COVID-19 crisis? There would be a lot to say here, but what I really want to emphasize about our experience through this crisis, what struck me, is the exceptional attitude and commitment of our teams and also of that of our portfolio companies. All companies have experienced the crisis differently depending on the activity, industry, size, geographic presence. We notably have significant exposure to health care. And some portfolio companies were on the front line of this health crisis, actually dealing with human lives. And the level of dedication that I've seen from portfolio company CEOs and employees, often under enormous stress, has been nothing short of remarkable. Our engagement with management teams and with our clients has been and remains a major focus. A leading consultant in our industry pointed out that our crisis communication and update reports set a new benchmark, and that is exactly what we are aiming for. Management teams and clients will remember for a long time how we behaved in this crisis, how transparent and supportive we were. The situation is evolving quickly, of course, and we're having to adapt as economies restart. We've experienced this for several weeks now with our offices in Asia, more recently in Continental Europe and now progressively in the U.K. and parts of the U.S. We have to remain prudent. But what we have observed thus far is a faster pickup in activity across our portfolio than we had anticipated. It's early days, and this could simply reflect an early burst of enthusiasm, but it's definitely a positive sign. We are confronting this crisis in a position of strength. As you know, ICG has radically evolved its business model over the past decade. Today, we benefit from the closed-end and long-duration nature of our funds. Long-term management fees drive the high visibility of Fund Management Company profit, which is the main driver of shareholder value. It's not the balance sheet any longer. The balance sheet is an enabler of future growth. It's a well-capitalized and highly liquid balance sheet, which coinvests alongside our funds. And as a result, it's widely diversified, geographically by strategy and also by nature of financial instruments ranging from senior debt all the way to private equity. This diversification is a key aspect of our strategy. It's critical for long-term resilience and also for growth potential. And finally, on that note, the current crisis obviously presents challenges but also exceptional investment opportunities. And unlike 11 years ago, we are in a very favorable position to take advantage of these opportunities with a strong liquid balance sheet and significant dry powder in our funds. Taking a look at the operating, I'm going a bit fast, review and starting with the market update. As we discussed during our Capital Markets Day, which, believe it or not, was only a few months ago, the alternative asset management industry has enjoyed meaningful growth over the past 10 years, boosted by increased demand from institutional clients and broadening investment opportunities. The GFC acted as a catalyst for this growth, and I believe that the current crisis will further accelerate the shift towards alternatives, towards greater allocation to alternatives as investors seek less volatility, higher returns in a low interest rate environment as well as diversification of risk. In the near term, this is translating into greater opportunities for existing strategies and possibly a window of opportunity for new strategies. And taking a few examples, strategic equity, which intrinsically has a distressed component, is seeing meaningful increased deal flow, and the opportunity set can only increase in the wake of the crisis. We're actually exclusive on 2 transactions, as we speak, one in Europe and one in the U.S. We have just raised Fund III last year at the hard cap and are likely to be at least 50%, 60% invested by the end of the year, and therefore, could be back in the market as early as next year, well ahead of plan and hopefully, with an even bigger fund. Sale and leaseback is another example. The new strategy we have successfully launched last year, it also finds itself in a sweet spot as financing needs create investment opportunities, and the asset-backed downside protected nature of the strategy makes it very appealing to investors in this environment. Incidentally, we've signed up a new sizable U.S. investor for that fund just this past week. So there is life in this market. I could also mention our direct lending strategy. The current crisis is precipitating the retrenchment of commercial banks from buyout finance. This will be shifting even more towards private lenders and should lead to further increases in future fund size. As one of the largest players in the space in Europe, we're well placed to benefit. In addition, the shock to the system caused by the pandemic is creating a window for more opportunistic strategies. It's too early, however, to have a view on the size of the opportunity. It will depend on the nature and speed of recovery as well as ultimately the level of demand from investors. A word on ESG. As you may remember, ESG was a key focus during our Capital Markets Day. And in many ways, this crisis reminds us why ESG is important. It's a fundamental trend and an integral part of our strategy and investment approach. We've built a solid reputation in ESG in our industry, and we're firmly intent on continuing to build on it. Our 2 most recent strategies, sale and leaseback and infrastructure equity, have a strong ESG component. We are, for instance, exclusive right now on a renewables energy transaction. We've also just commissioned a study on climate change with a view to help our portfolio companies, assess potential impact and remedial actions and also for us to have more tools to better understand and take into account climate change risk throughout our investment decision-making process and our portfolio management. Fund performance. As you know, our strategies are long term. Short-term movements in unrealized losses or gains, for that matter, are largely irrelevant. What matters is the ultimate performance of each fund, each vintage. All of our funds, and you'll recognize the list here on this slide, all of our funds, without exceptions, have experienced a crisis, in some cases, several, and that should be expected for long-term 10-, 12-plus year strategies. To be able to preserve the consistency of performance that we have demonstrated for decades and which is highly valued by our investors, I've often said that it's our #1 asset. Our portfolios and funds have to be managed appropriately. This has implications on structuring, realizations and deployment. So let's look at structuring. We have historically used structuring to improve the risk return profile of investments and to protect downside. This conservative approach is reflected in our numbers. As you could see, the leverage levels across our strategies compares very well to peers. We are at the lower end of the risk spectrum. But that's only part of the story. You have to really differentiate by nature of risk. For a given leverage, your risk is very different if you hold the debt instruments or if you're in the equity sitting after the debt stack. As you could see here, these are the bubbles on the right-hand side, for our equity and subordinated debt strategies, underlying average leverage is below 3.7x EBITDA. For our debt strategies, we accept a slightly higher leverage, you can see here, 4.6x on average, which is still relatively conservative. And also, we're in the less risky part of the capital structure. So it's very important to differentiate by nature of risk and what this boils down to is that we have a highly conservatively structured portfolio. Structuring is also not just at deal level, it can also be at fund level. And there, again, we have adopted a very concerted approach. Even our senior debt funds do not use leverage at fund level, which is unusual, most of the industry does. But of course, this puts our funds in a very solid position coming into a crisis. So this is a familiar slide on realizations. And you all have heard me in the past repeating that we are disciplined in realizing assets, anchoring gains and protecting downside. This approach takes all its importance now in a period of crisis and uncertainty. To illustrate the point, on the right-hand side of the slide, have used 2 of our most profitable strategies, the European flagship fund and the Strategic Equity Fund. Both strategies have realized assets during the past year, materially improving the risk profile of several vintages as a result. For the European fund, a significant realization last summer helped fully derisk Fund V, which, as you can see here, has already returned close to 1.5x the money. There's still significant additional value in that vintage, but whatever happens, this fund is already a success, it's track record. Likewise, Fund VI, a more recent fund, Fund VI is only 3.5 years old, so quite young for a 10-, 12-year strategy. The fund has already returned almost 60% of the capital. And in the same vein, ICG's Strategic Equity I was fully realized during the year. So in now it's entirely track record. And Fund II, which is a much more recent fund, has already returned close to 80% of the capital. So incurring early performance in funds' life creates significant downside protection and enables you to work through cycles. Knowing when and how to realize is critical. On that note, incidentally, we have agreed this week 2 realizations that are worth mentioning. One, for one of our oldest assets at a valuation that is more than 25% above the pre-COVID valuation. And the second one, and this one is for one of the largest exposures we have on balance sheet, and we have opted to crystallize gains by selling approximately half of our holding, again, for a valuation that is above our last September valuation. This should bring altogether over EUR 100 million additional cash to the balance sheet. So even in this environment, if you've been conservatively marking your assets and you're in the right industries, there are realization opportunities. Realizations are important, as we've just seen, but of course, the other side of the coin is deployment, which is another familiar slide. But we don't usually break it down to show the difference in risk approach between funds, which is the left-hand part of this slide. What that shows is that in the 12 months preceding the crisis, we have seriously reduced our investments in equity and subordinated debt with the bulk of our investments in senior secured instruments or asset-backed strategies. So at the lower end of the risk spectrum. And this reflected our view that markets were overheating, and as a result, puts us in a better position to weather the crisis. We actually only did 2 equity deals during the past year globally, which is our lowest deployment in equity in years. And additionally, we were lucky as one deal was in pharma and the other one was in food, and both have seen revenues increase by 20% -- 25, actually, percent plus since the COVID crisis. So how do you preserve consistency of high performance through cycles, which is the key? It's conservative structuring, it's discipline on realizations to anchor that early performance and it's discipline on deployment to know when to pull back on higher-risk investments. Let's take a look at fundraising now. And as pointed out earlier, this has been a very strong year for us, again, certainly well ahead of our budget. Three aspects I would draw your attention to. One, we benefited from our diversification with 11 strategies contributing to this achievement. Two, I mentioned last year during the results presentation that this was the first time we would try to raise 2 first-time funds in the same year and let alone 2 new funds with fees on committed. That's sale and leaseback and infrastructure equity. I also pointed out that success on 1 of the 2 would be a good achievement. Well, we've actually managed a successful first close on both. With both strategies being highly scalable, this is very positive for future profit growth. And the third point is, as you know, we brought forward the fund raise for SDP IV, our flagship senior debt strategy. And retrospectively, this was obviously an excellent decision. Over the past 2 years, we have raised capital for all of our main strategies, all of our flagship funds. This has translated into 2 consecutive double-digit fundraising years, so well ahead of our long-term target. But more importantly, it means that we do not need to go back to market in the near term for one of our large flagship strategies. We're fortunate in our fundraising cycle, if you will. Last year was supposed to be a low year in our cycle. By bringing forward SDP, it's now the current year that's going to be a natural low point in our fundraising cycle, which is fortuitous given the more challenging fundraising environment we expect near term. The other implication of this helpful fundraising timing is that we have significant dry powder, the most we've ever had, actually. We are in a strong position to support existing portfolio companies as well as take advantage of the opportunities that we see arising out of the current market conditions. This, by the way, is not incompatible with maintaining our strong investment discipline. Historically, it is in the wake of crises that we have found the best risk return profiles for investments. The fundraising outlook and growth prospects. So as mentioned, regardless of the market environment, this was going to be a lower point in our fundraising cycle. We have no significant fund in market this year. We're also expecting a more difficult market environment, at least for a period, as LPs take stock and focus on their existing portfolios. Having said that, building on our momentum, the first quarter is likely to be a good one for fundraising. We're expecting some EUR 2 billion-plus raised by end of June, which is -- it's a very good result in the middle of the crisis. It should not, however, be extrapolated. As I said, we're expecting a much lower rest of the year. We will continue during the year to raise for sale and leaseback and infrastructure equity as well as the tail end of SDP, the direct lending fund. We're also in the market with 3 different optimistic strategies. As I've pointed to earlier, it's too early to say if there will be demand from LPs. That will very much depend on how the economic environment develops in the coming quarter or so. What's important is that we are prepared with fully established strategies already in market. We are, therefore -- we're in a position to provide our clients access to dislocation strategies should they want it. As you know, we also have 2 new strategies waiting in the wings for the market to reopen for first-time funds, and that's traditional secondaries and the U.S. mid-market private equity. So as soon as the market reopens, we will come to market with these 2 new strategies. And in addition, we constantly have live discussions with new potential teams to bring on board. We are notably making some reasonably good progress on a health care strategy. So more on that at the half year. So we're forging ahead with our long-term strategic objective of further diversification and growth, all of which should translate into greater shareholder value. And on that, I'll hand over to Vijay to take us through the financial review. Vijay?

Thank you, Benoît. Good afternoon, everybody. I hope your families are keeping well. I'm delighted to present my first set of year-end results against the backdrop of one of the most challenging periods in history for all of us. However, we face the future with optimism, given our financial performance during the year and the strength of our business model, which I will now go through. Just as a reminder, all the financial information that I will present is based on alternative performance measures, which excludes consolidation of some of our fund structures. For our fund management business, I would like you to take away the following 3 key points, which I'll go through in more detail: one, we have continued our historic growth with over 25% growth during the year; two, we continue to improve our operating leverage and have achieved an operating margin of over 53%; and three, our long-term business model is very resilient with fee visibility of GBP 1.8 billion over the next 10 years. Starting with the growth of our fund management business. Our pace of growth over the recent past has been remarkable. As Benoît touched on earlier, we had the best year in history in fund raising, raising EUR 10.2 billion of third-party capital. Notably, we raised EUR 1.9 billion in March or nearly 30% of our long-term annual guidance when the impact of COVID-19 crisis was just becoming evident. In respect of AUM, at EUR 42.8 billion at year-end, our third-party AUM grew by 24% compared to the prior year and over 60% since FY '18. This growth in AUM has resulted in increased profits. If you look at profits on the right-hand side of this slide, we had record profits of GBP 183 million in FY '20, an increase of 27% on prior year and almost double the profits generated only 2 years ago. As we have grown, we have continued to deliver sustainable shareholder value. Looking at our fund management fee income, we generated GBP 254 million in fund management fee income during the year, a 28% increase on prior year. This growth in fund management fee income is attributable to our fundraising capabilities, combined with maintaining our fee margin, which was 86 basis points, similar to the prior year. Our fees are an equal blend of those charged on committed and those charged on invested capital, as you can see from here. If there was a slowdown in realizations, then this would result in us continuing to receive the fees for longer. On the flip side, if there was an increase in investment activity, then fees charged on invested capital will grow. This interplay between the 2 different sources of fee income enables us to continue to generate a stable fee income through economic cycles, such as one that could arise from this crisis. In addition, given the long-term nature of our funds and the fact that third-party capital is tied up over the long life of such funds, we have good visibility of our fund management fee income. As illustrated on the right-hand side of this slide, without the need to raise any further funds, we have visibility of GBP 1.8 billion in management fee income over the next 10 years from our existing AUM. This fee resilience is the fundamental strength of our business model. The part of the fees that are more unpredictable are a relatively small component of our income. On the left-hand side of this slide, 12% of our income in FY '20 was derived from CLO dividends. This income is dividend -- is dependent on the underlying ratings of the portfolio. While it's too early to take a view, it is likely that if the credit ratings of the underlying portfolios are downgraded, then that will temporarily impact the level of dividends we receive. Looking at performance fees on the right-hand side, we recognized GBP 23.5 million during the year, up just under 7% on the prior year. Our performance fee recognition criteria is based on IFRS principles, which requires us to have a test of high probability that such fees will not reverse in future and factors in exit time frames of the underlying portfolio. Due to COVID-19, we factored in a delayed realization profile, which was a change in our assessment pre crisis. Pre-COVID-19, we were expecting to recognize approximately GBP 30 million in performance fees or 11% of total third-party fees. The performance fees are now deferred and recognition will be dependent on future realizations. Looking at our operating margin. As we have grown, our operating leverage has continued to improve. Over time, we've continued to create shareholder value by scaling our core established strategies. In recent years, we have also invested in hiring and developing talent to launch a wide range of strategies and increase operational capability. These initiatives are starting to bear fruit. Our average head count increased by approximately 20% to 337 during the year. We have, however, continued to maintain cost discipline and increase our operating leverage. As a result, we achieved an operating margin of 53.6%, the highest to date in our fund management business. I will now provide an overview of our investment company. It's worth remembering that our balance sheet is a key strategic competitive advantage. As Benoît mentioned earlier, it's an enabler but also an accelerator of the growth of our fund management business. Entering the crisis, our balance sheet today is very different from the balance sheet in 2009, as you can see from here. I would highlight the following 3 key points. One, our balance sheet portfolio is resilient due to its diversification. We are now well capitalized with a low gearing. And importantly, we have significant liquidity, almost 4x than what we had back in '09. It is important to note that our balance sheet is not the main profit generator of our business. The Fund Management Company remains the main profit generator. I hope you'll understand from this slide, we are now, compared to any other time in our history, extremely well positioned to manage through the crisis. Turning to net investment returns. Our returns during the year of GBP 49 million were impacted by unrealized losses arising from valuations of our portfolio due to COVID-19, and I'll cover that in more detail later on. But before I do that, I'd like to highlight that as we have mentioned in the past, we do not actively manage our balance sheet. The returns are derived from the performance of the underlying funds that the Investment Company invests in. Whilst the returns of the Investment Company provides a snapshot in time, it's critical to understand how the underlying funds have performed on a life-to-date basis. Benoît touched on this earlier, and you will have noted that our funds have performed well, exceeding their underlying hurdle rates. This slide shows the profile of our net investment returns during the year. During the first 3 quarters, highlighted on the left-hand side of this waterfall, we had net investment returns of GBP 188 million, tracking in line with our long-term averages. In fact, up to end of February, we had net investment returns of just over GBP 200 million. As you'd expect, COVID-19 impacted the net investment returns in the final quarter, and we've recognized GBP 152 million of unrealized losses during the last quarter. This translates into 6.4% of the portfolio as at December 31, 2019. Going through each, highlighted within the square box in this slide, unrealized losses in investments in strategies within our corporate business segment that primarily comprises of our senior debt and equity strategies were GBP 51 million or just under 4% of the portfolio. This includes losses on Intelsat, which we have now completely written off, given it has filed for bankruptcy after the year-end. During the quarter, we recognized GBP 89 million or around 18% of unrealized losses in investments in our capital markets strategies. These are split into GBP 32 million of losses in respect of our liquid funds and GBP 57 million of losses in respect of our CLO portfolio. Both, as I will explain later, are predominantly correlated to market movements and GBP 22 million of these losses have reversed since the year-end. Our real assets and strategic equity investments suffered losses of GBP 12 million in total. It's important to highlight that these losses are unrealized. We do not expect to exit assets at these values. Also, they do not result in cash outflows or impact in our liquidity position. The benefit of our long-term business model is that we are not forced sellers. We can not -- we can wait for the market, and therefore, valuations to recover. You're likely to ask the question, how reliable are these valuations and whether more write-downs are expected. You should take comfort from 2 points that I will take you through in more detail in a moment. These are that valuations are the result of a very rigorous valuation process, which takes a long-term view of the underlying performance potential. And also, our portfolio is very diversified and most importantly, we have a low exposure to sectors heavily impacted directly by COVID-19. I will now discuss the first point, the governance of our valuation process. Our valuation process follows these key stages, with the first 3 occurring every quarter and the last stage applied for a half year-end and year-end reporting process. At stage 1, the investment teams prepare valuations at each asset level, based on information available from the underlying portfolio, triangulating that with the underlying investment pieces. Stage 2 is a critical process we call a QPR, or a quarterly portfolio review, where the valuation assumptions are reviewed and challenged by the Investment Committee and Benoît in his capacity as the CIO. This process is very involved and iterative and is carried out at each strategy level on an asset-by-asset basis. At stage 3, there's further challenge by our Group Valuation Committee. At the final stage, which occurs every 6 months, we present our bases and methodologies to our Audit Committee. Our external auditors also carry out their own independent assessment and present their findings to our Audit Committee, who would take views from both of ourselves and evaluate the judgments and the estimates made in the process. This is the level of rigor that underpins our valuation process. I will now provide an overview of the various valuation methodologies that we apply on our portfolio. There's a lot of detail on this slide, and I will focus on 2 key areas: the subordinated debt and equity strategies, representing 71% of our portfolio, as highlighted in the top of the slide; and CLOs and liquid funds, representing 20% of our portfolio, as illustrated at the bottom of the slide. I'd like to highlight that our valuation methodology has been consistent with our normal process and policy in prior periods. Obviously, a key focus during this year has been an assessment of the impact of COVID-19 on each portfolio. Starting with the subordinated debt and equity, which includes our strategic secondaries business. We value the portfolio based on an earnings-based methodology, taking a long-term view on performance and follow the market guidelines issued by the Board of International Private Equity and Venture Capital, or IPEV, members. IPEV issued specific supplemental guidelines in March to reflect the impact of COVID-19 in valuations, which we have incorporated in our methodology. In assessing the value of an asset, we considered the performance of the company prior to the outbreak and the potential impact on this year's projections, going-forward liquidity and the time frame of recovery. We also considered our long-term view on comparable multiples against the backdrop of the dislocation in the markets. Where comparables were not available or deemed reliable, we used a DCF methodology. In this case, we applied stressed cash flow projections for this year, then returning to normalized levels in subsequent years. This approach has resulted in the valuation outcome that I touched upon earlier. As Benoît touched on, given our investments are across the capital structure and not just in one segment like equity, this allows for downside protection. I will now talk about the 2 strategies that are most impacted by market movements. Starting with the CLOs. As a reminder, we hold risk retention investments that are either required by regulations or expected by our clients. We, therefore, intend to hold these investments through to maturity. We are, however, required to apply IFRS fair value principles, taking account of current market conditions as at the balance sheet date. In this regard, for our CLO equity investments, we applied a DCF methodology with the default rate being the key assumptions that we stress. Normally, we use a default rate of 3%. But given COVID-19, we applied more stressed default assessment, which resulted in an average default rate of over 2.5x or 8% of the normal in the first year. For the CLO debt investments, where we have a vertical strip investment, and investments in liquid credit funds, we factored in observable market inputs as at the balance sheet date, which had reflected the dislocation in the market at the time. As I mentioned earlier, these investments are correlated to the market prices and GBP 22 million of these losses recognized at year-end have reversed as of the end of May. There's quite a lot of detail that I went through here, but I hope this demonstrates that we have a thorough and considered approach to valuations that is not only consistent with the market in prior periods but also takes account of current market conditions and our long-term view. I will now discuss one of the key reasons for our resilience, the diversity of our portfolio. This is a familiar slide that some of you would have seen in the past. Looking at the right-hand side of this slide, 80% of our investments are in higher-yielding strategies, invested in over 300 companies active in 36 sectors across 34 countries. The remaining 20% of our investments, shown on the left-hand side, are what I touched on earlier, comprising of investments in our capital market strategies. We have a fairly diverse balance sheet. But what does the sector profile look like? This gives you some insight about the underlying sector diversity and explains why our portfolio is so resilient. It shows that our portfolio is heavily weighted towards sectors that have been relatively less exposed due to COVID-19. The portfolio's top 10 sectors' exposure in -- highlighted on the right-hand side. As you may note, there's a bias to noncyclical cash-generative sectors with defensive growth characteristics. Notably, as Benoît touched on earlier, health care and IT services are performing well under the current circumstances. 5% of our portfolio is invested in sectors that are directly exposed to the impact of COVID-19. These are energy, hospitality and travel. I will now discuss the strength of our balance sheet. Our balance sheet has a diverse source of liquidity with a long-term maturity profile. At year-end, we had GBP 917 million in unrestricted cash and an additional GBP 300 million in undrawn facilities. We had drawn GBP 250 million of our facilities in March as a precautionary measure, of which we have repaid half in May. The weighted average life of our debt is 4.2 years, and this was bolstered by a very successful EUR 500 million bond raise in February of this year with a maturity of 7 years. The strength of our balance sheet underlines the sustainability and resilience of our business. So what is the sensitivity to our balance sheet from any future material write-downs? The key parameter to consider is our net gearing covenant, which is 2.5x. Given our shareholder fund base at year-end, this means that we will need to incur further write-downs of over GBP 900 million in addition to the GBP 152 million. That's over GBP 1 billion of losses. This is equal to recognizing additional losses overall 40% of our balance sheet as of the year-end. Unrealized losses of this magnitude would represent 2x the level of unrealized losses we recognized in the 2 financial years during the GFC in 2009 and 2010. I hope this demonstrates that we have significant balance sheet capacity to withstand the current crisis. Looking at the Investment Company operating costs. We've maintained the cost discipline in the Investment Company as our fund management business becomes more dominant. Variable costs represent 77% of the total costs. These are lower than in prior years, in part reflecting lower incentive costs due to the performance of our balance sheet investments. Finally, touching on our guidance. As I hope you all have seen from our presentation so far, we've entered the crisis with a very profitable, diversified and fast-growing business with a strong capital and liquidity position. However, the crisis is impacting us as well, and it continues to be very unpredictable. We have, therefore, reflected that in our guidance. Specifically, we are highlighting in the first 4 points of our guidance here on that whilst we are confident about the longer-term outlook, the crisis could impact our performance in the short term and in particular, this financial year. With regards to the guidance on the last 2 points, net gearing and dividends, our guidance remains unchanged. Particularly, I'd like to highlight that we are reconfirming our commitment to pay dividends of between 80% and 100% of our post-tax FMC profits. In summary, we are proud of our strong performance in a very uncertain year and are confident that we are exceptionally well positioned to navigate through the crisis and grow by taking advantage of the opportunities it creates. I will now pass on to Benoît to wrap up. Thank you.

Thank you, Vijay. In conclusion, ICG is well placed to come out of the current crisis in an improved competitive position. There is no change to our long-term strategic objective of further diversification, expansion, growth and ultimately, shareholder value creation. We benefit from a well-capitalized and liquid balance sheet and EUR 11.4 billion of available capital across our funds, so as to take advantage of the opportunities that will undoubtedly emerge. I believe that the alternative asset management industry should ultimately benefit from the crisis and experience an acceleration of its growth and probably further consolidation benefiting the larger, more diversified players. And finally, dividends are up again 13% on this year on the back of a 50% increase last year, a tangible sign of confidence from management and the Board on the prospects of ICG. This concludes this presentation. So thank you for -- very much for your attention. I think we'll -- now we'll be taking your questions, and I think Ian you're moderating.

Thank you, Benoît. [Operator Instructions] The first question comes from Arnaud Giblat at Exane. Vijay, you mentioned that the markets reacted strongly since the end of March with GBP 22 million recovered in capital market investments. Arnaud would like to know, should they expect any uplifts in the portfolio in respect to corporate investments since the year-end?

Thank you, Arnaud. So just to clarify, the uplift that I mentioned is related specifically just to the CLO debt investments and the liquid funds. That doesn't apply to the CLO equity. We haven't done a similar analysis for CLO equity. In respect of corporate investments, as I mentioned, we take a very long-term view on our portfolio, and that would also factor in the performance in the short term of the underlying portfolio. We haven't undergone another cycle of looking at our performance on an asset-by-asset level. We'll do our valuation exercise in the next month. But we maintain our long-term view on our portfolio in terms of what the underlying performance will be. So I would not expect a significant change in the valuations in the short term for that portfolio, but it is an asset-by-asset view.

Yes. And if I can add to that. And -- the question is very relevant. It's true that we are observing a stronger pickup in activity than we had expected or feared, but it's very early days. And in any event, we tend to have quite a cautious valuation approach. So it's unlikely that we would be on the -- for the closed-end funds, it's unlikely we'd be doing significant market in the near future. Again, there's not much merit for us to do that. Their LPs are not that interested in that aspect of it. They're much more interested in long-term prospects of vintages. What could happen is that you could see some realizations, partial or complete, either for our own portfolio companies or comparable portfolio companies in the market. And so that may lead to uplift in valuation. But again, that's a big if. It's if the early indications of market balance are confirmed. So that's possible. We are seeing deal flow coming back, so it's possible that there could be exits in the coming 6 months or so. But it's too early to call, I think.

We've got a number of questions on CLOs, as you may expect. One question, Vijay, coming to you is about the sensitivity of the CLO dividend income in FY 2021, given -- and the expectations for downgrades from credit ratings. And also linked to that, the question of why that's recognized in the FMC rather than the IC?

Sure. So starting with the first question on the dividend income sensitivity to the underlying portfolio. So the way this -- we actually issued an introduction to CLO -- 2 CLOs yesterday. So I encourage all of you to read that. It actually provides a very good insight of how CLOs work, particularly how the CLO cash flow waterfalls work. As a reminder, the way the cash flow waterfalls work is that if there is any rating changes in the underlying portfolio, then cash flows are diverted from the more junior tranches towards the more senior tranches. And as many of you may be aware, the rating agencies have been playing a very significant part on the back of this crisis to review the ratings of the underlying portfolio. And as a consequence, ratings have continued to go downwards. If there is a significant downward shift towards ratings, then that will impact cash flow diversion, and therefore, impact the CLO dividend income that we could receive in future. We need to recognize that this is not a permanent change. It's temporary because over time, as those companies get re-rated back upwards, then CLO dividends could start coming back up. So in the short term, we do expect a reduction in CLO dividend income because we are beginning to see some re-rates within our CLO portfolio. In the near term, in the next 3 to 6 months, we think that the same level of dividends will continue to be received. But beyond that, we expect a reduction in dividend income. The second question which we've been asked multiple times in the past in terms of why do we recognize CLO dividend income in the Fund Management Company and not in the Investment Company. And the reason for that is very straightforward, and that is we have to hold CLO dividends. It started with regulatory reasons in the past where both EU and U.S. regulations required that the U.S. has lifted that. Holding CLOs is part of our business. We see managing the CLO portfolio, and therefore, holding the risk retention strips is just -- as sponsors of the CLO portfolio, we see that as part of management fee income. We receive subordinated fees, but we see the income as a total package as managers. And that methodology that we apply is no different to other CLO sponsors out there that also recognize CLO dividend income as part of their profits.

Thank you, Vijay. Staying on the capital market strategies, Benoît. A couple of questions about our liquid strategies about what outflows -- what we're hearing from investors about potential outflows? And also what we are thinking about in terms of how -- what percentage of AUM liquid business could potentially grow to?

Thank you. So a couple of questions there. On redemptions, we're not seeing anything. We've had negligible redemptions since the COVID crisis, and actually, it's lower than previous year. We've actually had inflows as I think a number of investors were just trying to take advantage of the market correction. Most investors were investing I mean we're calling it liquid. But for most investors, it's not really liquid. For them, it's -- these are long-term investments. So it's not that surprising. And I don't think we're that different from other managers. But certainly, no. So we're not experiencing any redemption or noise of potential redemption, and we're actually seeing inflows. It's part of the -- I mentioned that in the first quarter, we were likely to be at EUR 2 billion, maybe a bit more of total fundraising. Some of that is in the liquid space where we're seeing inflows. In terms of relative size, it's hard to say. I think because of the share of CLOs in our capital markets business unit, I think that it's slightly to reduce over time in a proportion of the overall AUM, essentially because there's a point where your CLOs just replace older CLOs that are maturing. You're no longer growing your base, you're just replenishing it. So there is going to come a point where as that CLO base doesn't increase anymore, proportionally the overall capital markets piece will come down compared to the -- to our overall AUM. And there is -- we're nowhere near that. But there comes a point as well on loans, you reach a stage where you're becoming big for the market and it's becoming more difficult to grow. We're not there yet at all. We still have a long way to go. But given our growth -- our overall growth profile, eventually, I would expect that capital markets for both reasons end up becoming smaller and smaller as part of the overall.

And staying with you, Benoît, a couple of questions on deployment about what you're seeing in the market a bit more color regarding the European corporate senior debt product. And also how in a lockdown scenario, you're ensuring that you maintain that level of diligence on new investments and also follow-on investment?

Yes. So well, there have been 2 phases. I mean there's no doubt that up until a few weeks ago, as lockdown measures started to ease, there was hardly any deployment. I mean what little deployment there was, was essentially the follow-on of discussions that have taken place before and where due diligence had been done. So we took the opportunity to increase our position in one of our best-performing assets in Europe. But that -- we -- the -- all the effort had been done prior to the crisis. We're now starting to see some life back, and people are starting to be able to do due diligence again progressively. And within Continental Europe, you could start to travel. So it's starting to happen. Certainly in Asia, it's already happened. Might come as a surprise, but we've had people flying to due diligence meetings in Asia now. So it's reopening. Obviously, it's lower than it was. But at the same time, the teams haven't -- they spend the time since the outset of the crisis to actually work on future potential deals. So there's a lot -- there's a big backlog of discussions that have gone underway. And where -- we now need to take it to the next step that requires physical due diligence. But as a result, there's quite a -- there's a meaningful backlog of potential transactions. You have to be a bit cautious there because certainly in our sub debt and equity, the highly structured nature of the deals that we do means that it's very difficult to have visibility on the success rate of deals that are in the pipeline, but there's -- it's significant. We were just looking at the European sub debt and equity pipeline yesterday with our LPs, with our investors, and it totals up north of EUR 7 billion. Now that doesn't mean we're going to invest that. And maybe we'll only do one deal out of that. But the fact that it's there, that it's in pipeline, incredible transaction, it's -- I think it's quite promising. I think part of your question was on direct lending. As I mentioned during the presentation, there's no doubt that in the wake of the crisis, the trend that had started of commercial bank pulling out of the space, that's just accelerating. I think it's actually likely that some banks will try to offload portfolios of leveraged loans. And what that means is that's creating a big opportunity for direct lending, in particular, for very large transactions, where right now, there's nowhere to turn. So we're having a number of such discussions. Again, up until very recently, the due diligence element meant we were restricted. There was only so much we could do. We could work on legal docs. We could do a number of things. We could read the due diligence if there was something ready, but we -- the meetings could not be held. That's starting to change. So I wouldn't be surprised if we started seeing greater deployment in the months to come and certainly September onwards.

Thank you. Vijay, back to CLOs and the valuation of the equity. You talked about 8%, and I've got a number of questions, asking why 8%, you concluded that was the right number to use? And also what other critical assumptions, particularly around recovery rates, have you used? And linking into that, following on from the comments you made about the CLO dividend income going forward. A question from one of our shareholders is what does that mean for the dividend?

Sure. So starting with the first question on the valuation of the CLOs. So we adopted a 2-dimensional view in looking at the portfolio. One is what were we seeing within the portfolio? And second is what is being seen by the market. And then we sort of compared that to what our experience has been. So just to give you a little bit more color on how we came up with the 8%. We applied a bell-shaped stress scenario looking at the portfolio over the next 24 months, stressing the default rates by up to 12% per annum for the last 2 quarters of the next 12 months. So went all the way up to 12%, which is quite significant, more than 4x our normal default rates. And that is what's averaged at 8%. S&P have issued some guidance out there, but they've talked about similar default rates being experienced in the next 12 months. And then finally, our experience. During the GFC, we only had European CLOs at the time. And our experience at the time between 2008 and 2011, our portfolio had a default rate of 1.8% compared with the market default rate at the time, which is illustrated in -- once again in S&P paper of 4.9%. So we felt very comfortable with the 8% that we have picked for the default rate for this year -- for the year-end purposes. We obviously continue to monitor our underlying portfolio and how the underlying portfolio is performing, and we'll continue to assess the valuation on the back of it. There hasn't been anything that has happened adversely since the year-end that tells otherwise. There's been no default in any of our portfolio. We have 24 CLOs. We do not have any default in our portfolio since year-end. In respect of the second question on dividends -- sorry, there was a question on recovery rate on CLOs. We've maintained a recovery rate of 75%. We felt that we wanted to stress one assumption, which was the most significant assumption in the valuation. By flexing multiple assumptions, you would have a double-dip impact, which we did not feel as appropriate. And once again, this was based on our experience back during GFC. Coming to the question on dividends. As both Benoît and I have mentioned, we expect to continue to commit to our progressive dividend policy of paying out between 80% and 100% of both tax and FMC profits.

Maybe one thing that I would like to add. I mean, oddly, there seems to be -- the connection is not always made between views on credit, whether it's on the liquid space for CLOs or on private debt direct lending and private equity. Just to be clear, they are in the same deals. So if you're assuming high default rate in CLOs or you're wondering about higher losses in private debt, that implies significant losses in private equity. You don't lose $0.01 in debt until the equity is completely wiped out in those transactions. So that's important to remember. You can't, on the one hand, consider that the private equity will be resilient, which I think it will be. But then on the other, you would be worried about the credit part. The credit part is only impacted once the equity has lost everything. So I think that's important to remember. They are not disconnected. They are in exactly the same transactions. That's one thing. And the other aspect, which is something we've mentioned before, but it's important when you're looking at your assumptions of -- particularly of recovery rate, is compared to the GFC, the level of capitalization in transactions today is much higher. During the GFC, it was a 30%, 35% equity to debt. Today, you're closer to 45%, 50%. So there's a much bigger buffer. If you're sitting in the debt, there's a much bigger buffer to go through before your debt is impacted at all. And I don't think that people have fully completely factored that in, in looking at potential defaults and potential recovery. We could go on, I mean, there's another aspect, which is very different to the GFC. Pre-GFC, there was a whole raft of recapitalization, which means that essentially, the private equity sponsors are really derisked. They've taken their money off the table by regearing their transactions. Hasn't happened this time, which means that private equity sponsors have a lot of skin in the game in these transactions, and therefore, they're very likely to support their businesses and as a result, protect the debt tranches.

Benoît, staying with you and thinking about our clients, the LPs. There's some guidance out yesterday from the Department of Labor in the U.S. that said to fund contribution plans to include private equity and their allocations. So one question is, how significant is that for us, for ICG? And on the flip side it's how concerned are you about clients being able to fund their capital calls in the current market?

So I'll take your questions in inverse order. Historically, there have been very, very few instances of LPs defaulting on their capital calls. It's never happened to us. But even more broadly in the market, there have been very, very few instances of that. And actually, today, because of the growth of the secondary market, that's not what an LP would do. Even if you had an LP with serious liquidity issues, what they would end up doing is they would sell their position in the secondary market, then someone else would take it up. So the risk for us of having an LP defaulting their commitment is, I think, practically nonexistent. Certainly, we've never seen it. And by the way, we've made capital calls during this crisis because we were still doing some deals, and there's never been even a question from any one of our LPs. On the prospective appetite of pension funds or -- I mean, it's -- there are many factors that come into play. I think the long-term trends are pretty obvious. Short term, which way will that go? I think I'd be cautious there. It's hard to know. I mean strangely enough, this time around because some private equity funds were very quick to write-down some of their assets, particularly in the U.S. because they had some significant exposure to energy, we have clients who ended up with too low of an exposure to alternatives. So it's the reverse of what we experienced in the GFC, where there was a denominator issue where the public markets had come down, but the private markets hadn't come down as much. And so clients ended up with too much as a result in alternatives. This time, what's happened was the reverse, and they ended up with being under allocated to alternatives and looking for ways to increase their allocation. But that's temporary. It ends up evening out at some point. So even those new and potential changes in regulation and the opening up of 401(k)s are -- yes, probably one day in the near future. As far as I'm concerned, I don't think we'll see significant changes.

Thank you. Vijay, a couple of questions on numbers and guidance going forward. One is about the net investment returns for the coming years. And the fact that if the portfolio valuations expect to come up, then will net investment returns get back to a more normalized annualized rate? And then on the other side that if CLO dividends or investment returns remained low, is there a natural offsetting hedge in a vertical merger with staff bonus payments?"

Thank you. I think on net investment returns, I hope you would appreciate that it's very difficult to predict how the markets will continue to perform, whether we have a V-shaped recovery. Until -- as of yesterday or day before yesterday, people felt that's where we were headed. Today, the market is looking slightly different. So we are in no different position than anybody else in terms of determining what the near-term outlook on net investment returns would look like. Over the long term, we remain committed to delivering the guidance we've given in the past. In respect of the question on CLO dividend and aligned to bonuses, I think it was, we'll continue to look at the profitability of our business. It's not just tied to CLO dividend, it's across the board. On the back of the crisis, we've taken some very prudent approaches in terms of what we were planning to do for FY '21. For example, we are focusing on hiring just for critical hires only. Our budget pre crisis did have some higher level hires. We decided to sort of take a view on that. Similarly, if there are other large ticket initiatives that we were thinking about considering for FY '21, which were discretionary, we have decided to sort of put a pause on that. So we'll continue to sort of review our profitability, not just related to CLO dividend, but just overall profitability of FMC.

Thank you, Vijay. And Benoît, returning to fundraising, you mentioned a EUR 2 billion number for the first quarter. Can you give some more color on where that is being raised? And also an update on where we are in SDP IV.

Well, I mean, we have 3 closed-end strategies in market that's SDP, it's sale and leaseback and it's infrastructure equity. So it's coming from these 3 strategies. The -- where are we on SDP IV, which, I guess, the underlying question is, how much more is there to go. That's not an information we've made public. There is still some to go, but we -- I mean, there's a reason we hit a fundraising record in the year is because we brought forward quite a bit of SDP. So there is still more to go for to reach the target that we want to reach. But it's not the bulk of the fund that was raised last year. So we're finishing up essentially during the course of this year. And as I mentioned, we're still raising in liquids. We're having inflows, and I would expect that to continue. What's unlikely -- highly unlikely is that there's new CLO issuance. You never know because the market has bounced back quite a bit. But the arbitrage isn't there today, either in the U.S. or in Europe. So I think it would be prudent not to assume any CLO issuance during this financial year.

And the final question, I think, for the day is regarding -- again, staying on the fundraising topic, about whether we've looked at the possibility or had any incoming inquiries from clients about raising perpetual capital funds for some of the more established strategies?

Yes. That's a really good question. We've touched on that in the past. Yes, I mean the answer is yes. We actually have a number of segregated mandate that I'm not sure you could call them perpetual, but they are very long, 20-year plus. Could we do more? Absolutely. I think today, we're lacking enough strategies for that. I mean there is one obvious candidate, which is infrastructure. But we're in the process of raising our very first fund, so we need to walk before we run. But that would be an obvious candidate for a longer-term commitment from LPs. You could -- sell and leaseback could also qualify for that, and we've had some discussions as well with investors on that. It's a bit difficult when -- in both cases, these are first-time funds. That's not when you want to be heroic and break new ground. You want to get your first fund done, and then you can think about doing somewhat more unusual structures for the market. But we've had some discussions with LPs actually in both strategies. So I'm sure this is something that you'll see more of and there are obviously significant advantages to that. So that hasn't escaped us. We still need to do a bit more work before we're in a position where that becomes meaningful for us.

Thank you, and thank you to everybody who's joined the call today. If you do have any further questions that you wish to email me, please do so, and I will answer you. And thank you, everyone else, Benoît and Vijay and everyone for participating. Thank you very much.