Innovations in the fund finance market can enable fund managers to use subscription lines for longer to delay the use of more expensive portfolio or asset financing.
The fund finance market has grown astronomically in recent years, reaching $1.2tn (£0.95tn) globally according to Ares research published last October. The market is forecast to swell to more than $2.5tn by 2030.
A key facet of the market is subscription lines – dubbed sub-lines – that are loans secured against uncalled capital commitments from investors in the fund.
Read more: Investec partners with Ares to offer sub line financing
Funds will typically use sub-lines at the early stages, while they have access to significant uncalled capital. As that capital is deployed over time, they will transition to using a NAV facility, which is based on the value of the fund’s assets.
But Shailen Patel, head of strategy and product at fund finance lender NLC Capital Partners, sees innovations within the sub-line market that will help funds use this type of financing for longer.
Read more: Macfarlanes: NAV financing is “hot topic” in fund finance
“There is a real desire for general partners to utilise sub-lines for longer to delay the use of more expensive portfolio or asset financing,” Patel said. “As a result, subordinated sub-line offerings which extend the advance rate against the uncalled commitments are becoming more popular. These take the form of Tranche B loans, second lien and hybrid financing.”
Additionally, Patel says that using sub-line term loans combined with traditional revolving credit facilities (RCFs) can create a flexible solution that reduces costs.
“The use of term loans in the sub-line can be used to delay more expensive forms of portfolio and asset borrowing until later in the lifecycle of the fund, meaning the absolute returns to investors are enhanced,” he said.
“Term loans enable a fund to borrow for longer and provide greater certainty to limited partners for when they will need to provide liquidity.”
Using the traditional RCF structure, Patel explains that general partners typically maximise their commitment under their limited partnership agreement and therefore pay away substantial bank fees before any monetary amount has actually been borrowed.
Read more: Moody’s: Demand for sublines to remain high
“When the historic average utilisation of fund RCFs is considered, this number in our experience sits at a much lower percentage, meaning that there is significant wasted cost for investors over the fund lifecycle,” he added.
“Introducing term debt in shorter tenors earlier in the lifecycle means that capacity can be re-introduced into the RCF therefore requiring the general partner to have significantly less committed at the outset.
“The dynamic approach to sub-line management also helps fund managers to speak to a better governance story around fund finance and fund costs more broadly with investors.”
There have been concerns around the rapid growth of fund finance, particularly NAV facilities, with regulators seeing risks around “leverage on leverage”.
But Patel argues that the level of NAV loans in private markets usually hold an appropriate loan to value relative to the strategy, meaning that the contagion risk to investors is relatively small against what can be a sizeable addition to the return profile of the fund.
