Just over half of investors expect to see an increase in the use of subscription lines in 2022, according to the LP Perspectives 2022 Study by affiliate title Private Equity International, with less than 10 percent predicting a decline.
“There has been no slow down in demand for subscription finance,” says Jonathan Harvey, part of the fund solutions team at Investec. “The subscription market is a derivative of the fundraising market.” And with fundraising remaining strong, Harvey says there has been no decline in appetite, as LPs look to put more money to work in alternatives.
According to Harvey, almost every fund raised today employs some form of subscription facility. “Where we are starting to see some flex is on the amount that can be borrowed as a percentage of the fund,” he says. “Historically, the norm was around 20 percent, but the limits set in the LPA are increasing. For me, that is a sign that LPs have accepted the need for subscription lines to help mitigate future drawdowns.”
Some investors do still have concerns about the nature of subscription finance, however. “LPs continue to press for greater transparency into how the use of subscription facilities impacts on fund performance, including how the preferred return is calculated,” says Jennifer Choi, managing director of industry affairs at the Institutional Limited Partners Association.
“Additionally, LPs remain concerned about whether the purported promise of these facilities – such as smoothing the administrative burden around capital calls – is translating to actual benefits for LPs in terms of enhanced visibility into capital call timing and amounts. Encouragingly, the majority of LPs report that, in most cases, outstanding amounts on these lines are being cleared down in under 12 months.”
Roy Kuo, head of alternative strategies for the Church Commissioners, which manages the Church of England’s endowment, is one investor who supports the proliferation of fund finance. “I think subscription lines can make a lot of sense,” he says. “It makes things more capital efficient. It does decrease the money multiple but it increases the IRR. It took a year or so to adjust our cashflow modelling to account for that but now we find it works very well.”
Options on the rise
In addition to subscription lines, NAV financing is also on the rise. “It can be a creative tool to help GPs manage portfolio companies where the underlying lenders to the assets have less appetite,” Harvey explains.
But just over half of respondents to the survey are concerned with the extent to which GPs are using credit lines to fund portfolio investments, and Harvey says it is important that the rationale for the borrowing is clear. “LPs need to be able to see the value that the NAV line is creating,” he says. “If it looks more like a defensive play then I can imagine there would be questions from investors.”
Of course, NAV financing is just one of the options available to GPs, given the rise of continuation vehicles. “NAV financing remains attractive, but it is just one option on the table when it comes to considering the future of some of these assets,” says Harvey. “Which option is most appropriate is case dependent, but often a continuation vehicle is suited to a longer-term strategy, whilst NAV financing may be better suited to a short- or medium-term outlook. It is a real positive for the industry that there is liquidity available, not only at the beginning of the fund lifecycle, but throughout the fund’s life.”
“Where we are starting to see some flex is on the amount that can be borrowed as a percentage of the fund”
Another area where Harvey sees a marked increase in demand is GP financing – where managers are looking to raise capital to fund their commitments given significant step ups in fund size and rapid returns to market. “GPs are often having to make those commitments before receiving carry from previous funds, so financing the management company against its management fees is proving to be popular.”
Another key trend sees the emergence of corporate financing structures for management companies. “That then makes the debt more investment grade compared to a typical fund finance GP facility,” says Harvey. “That can really help with succession planning issues, as well as allowing the GP to commit money to new funds. At the same time, a lot of GPs are bullish about the value their manager holds, particularly in light of Bridgepoint’s successful IPO. Investment grade financing of management companies is likely to be a hot topic in the future.”