LPs need to understand GPs’ motives behind the use of NAV loans

Investors want to be in the conversation regarding GPs’ use of NAV facilities and need to understand their objectives around using more leverage, according to panelists at PEI Group’s NEXUS 2024 event.

“We want to understand more about wuhy people need it. We would hope to be in the middle of that conversation so we can understand. And those answers are going to be instructive for us in terms of how we move forward,” Lamar Taylor, interim executive director and chief investment officer of Florida State Board of Administration, said on a panel on Thursday.

Sharing his own personal view on GPs using more leverage, Taylor said he for a long time “railed against the use of subscription lines when they began to be more of a tool for IRR management.”

“The NAV facility to me is an interesting question, because I have to understand why are we adding a layer of leverage with something that’s already in a way beneficial to me as the LP. You’re now going to put somebody between me and cashflows? We hope as LPs we would have some insight into the capital structure of our partnership and that not be the assumption that we don’t.”

He added that LPs would first need to understand GPs’ primary objective for the additional layer of leverage.

“If it’s for distributions, that doesn’t make a lot of sense. If it’s for something that is a credible case around how it can be accretive to returns, well, then that’s a different conversation to have,” Taylor said. “But it is a new and innovative tactic. To me, what I see is cross collateralization on [an] entire portfolio of assets. And we’ve had experiences with that, and it hasn’t really worked out. I’m sort of cautious around it.”

Robert Burd, deputy CIO of Maryland State Retirement and Pension System, said on the panel: “GPs borrowing to give some liquidity to an LP – I don’t think we can ever be on board with that.”

He added that LPs can get liquidity through other means. For example, he noted that the pension system can utilize total fund leverage of up to 10 percent. “That enables us to get public market exposure through derivatives like futures and swaps. And these derivatives are unfunded, so you can use a portion of that unfunded amount to source any kind of liquidity needs that you may have.”

Meanwhile, Bei Saville, CIO of Advance Treasury and Fingerboard Family Office, said she sympathizes with GPs who use NAV loans.

“The trick here [for LPs] is that you have to have distributions to be able to make newer commitments. So, it’s all that ecosystem.”

A key question for LPs to ask is whether the use of NAV loans will destroy the value, partnership and trust between LPs and GPs, she noted.

“What’s the cost of capital? Some of the publicly traded private [markets] firms will probably have much better ability to raise that level of debt… than smaller-sized private firms. When the private equity GP layers up very expensive debt, you do wonder [about] the cost of doing that just to solve the short-term liquidity issue to address a small portion of LPs,” Saville said.

Neal Prunier, senior director for industry affairs at the Institutional Limited Partners Association, recently said the “vast majority” of LPs don’t support using NAV loans. He put this down to concerns over poor communication and how the debt is being used.

Affiliate publication Private Equity International’s latest LP Perspectives Study found that 61 percent of LPs said that restrictions around GPs’ use of NAV loans in fund documentation is ‘somewhat important’ or ‘very important’. Meanwhile, the share of LPs who consider restrictions to be ‘very important’ has increased from 19 to 25 percent.