PDI CFOs 2019: 4 takeaways for GPs about LPs

As private credit financial and operational professionals gathered in New York for sister publication Private Debt Investor’s second annual PDI CFOs & COOs Forum, one theme became clear: limited partners are becoming increasingly astute about the private credit asset class, and their asks are showing it.

As panelists and delegates can attest, subscription credit lines and transparency were only a few of the many topics broached when the discussion turned to interacting with and meeting demands from investors.

Here are some key takeaways managers should know.

LPs are wary of sub lines with prolonged amounts outstanding

Subscription lines have come to the fore in recent years, and made for a hot topic of conversation among the financial and operational professionals, advisors and limited partners at the conference.

“We want our capital called,” one LP said, adding that any amount outstanding on a subscription facility longer than 180 days didn’t sit well. If there’s a leverage facility, the investor went on, the firm wants a dollar of fund equity used for every dollar of leverage deployed.

One LP consultant said when conducting due diligence, they will scrutinize the length of the subscription line; issues arise when a manager uses the loan to effectively lever the fund, this person said.

A fund manager noted that even LPs investing in the manager’s unlevered sleeve of its private funds are wary of subscription lines, as investors are still wary of these facilities being used as a way to lever the fund. The firm in question, however, has reached an agreement with its LPs that it will call capital every 90 days, thus facilitating a regular paydown on the subscription line, that manager explained.

High-net-worth individuals are still learning – but shouldn’t be underestimated

The retail channel has been a focus for credit managers recently; the asset class has found success with institutional investors, and now they hope to replicate it with wealth management platforms.

This investor constituency is largely still getting up to speed on the asset class, one person from a financial technology company said. One fund manager drew a comparison to where the institutional investor base resided about five years ago.

Still, another fund manager that has raised a good deal of HNWI capital contested the notion of this investor base as a less sophisticated constituency than institutional investors. This person noted there are institutional LPs that remain less experienced in the asset class, and wealth management platforms that know the ins and outs of private credit intimately. This person added that HNWI investors will still put private credit managers through the same hoops as institutional investors would.

Investors are demanding more transparency

LPs are continuing to request more information from fund managers, conference attendees said.

One fund administrator said that the biggest issue arising in side letters is not fund economics, but concerns around data reporting and transparency. One of the above gatekeepers noted that, from the LP side, transparency was getting better.

The above LP said their office is often in contact with credit managers, particularly about troubled situations and investments that have gone sideways. “We’re not trying to be a nuisance; we just want to make sure we are doing our due diligence and our fiduciary duty,” the investor said. 

One person at a fintech company noted that bringing alternatives to the HNWI market takes some thought and requires transparency. HNWIs may not be used to drawdown funds and all their accompanying issues, among them: how will the HNWI get updates on their portfolio? Keeping abreast hundreds of HNWIs, which collectively could make a sizeable fund commitment, takes a lot more planning than keeping dozens of pension funds and endowments in the loop.

First-time managers face different hurdles from consultants

Those raising a debut fund face unique challenges, but this is something consultants understand: just because there is a Roman number “I” in a fund name doesn’t signal an automatic write-off from gatekeepers.

One gatekeeper noted that their firm expects to see a solid business plan that identifies key business risks upfront and plans to mitigate them. The firm also looks for fleshed out plans to address those issues as the first-time manager grows.

This person noted it was a “no-brainer” for a firm raising a debut fund to hire a fund administrator, a move allowing the young credit shop to take advantage of economies of scale via the third party.

This attendee’s consulting shop takes a risk-based approach on the managers it chooses to monitor. A first-time fund manager may be checked in on quarterly or even more frequently than a seasoned firm with stable leadership.

Another LP advisor said their firm understands first-time managers have to do some outsourcing, noting the people have to “pick and choose” which areas on which the debut firm will put an immediate emphasis.