What are some of the ways to take advantage of credit lines?
There are a range of ways in which managers have utilised fund lines of credit for many years beyond the IRR enhancement objectives that have received a lot of attention over the last 12 months or so.
The most obvious and basic is to bridge capital calls for deals that are on a short timeline or for another reason make it difficult to call capital in advance of the deal closing.
Other situations where you might utilise a line include when a fund is making an investment and intends to syndicate down part of the equity as co-investment. While fund agreements usually permit a GP to call capital from limited partners to cover the full amount of the investment, alternatively, the GP could bridge the co-investment on the fund’s line of credit during the syndication period in lieu of calling capital from limited partners – with the co-investors bearing the associated interest costs, of course.
What is your view on the use of lines of credit for IRR enhancement?
Ultimately, we work for the LPs who invest in our funds, so my views reflect what we hear from our LPs. On that aspect, our LPs’ views are somewhat mixed. Some strongly prefer it and some prefer to limit the duration of borrowings. But all agree that the most important thing is transparency into how the manager uses the credit facilities so that an LP can compare returns and performance from one manager to another.
What do you think of the ILPA guidelines on fund finance released earlier this year?
We are really supportive of ILPA’s initiatives to create a standardised reporting framework so that LPs can compare GPs on an apple-to-apple basis and the guidance on fund lines of credit reporting is no exception.
I think that there may be different answers for different asset classes or different sets of LPs, so I don’t know that you can have a blanket one-size-fits-all set of rules for how a GP manages a fund, but I agree that there should be consistent and transparent reporting to investors so that they understand exactly how a manager is operating a fund and how its returns are generated.
In terms of some of their specific operating guidance, one point that has generated a lot of discussion is the suggestion that a preferred return should start accruing from the point in time that capital is drawn on the line of credit as opposed to when capital is called from an LP. I think that the preferred return is intended to measure the actual net return that an LP experiences without a lot of judgement or assumptions. Once you start deviating from that, you risk losing its relevance and having the preferred return calculation become something that requires interpretation and is calculated different ways by different managers.