Just over half of investors expect to see an increase in the use of subscription lines over the next 12 months, according to Private Debt Investor’s LP Perspectives 2021 Study.
Matt Hansford, head of origination and NAV financing at Investec Fund Solutions, agrees that appetite is high. “We have seen absolutely no damping in demand for subscription facilities whatsoever,” he says.
“We hear great reports about large funds closing incredibly quickly, but for the majority, fundraising will take longer because LPs want to meet face to face,” Hansford says. “Furthermore, some investors are now looking to make commitments out of Q1 allocations, so managers are using bridging facilities to ensure they are not leaning too hard on those supportive, initial investors. ”Indeed, there is heightened interest in using subscription finance to bridge through fund closes, given the challenging fundraising environment.
Subscription facilities are also being used to support investment activity, in particular by bridging the debt portion of a deal. There are companies in the market at the moment that represent good value because although trading performance has been impacted by covid-19, the underlying business model remains strong.
“Firms are looking to all-equitise deals, without the cost of all-equitising,” explains Hansford. “It may be that now is not the optimal time to go to the lending market. By bridging, the manager can hold off for 12 months in order to make improvements to the business and let it ride out some of the covid crisis whilst also giving some room for lending appetite to return for out of favour sectors.”
Meanwhile, managers are also looking to make use of fund finance facilities at the back end of the investment period, by converting subscription facilities into hybrid facilities that also take net asset value into account, says Hansford.
Perhaps surprisingly, however, given the extent to which subscription facilities have become an established part of the asset class in recent years, LP opinion on the subject remains divided. Over half of investors – 58 percent – are not concerned with the extent to which their GPs are using credit lines to fund portfolio investments, but 42 percent still need convincing.
In particular, there were concerns early in the covid-19 crisis that subscription lines could precipitate challenges to manager performance, says Gabrielle Joseph, head of due diligence and client development at Rede Partners. “Although that hasn’t played out as many initially feared.”
“As an LP that needs to put money to work rather than having significant contingent liabilities, I have mixed feelings on this topic,” adds Peter Linthwaite, head of private equity at Royal London Asset Management. “There is a clear advantage in short-term lines of perhaps three months to smooth fund operations, but long-term facilities are unhelpful to us.”
Hansford believes GP transparency regarding the use of subscription lines has advanced dramatically, allaying many of LPs’ initial fears. But it is clear there are still points of contention emerging as the product develops. In particular, as Linthwaite infers, LPs are concerned about borrowing periods being extended.
Tense talks are also taking place around the size of facilities. Norms of 20 to 25 percent of committed capital are increasing to 25 to 30 percent on occasion, says Hansford. Here, the drivers are typically the need to bridge co-investment, which has become increasingly prevalent in recent years.
While LPs certainly appear to be becoming more pragmatic about the use of subscription lines, it is clear they are not giving managers carte blanche to employ fund finance strategies at will.
“LPs seem to have become more comfortable with the widespread use of subscription lines, provided they’re used as a cash management tool and not just to juice returns,” says Jennifer Choi, managing director of industry affairs at the Institutional Limited Partners Association.
“LPs are requesting more information from GPs, specifically around the impact of such facilities on IRR and exposure to these facilities as a portion of uncalled capital. This isn’t surprising, as LPs have become both savvier and more engaged around liquidity management, particularly when you compare the current moment to what we experienced during the financial crisis a decade ago.
“The frontier for fund finance seems to be in the rise of NAV-based and hybrid facilities. LPs are still getting comfortable with how NAV-based facilities are structured and any implications for the fund, particularly in a more volatile economic environment where you may see covenants triggered at the underlying asset level.”