What's up and down in fund finance?

Investors share the biggest trends in the fast-growing world of fund finance

As an asset class built on providing flexible funding solutions, it was inevitable that private credit would turn its attention to private markets funds themselves. Here are some of the biggest trends in the fast-growing world of fund finance.

Much like the businesses they support, private markets firms need capital to continue growing, boost returns and provide liquidity to their investors. It’s hardly surprising, therefore, that private credit has spotted the opportunity to provide that capital – and in increasingly innovative ways.

Demand for fund finance has seen rapid growth over recent years as private markets firms have branched out into new strategies, sought ways to smooth LP capital calls and faced pressure for liquidity at a time when asset sales are hard to come by. So what are the latest developments in this market on the move?

The market is growing…

“There are two key factors underpinning growth in NAV financing,” says Stephen Quinn, Senior Managing Director at 17 Capital. “One is the growth of private equity itself – it is sitting on $7.5trn of unrealised assets. That’s the stock. The other is increasing awareness and adoption. The market has been around for a while, but Covid was a big catalyst for adoption – there was a real need for capital and liquidity and other sources had dried up. People started looking at other options and this was clearly attractive. Since then, it has developed a range of use cases.”

…and the options are broadening

“NAV finance is gaining scale,” says Vjerana Burleigh, Managing Director on the Secondary and Portfolio Finance Team at AlpInvest. “That’s across private equity, private credit, real estate and infrastructure, but it’s also across use cases. In private equity, you are seeing fund level finance, LP finance and GP finance – it’s super broad. Just five years ago, the market was only around $5bn in value for private equity; today, we estimate it’s at least five-fold that number.” Some LPs are welcoming the opportunity to invest with open arms “It’s a very attractive product,” says David de Villiers, Managing Director at Wilshire. “You’d be hard-pressed to find better returns for the type of risk you are assuming. The returns are usually in line with senior direct lending and more recently, we’ve even seen returns of a similar level to opportunistic credit. This attractive risk-return profile is the reason we’ve been backing NAV lending sponsors.” Yet many find it hard to place in their overall portfolios
“We have to determine which bucket to put this in,” says de Villiers. “It’s possible to justify putting NAV loans alongside direct lending because of the nature of the returns, but you can make a case that GP financing, which is more complex, fits better with opportunistic credit.” Jakob Schramm, Head of Private Credit at Golding Capital Partners agrees. “We like to cover the whole gamut of strategies and so we’re constantly monitoring new developments,” he explains. “So, we are looking at NAV loans, but the question is how we fit that into our overall portfolio. It’s credit and the downside protection is vital and it’s something that is truly diversified and not 100% correlated with the rest of the portfolio. It’s an interesting market.” And there are some common misconceptions, according to some players“There are two myths we need to dispel,” says Quinn. “The first is that NAV borrowing is being used to distribute capital to LPs. That’s not the case. Most of the capital we provide is to fund portfolio companies. The second is that our funding is going into portfolios because they are distressed. Actually, we are providing funding because these are high performing companies – otherwise, we’d be throwing good money after bad and that would make little sense.”

Healthcare and life sciences funds in Europe are, on the whole, much smaller than those in the US. This means they have to invest their capital in a much more conscious way.

NAV finance should be seen as a complementary tool
“Much like secondaries, NAV finance is more of a complement than a supplement,” says Burleigh. “It can’t fix portfolio issues or misalignment; we view it as a way to optimise performance. It’s the high quality sponsors that are using this in a conservative way and with robust structures. It is being used so that managers can manage their portfolios in an appropriate way.”

LPs are creating more diversified portfolios as private credit funds step into the fund finance breach

“The growth of NAV loans and subscription lines of credit in the private markets space is an interesting development as the banks pull back,” says Vijay Padmanabhan, Manging Director, Private Credit at Cambridge Associates. “It may take some interest away from direct lending, but it will be good for private credit overall as it continues to expand into areas with varied risk-return profiles.”

“It’s an interesting time in the development of fund finance for institutional capital to step in and plug the funding gap,” says Shelley Morrison, Head of Fund Finance at abrdn. “LPs are looking for newer strategies, including in private credit areas that are not strongly correlated to the assets they already have and that can insulate them from volatility. LP-backed fund finance and subscription lines of credit can offer defensive strategies that offer downside protection backed by assets or high quality collateral. In an elevated interest rate environment, that adds to their all-in yield.”