Investors with money stranded in private equity funds are weighing an expensive solution: borrowing against their stakes, sometimes at double-digit interest rates, until the market for their holdings turns around.
“Net-asset-value” financing to free up cash has already taken off among private equity firms holding $4.8 trillion of assets who’ve balked at selling investments amid a soft market for mergers and acquisitions. Now lenders are pitching those firms’ clients on the loans as well.
Lenders such as 17Capital, Apollo Global Management Inc. and Ares Management Corp. see a growing market targeting investors in the PE funds. In theory, it’s a more attractive way for pensions and other institutional investors to raise cash instead of selling their fund holdings at today’s painful discounts. The loans could help them generate liquidity to invest elsewhere and fix their bloated allocations to private equity.
The downside is the high cost — interest rates can run from 8 percent to 10 percent — and the potential for big losses if values erode on their private equity holdings, some of which are already highly leveraged.
“It’s another tool in the tool box,” Joel Holsinger, co-head of alternative credit at Ares, said in an interview. “As we’ve seen in the NAV market, I think this market only grows from here.”
Ares, based in Los Angeles, has been having conversations with institutional investors about NAV loans and other structured solutions such as preferred equity, Holsinger said. So far, the uptake has been less active than among private equity sponsors because investors are waiting to see if the market for asset sales will improve and distributions will increase, he said.
More private equity firms tapped NAV loans to manage their portfolios as deal activity plunged and fund-raising remains challenging. Median private equity realizations for the biggest publicly traded U.S. firms fell 43 percent as of June 30 for the trailing 12 months, according to data analyzed by PitchBook. Fundraising tumbled 57 percent this year through June 30 compared with the same period of 2022.
Amid that backdrop, 17Capital, a leading provider of NAV financing owned by Oaktree Capital Management, estimates that the market could grow to more than $700 billion by 2030, from about $100 billion now.
Despite the cash drought, there is wariness about NAV loans because adding expensive debt onto an already-leveraged portfolio amid high interest rates and an uncertain economy could create a toxic brew.
“On the LP side, it’s very risky,” said Gaurav Patankar, chief investment officer at MercedCERA in Merced County, Calif. “You are creating equity risk out of what should be credit risk by leveraging your portfolio.”
Normally, selling stakes in the secondary market would be the preferred way to raise cash. But current discounts can be tough to stomach — it’s at least 10 percent of NAV, and closer to 50 percent for venture stakes — spurring investors to at least explore the idea of NAV loans.
Apollo has fielded an increase in inquiries from large pension funds looking for liquidity and to defuse the so-called denominator effect, said Bret Leas, the New York-based firm’s head of structured credit. That’s what happens when the value of publicly traded stocks and bonds drops, leaving private investments as a bigger share of the total portfolio — thus violating strict limits on how much money some investors can have in private assets.
This still wasn’t enough to sway one potential NAV borrower, according to a person with knowledge of the matter. A major state pension plan reached out to lenders about a loan, but ultimately decided to simply raise its limit on private equity, said the person, who wasn’t authorized to publicly discuss the confidential talks.
NAV loans to portfolios of fund holdings can have a loan-to-value ratio of around 30 percent to 50 percent, higher than the 30 percent maximum seen for loans to buyout funds, according to Pierre-Antoine de Selancy, co-founder of 17Capital. Fund portfolios can carry more leverage because they are highly diversified, due to their broader mix of assets.
17Capital is having a lot of conversations with institutional investors about NAV loans and sees the deal pipeline building, de Selancy said, citing more opportunistic investors looking at newer vintages of investments. “Realizations slowing down has had an impact,” he said.
Investors with large portfolios can command better pricing because of the scale and diversity of their holdings. But the interest rates are still relatively high, so tapping an NAV loan can create a drag on returns because any distributions that do come in would first need to go toward paying back the loan.
“There are many more options an LP could pursue if they can’t wait for liquidity, and some of those options are probably easier or more appealing than an NAV option,” said Andrea Auerbach, head of global private investments at Cambridge Associates.
Smaller institutional investors don’t always have resources to properly evaluate these loans, making it harder to win approval by their investment committees, Patankar said. What’s more, an economic slowdown could make their cash shortage even worse as M&A markets sag, and values could crumble for their holdings that back their NAV loans. That would make it even harder to sell assets and potentially trigger a default under the loan.
“In a perfect storm, it would make an LP portfolio even more illiquid instead of liquefying it,” Patankar said.