Use of a long-dated subscription credit line “could be a flag” if the intention behind it is to artificially boost IRRs, according to Per Olofsson, head of alternative investments at AP7, the seventh Swedish national pension fund.
“I personally would like to see that it’s more for capital efficiency reasons rather than trying to gear up portfolios to create short-term IRRs,” Olofsson told Private Equity International. “[Long-dated subscription credit lines] could be a flag if it’s intended to increase the overall leverage.”
In the last couple of years, the industry has seen an increase in the use of fund finance, buoyed by access to cheap debt. Fund financing can take several forms, with the most common being subscription lines of credit that allow general partners to access a revolving facility for a set time period.
These credit facilities allow general partners to make acquisitions and delay calling capital from LPs, often for up to a year. This can boost IRRs.
Despite assertions from some fund managers that annual capital calls make LPs’ lives easier, Olofsson said that, while aggregating cash flows makes sense up to a point, his preference is for funds to call down capital on a more regular basis.
“It’s preferable not to have 20 different cash flows during a year from one manager. A few times every year I think is optimal,” he said.
“I don’t see any problem if they have smaller cash flows back and forth and then aggregate that during a period, let’s say up to a quarter or so. That’s fine with us.”
At an investment board meeting on Monday, former California Public Employees’ Retirement System board member Michael Flaherman brought up the use of subscription credit lines for the second time, asking the California pension fund why a promised report into the matter hadn’t materialised.
“This is an increasingly common practice and raises significant concerns of systemic risk for your private equity portfolio,” said Flaherman.
“It is especially concerning when the chair instructs the staff to bring back a report about hidden risks in your portfolio and they do not do it, and then you have somebody like Howard Marks pointing out the hidden risks serve to bump up people’s compensation,” he added, referring to a note written by Oaktree Capital Management’s co-chairman a few weeks ago on the benefits and drawbacks of credit line use.