ATP Private Equity Partners, the fund of funds arm of Denmark’s largest pension, has changed its due diligence process to reflect the flattering effect of subscription credit lines on fund performance.
From August, Copenhagen-based ATP PEP will ask GPs to provide an internal rate of return that has been adjusted to compensate for the use of subscription credit lines, managing partner Torben Vangstrup told PEI.
A June report from Carnegie Mellon’s Tepper School of Business found that the lines distorted a fund’s IRR by 6.1 percentage points on average. Funds sampled had borrowed an aggregate total of $5.3 billion in the first three quarters of 2018, compared with $86 million in 2014.
“I spoke to one GP recently that said credit lines have improved their performance by up to 3 percent,” Vangstrup said.
“We need to be able to compare all GPs on equal terms, so we have to actually adjust for the use of credit lines in the performance data. Every due diligence we do going forward, we’ll ask the GP to make that calculation for us.”
The Institutional Limited Partners Association recommends GPs provide the net IRR with and without credit facilities, as well as disclose whether the proceeds have been used solely to bridge capital calls or for other purposes such as accelerated distributions.
Some remain unconvinced about stripping out the effects of a credit facility. “Speed to close and ability to close all cash are becoming more important in this competitive environment,” Josh Cherry-Seto, CFO of mid-market firm Blue Wolf Capital, said at a fund finance discussion hosted by sister publication Private Funds CFO in June.
“Without a line we would need to call capital in advance and leave cash on the balance sheet. We would at least a few times call large amounts of capital for investments that do not consummate. It is not such a simple exercise and I don’t think, if calculated honestly, the results would be favourable.”
But LPs have other motivations for seeking greater transparency. Earlier this year, PEI reported that lenders were rushing to close a potential fund finance loophole in response to Société Générale’s dispute with Abraaj Group investors. GPs are now encouraged to notify LPs about a security on their commitment at the time it is created rather than in their quarterly updates, previously the norm, to prevent the likelihood of a default.
“The other reason why I’m requesting further information on the use of credit lines is we need to understand the amount of capital we have outstanding at any given point of time and not only as stated in the quarterly reports,” Vangstrup said.
“It is crucial for us to understand the accurate size and risk associated with our outstanding commitments, not least in a situation where this world isn’t going to be as rosy as it has been lately.”
ATP PEP manages around €9.2 billion on behalf of the DKr307.5 billion ($46 billion; €41 billion) ATP. The unit closed its New York office last year after tightening the investment mandate for its latest fund to limit its geographic scope to Europe and North America, exclude venture capital and seek fewer, larger fund commitments.