UK’s LGPS pension fund frustrated by GPs’ use of sub lines

Ian Brown, head of private markets at the roughly $52bn pension pool, has said subscription credit lines' main benefit is to inflate returns for managers at the expense of investors.

The head of private markets at one of the UK’s largest public pension systems has expressed frustration at GPs’ use of credit facilities.

Ian Brown, of the roughly £45 billion ($52 billion; €63 billion) Local Government Pension Scheme Central, told Private Equity International that some of the pension pool’s managers have not drawn capital yet, despite them having made plenty of investments during the pandemic.

Ian Brown, LGPS
Brown: there is not enough transparency about the use of sub lines

“Some of the managers haven’t even drawn down yet because of subscription lines. It’s been a bit frustrating for pacing,” he said. Brown added that the pension pool has about 40 underlying investments in the primary fund across five managers, and some have delayed capital calls.

Brown noted that LGPS Central “probably has more capital invested in Asia than elsewhere” because one of its Asian managers has been particularly active. Two of its US-based managers have been less active and also have yet to draw capital, he noted.

He expects the private equity primary fund to take another 18 to 24 months to be fully invested.

Private equity funds have long used subscription lines of credit as a method of short-term financing. The use of facilities has grown rapidly alongside the growth of private equity funds and other alternatives investments, according to a report by advocacy group The Fund Finance Association. By FFA’s estimate in 2018, the value of committed subscription credit facilities held by banks and other financial institutions reached $400 billion.

Brown expressed concern about the proliferation of sub lines among PE funds. “I don’t like subscription lines,” he said. “They are marketed as creating convenience and predictability for investors, but their main benefit is to inflate returns for managers at the expense of investors. When drawdown is delayed for sometimes 12 months, the IRR uplift can be significant; this is the fund IRR but not the investor’s cash IRR, and it can make carry hurdles much easier to achieve.”

He added that there is not enough transparency about this, or the cost of running the facilities, and consequently not enough LP understanding.

LGPS Central, which manages assets for eight pensions based in the UK’s Midlands, established its debut private equity fund in 2019 as part of a plan to deploy more than £2 billion in the asset class “over the coming years”, according to a statement.

Its member funds are pensions of Cheshire, Derbyshire, Leicestershire, Nottinghamshire, Shropshire, Staffordshire, West Midlands and Worcestershire.

LGPS Central’s 2018/19 Vintage Private Equity Fund comprises a primary PE fund and a co-investment vehicle. Brown declined to comment on how much capital was raised for both vehicles and their financial terms. He noted that the 2018 vintage is fully committed across five global managers.

Plotting next PE vintages

Approximately 40 percent of the pension pool’s current PE primary fund is committed to managers investing in the US, 40 percent to Europe and the remaining 20 percent in developed Asia, according to Brown.

Brown noted that the pension pool is in discussions with investors on successor vehicles. “We expect the next primary fund and the successor co-investment vehicle to be materially bigger than the 2018-vintage, although we have not yet settled on the size,” he said. He expects the next PE fund to have exposure of about a third each in these regions.

Brown said investor appetite for Asia remains healthy, especially with developed economies in the region emerging more quickly from the hit of covid-19. He noted, however, that the pension pool remains careful about investing in the region. “We don’t want to be making 12-year investment decisions simply by reacting to 12 months’ experience of covid-19.”

At the same time, Brown said there is “a fairly strong feeling” among a lot of investment professionals that there will be more growth in Asia, than in the US and Europe.

“For us, the more important thing is if we look out 10 years and say, ‘where is the growth going to be in the world, in places where we feel comfortable investing?’ that feels more likely to be in Asia, particularly China, Korea and one or two other developed markets there,” Brown said.