‘You don’t want to be calling your LPs out of bed’ – behind the drop in capital calls

A considerable drop in the number of capital calls made by private capital funds comes as no surprise to those in the asset class, as managers have increasingly been looking to subscription lines to simplify investments.

The frequency of GPs getting in touch with their investors to ask for capital pledged for fund commitments to be wired across for investments has fallen, research shows.

The average number of capital calls made by private capital funds dropped to 1.9 last year, a 10-year low and down from 2.3 in 2020, according to data from Investec. The research mapped 10 years’ worth of activity from 45 UK and mainland European funds, ranging in size from €150 million to €3.75 billion.

“Feedback from investors is they don’t want to be called five times a year. They want to be called twice a year,” Richard Hope, head of EMEA at Hamilton Lane, told Private Equity International. “You don’t want to be… calling your LPs out of bed on holiday to make sure they’ve sent the capital call… The use of the fund facility technology allows you to smooth that.”

Almost all funds with any level of sophistication have a bridge line in their funds, which is beneficial for both managers’ and investors’ back office functions, said Andrew Perkins, head of the finance group at law firm Macfarlanes.

The market has seen a straightline evolution. Roll back 10 years, and subscription lines were not universally used and included in limited partnership agreements for European managers. As more buyout houses adopted them and investors became exposed to these tools, the likelihood of anyone having an adverse view of bridge facilities lessened, Perkins added.

The size of such facilities is market driven. The lenders themselves have a say in how large a bridge facility they are willing to provide. “You might find that the bank says, ‘Well, I know you can borrow up to 40 percent of the total commitments, but actually looking at your LP base, we’re only prepared to do 25 percent,'” added Christopher Good, fund formation partner at Macfarlanes.

A tool for fund management

The use of subscription lines is another tool GPs can leverage to improve the net performance across all metrics – IRR, money multiples and overall absolute gains – according to a managing director at a global investment firm active in funds of funds, secondaries and co-investments.

When the tool was initially adopted in the US, strategies saw results, they say, adding that a part of the European manager cohort has been more conservative. “It ended up in a less optimal investment experience for investors and it resulted in ultimately higher gross net spreads and less attractive performance.”

The use of fund financing products – and recycling capital more broadly – allows managers to invest more of their fund capital, while giving GPs downside protection in the event capital reserves are required. The ability to house more platform deals in a fund also allows GPs to reach their carry more quickly.

Investec, which provides financing to private funds, expects to see further growth in fund finance beyond NAV facilities, secondary facilities, GP-led continuation vehicles and co-investment facilities, particularly within off-balance sheet financing, securitisations and the use of institutional capital, Oliver Bartholomew, part of Investec’s fund solutions team, said in a statement about the research.

Whether higher interest rates lead to a decline in the use of products such as subscription lines remains to be seen, but the use of these tools is a positive trend for investors as absolute gains have been optimised, the MD says. Ultimately, Good adds, the investment programme drives the fund, which in turn drives the frequency of capital calls.

“We may hit a point in the market where everyone just goes, ‘Right, this is the bottom of the market, we now have to deploy our new fund this year and very quickly, and it might be really busy.’ That’s what drives the number of calls,” said Macfarlanes’ Good.