Fund level finance: The noise escalates

There is a debate brewing in the private fund management universe, which includes real estate equity and debt funds, concerning a part of the debt market that serves it: subscription credit lines.

Emanating from the US, and amplified by high-profile voices in both the manager and investor communities, the use of these lines has come under heavy scrutiny. The overriding concern relates to the use of these facilities inflating internal rates of return, leading to artificial performance for the managers using them.

At the California Public Employees’ Retirement System’s investment board meeting last month, a former board member raised the issue of subscription credit lines. Michael Flaherman, a visiting scholar at the University of California Berkeley, said the lines “[raise] significant concerns of systemic risk” for the private portfolio and voiced worry about the use of them to “bump up people’s compensation”. He had raised the issue before.

Weeks before, Howard Marks, chairman of private equity and real estate firm Oaktree Capital, published a white paper highlighting the benefits, but also the risks, of fund level finance usage.

He also warned the use of subscription lines of credit by private equity funds could, in a worst-case scenario, add substantial risk for general partners and their investors. Marks highlighted risks ranging from tax implications to the ‘doomsday’ scenario of limited partners defaulting on fund commitments.

As a consequence of this public scrutiny, the use of this financing has become one of the most talked-about issues in the private funds universe.

There are no simple answers. As Neil MacDougall, managing partner of private equity firm Silverfleet, who features in this PEI magazines collaboration, puts it: “You ask 10 people a question, you get 10 different points of view.”

There is more to be done to understand the advantages and risks of the prolonged use of credit facilities at the fund level. In this issue, Real Estate Capital, alongside its sister publications, embarks on a detailed examination of their use