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Large pension funds and other big institutional investors have started to borrow against their private equity portfolios to raise cash after a slowdown in dealmaking activity and public offerings has dimmed their hopes of exiting trillions of dollars in ageing deals.
Investors have begun to turn to so-called net asset value loans in recent months to boost liquidity at a time when big chunks of their portfolio are locked up in private equity, venture capital and property assets that have returned very little cash, according to people involved in the deals.
The tactic, in which borrowers pledge their fund stakes as collateral for loans, is mostly used by private equity groups to unearth cash to fund acquisitions or dividends. However, it is being adopted by investors in buyout funds as a way to generate cash without fire-selling assets at unfavourable prices.
Investors in private equity are short on cash because distributions paid by their funds over the past three years are about half of historical averages, causing the stockpile of unsold private equity deals to hit a record $3tn last year. There is now a $400bn-to-$500bn shortfall of cash that should have been returned to investors, according to Cambridge Associates.
At the start of the year, dealmakers were forecasting a rebound in M&A and public offerings that would cut into the stockpile. Donald Trump’s trade war, however, has frozen activity and private equity executives are now predicting IPOs could be on pause through this year.
“It’s not like suddenly flicking a switch,” said Michael Hacker, the global head of portfolio finance and partner on the secondaries team at Carlyle AlpInvest. “A lot of the current market activity has been in the works in one way or another going back to last year when a lot of the projected exit activity didn’t materialise.”
NAV loans are often considered as an alternative to selling private equity stakes on the secondary markets, another route that investors have taken to raise cash in recent months. By borrowing instead, investors can get cash without selling their stakes at a discount and realising a loss.
The loans are typically for four or five years and have loan-to-value ratios of about 20 per cent, causing buyers like insurance companies and private credit funds to deem them safe assets.
NAV loans are controversial on Wall Street because they require investors to cross-collateralise their fund assets: in essence, to secure a loan with a broad pool of assets, putting their entire fund investments at risk. Last year, an industry trade body issued guidelines surrounding the use of NAV loans to pay dividends after the Financial Times reported on the growing use of the tactic.
Niche player 17 Capital and bigger firms Carlyle and Ares Management are among the most active providers of NAV loans.
Investors first started taking out NAV loans a couple of years ago, as the use of financial engineering tools like fund securitisations became a more mainstream way to extract cash from the logjam of unsold assets.
Other investors that have taken out NAV loans are family offices and sovereign wealth funds, according to people involved in the deals. So far, the biggest loans have reached around $800mn in size, although people familiar with pending transactions said that they will soon eclipse $1bn in size.
“It’s a liquidity management tool that not everybody is using, but the largest, more sophisticated limited partners are using to help manage their balance sheet,” said one lender who has provided financing for these loans.