Perspectives: LPs shun fund-level leverage

LPs tolerate subscription credit lines, especially in greenfield infrastructure, but reject the use of leverage to boost returns.

Just over half of investors across private markets asset classes expect to see an increase in the use of subscription lines over the next 12 months. But investor opinion on the subject remains divided. While 58 percent are unconcerned with the extent to which their managers are using credit lines to fund portfolio investments, this, of course, means 42 percent still need convincing.

Certainly, investors in infrastructure funds are keen that managers remain disciplined in their use of financing. “From our experience, most GPs use fund financing to bridge capital calls on a short-term basis, to flatten out the payment profiles and to make the overall process more efficient,” says Frank Amberg, head of private equity and infrastructure at MEAG. “It can also provide some upside on returns. However, most GPs use it in a very cautious way with limits on size with respect to unfunded commitments and duration. We are less supportive on fund finance without such limitations.”

Although investors in infrastructure funds may not be averse to the use of subscription lines to smooth capital calls, they are less accepting of fund finance used purely as a means of boosting returns.

“A significant number of managers will embrace the use of subscription lines to help them manage capital calls,” says Tavneet Bakshi, partner at FIRSTavenue.

“It is not as prevalent in infrastructure, but I don’t think it is frowned upon. But adding leverage at a fund level is not as appropriate in infrastructure, and particularly in core infrastructure, as the assets themselves tend to support a significant amount of leverage, so there tends to be higher gearing at an asset level. Investors allocate to infrastructure based on its resilience and sustainable yield. They are not looking for leverage to boost returns. And so, leverage at a fund level is not really a feature of this universe.”

Threadmark’s co-founder Bruce Chapman says that fund finance does have an important role to play in greenfield projects. “Greenfield infrastructure often relies heavily on subscription lines to fund construction, which may take three or four years,” he says. “Equity will only typically be drawn down from LPs in the last six months of construction and most LPs seem to appreciate that.

“However, if you are talking about fund finance as it is used in the secondaries industry, for example, where a subscription facility may be taken out to delay the drawdown of equity from investors and simply to improve IRRs, that isn’t something we typically see in infrastructure. In general, I think it is fair to say that infrastructure LPs do not like fund level leverage.”