The dust is settling after the Institutional Limited Partners Association released guidance for net asset value loans on July 25. Now, investors are thinking through how they will implement it.
NAV loans have been a hot topic among asset owners for nearly a year, with concerns growing about why and how investment managers are using these debt instruments. As managers have had to hold on to investments longer, many have been using the loans to fund cash distributions to investors.
“At a high level, the guidance is a good first step at providing the bare minimum that should be done around NAV facilities,” said one allocator, who spoke on the condition of anonymity. “While some GPs have operated under the belief that the LPA gives full autonomy to make these decisions, the guidance specifies the need for transparency and communication around these decisions.”
ILPA’s guidance aims to quell some of the consternation over NAV loans, although it avoids suggesting that the industry ban them altogether. While the value of the NAV loan market currently is $100 billion, ILPA notes that the Fund Finance Association estimates that it will grow to $600 billion by 2030.
“The industry won’t put its foot down and say you can’t do this anymore,” said Andrea Auerbach, global head of private investments and partner at Cambridge Associates. “The cat is out of the bag and the industry, both sides of the aisle, need to determine what is an appropriate role of NAV facilities in private equity.”
According to Auerbach, private equity’s distribution yield is touching bottom. In venture capital, that yield is at an all-time low.
“There’s a confluence of events where LPs aren’t getting the distributions that they expected, GPs are coming back to the market to fundraise, and LPs are saying we need those distributions,” Auerbach said. “GPs are reaching for NAV facilities, but it’s a synthetic distribution.”
ILPA’s guidance wants to get at this concern, by encouraging GPs to be more transparent about how they plan to use the proceeds of NAV loans.
More specifically, unless explicitly permitted by an LP agreement, ILPA recommends that investment managers seek consent before taking on a NAV loan, regardless of how they’ll use the proceeds.
Even if an investment manager has explicit LPA permission to take out a NAV loan, they should still engage with the limited partner advisory committee for approval if they’re going to use the loan to generate a distribution.
“We think that it is best practice to be as proactive and transparent as possible as the manager. That’s why we made that recommendation,” said Brian Hoehn, senior associate at ILPA. “GPs should always be erring on the side of extra transparency.”
But, according to one allocator, LPAC engagement only works if the committee has the right people on it. They said this “assumes the committee is properly structured and represents the best interests of all investors. This is not always the case as investors have different objectives which sometimes conflict with each other.”
There’s a gulf between the LPs who prioritize liquidity and those who have zeroed in on long-term returns. Tossing a decision to the LPAC works when both sides have equal footing — but it fails when one side has more LPAC representation than the other.
According to ILPA, the information provided to investors should include detailed rationale and information on the use of proceeds, and any alternatives considered. It should include information on the facility size, its structure, and things like subordination and cross-collateralization. Details on key economic terms and LP obligations are also important to include.
Auerbach said that she would like to see what fund performance looks like before and after a GP takes out a NAV facility. “What is the authentic return of the vehicle before bringing in the performance-enhancing drugs that NAV loans can sometimes be?” she asked. “If you weren’t using a NAV facility, what would the return look like?”
