Growth on growth
As the private credit sector grows, the opportunities for fund financing are booming. Kathryn Gaw reports…
The fund finance market has undergone a transformation over the past three years. Increased demand for flexible financing solutions, a shift towards more structured products and the rapid expansion of the private credit market have created new opportunities to deploy fund financing solutions.
“The buy-out space and alternative assets more generally are raising more and more money year-on-year and funds are getting bigger,” says David Wilson, partner at net asset value (NAV) financing specialists 17Capital. “As industry assets under management (AUM) grow, there is more demand for fund finance to help support that growth and to be a driver of value creation.”
The global fund finance market is believed to be worth more than $1.2tn (£0.92tn), according to an Ares white paper published in October 2024. Ares believes that $850bn of this total is invested in subscription lines – dubbed sublines – while $175bn is in secondaries NAV, $50bn is in single fund NAV, $55bn is in GP solutions, $30bn is in hybrid facilities, and $25bn is in collateralised fund obligations (CFOs). Ares has predicted that the overall fund finance market will be worth more than $2.5tn by 2030.
However, other estimates are a bit more conservative, with most industry experts valuing the fund finance market at between $800bn and $1tn, with NAV financing solutions representing a much smaller share. A year ago, Oaktree Capital Management and 17Capital research found that NAV finance deal flow rose to around $44bn in 2023. They believe that the NAV finance market could reach $145bn by 2030 and will play a “major role” in the evolution of financial markets in the process.
Whatever the current value of fund finance, one thing everyone can agree on is that the market is set for significant growth in the years ahead.
“The fund finance market, traditionally dominated by a relatively small group of lenders, has seen significant expansion of credit supply in recent times amid funds’ increasing financing needs,” says Alexandra Aspioti, vice president, senior analyst at Moody’s Ratings.
“The rise in demand for financing over the past few years has created opportunities for non-traditional lenders, such as insurance companies and alternative asset managers, to fill the gap. We have observed a significant increase in liquidity provided by non-bank lenders.
“We expect this trend to continue, with non-bank lenders – especially private credit funds – driving innovation and offering flexibility to accommodate the needs of funds and sponsors.”
Fund finance has been around in some shape or form for as long as funds have existed. It involves providing loans or credit facilities to investment funds, using the fund’s assets as collateral. It can help funds access enhanced liquidity, while supporting their growth. It is also considered to be on the lower end of the risk spectrum, thanks to the underlying security and cautious lending approach taken. Most fund finance deals cap their loan-to-value at 10 per cent, while returns frequently reach double digits.
Traditionally, banks have dominated the fund finance space, thanks their access to large capital reserves, regulatory expertise, and risk management capabilities. However, over the last few years this has changed.
In 2022, Citibank exited the subline market, primarily due to regulatory pressures. A key factor was the heightened scrutiny and risk associated with lending to private equity funds, as the market became more competitive and sensitive to credit risks. The following year, Credit Suisse left the fund finance market altogether following its acquisition by UBS.
The departure of these two titans left a significant gap in the market, and private credit funds have been quick to take advantage of this opportunity.
“Subscription credit facilities are a core financing tool for private funds, with adoption of this type of bridge financing having reached record levels,” says Aspioti.
“Sublines – traditionally dominated by banks – are becoming more popular among insurers. In addition to offering attractive returns on a risk-adjusted basis, these facilities provide valuable diversification for insurers’ balance sheets, because the collateral is not directly tied to typical market risks.”
Read more: Funds to use sub-lines for longer thanks to market innovations
Sublines are considered to be very good quality loans, which are priced very cheaply. However, the large size of these loans means that only the largest financial institutions can afford to offer them. In the private credit space, that means that only a couple of managers have the scale to offer sublines.
The NAV financing market is a different story. NAV financing grew in the wake of the global financial crisis, when traditional funding sources became less accessible, and funds sought ways to access liquidity without needing to sell assets or call on investors for capital immediately. Today, it is one of the fastest-growing segments of the private credit market, with new solutions being unveiled on a near-weekly basis.
Last year, Pemberton Asset Management raised more than $1bn for its NAV Strategic Financing Strategy, which provides finance to private equity firms, against the value of their investment portfolios. In September, HSBC Asset Management launched the first vintage of its own NAV financing strategy, with a significant anchor commitment from HSBC Group.
Validus Risk Management established its fund finance business in response to the growth of the market.
“The NAV lender market continues to grow, although there are few entrants which are completely new to this space,” says Gianluca Lorenzon, head of fund finance advisory at Validus Risk Management. “Instead, more lenders are starting to expand their current offering to include NAV.”
Lorenzon describes NAV financing as a modern version of a Lombard loan. Lombard loans and NAV financing both involve borrowing against the value of a portfolio’s assets. While Lombard loans are typically secured by financial assets like stocks, NAV financing is based on the net asset value of a broader investment portfolio.
“Successful implementation requires finding the appropriate balance between the desired return and risk,” says Lorenzon.
“The risk reward appetite balance has changed since the pandemic, with investors now more sophisticated and pricing risk better compared to an environment where NAV loans were mostly priced on scarcity.”
NAV finance is generally used when managers are looking for additional capital to further grow the companies that they’ve already invested in, for instance, follow-ons and M&A. It is also used to finance the managers themselves, although this is now more commonly referred to as GP solutions.
Read more: Fund finance platform rolls out faster NAV lending solution
“NAV finance is still in adoption phase,” says Wilson. “There’s nowhere near 100 per cent of funds doing it, but more and more funds are seeing that their peers using it. They’re seeing how valuable the flexibility of having that tool can be.
“Very often we’re doing transactions with groups that are doing a NAV financing transaction for the first time. But once they do it once, they tend to do repeat transactions. Once they’ve started it, it becomes a strategic tool that they use every time they raise a fund.”
Wilson and Lorenzon both expect to see a wave of new entrants enter the NAV financing market, but they have warned that it may not be easy. Although NAV financing is arguably the most accessible segment of the fund financing market for private credit fund managers, it still requires a certain amount of AUM and expertise.
“It’s not easy to launch a new strategy, particularly in a market where fundraising has been difficult,” says Wilson. “But there are a few groups out there attempting to mimic what groups like us have done in this space. They’re not really at the stage where there’s a significant amount of lending because they need to raise the capital first. But there are definitely more potential new entrants.”
Instead of competing with established players, many newer entrants are choosing to focus on their own niches within the fund financing space. For example, CFOs are being increasingly used to add liquidity to private credit and private equity portfolios.
In November, Monroe Capital today announced the closing of its inaugural CFO – a $315m portfolio of strategies, including Monroe’s flagship senior secured direct lending and alternative credit solutions platforms, in both rated and non-rated securities.
Carlyle Group subsidiary AlpInvest Partners issued a $1bn CFO in October 2024, in response to demand from its insurer investors.
Investors are also encouraging more diversity in the fund finance space, by showing a willingness to back new solutions which can deliver lower-risk returns during a time of widespread economic instability.
A recent analysis by Moody’s found that among 30 of the world’s largest insurers, 28 per cent intend to increase their exposure to fund finance, including sublines.
“This interest aligns with insurers’ growing appetite for diverse segments within the larger private credit ecosystem,” says Aspioti. “Although our survey found that few insurers have disclosed participation in fund finance compared to other asset classes, those who have engaged are drawn by its favourable risk-return profile.”
Read more: Leveraged loans and direct lending reached record highs in 2024
As institutional investors seek out more liquidity and new allocation opportunities, alternative fund managers are ready to step up and deliver even more fund financing solutions. While NAV financing and CFOs are already the domain of the alternatives, there is scope for larger GPs to take a closer look at sublines and the capital call market. Moody’s expects to see more partnerships in this area, as banks, insurers and other institutions team up with experienced private credit managers to finance these new offerings.
“Banks with long-standing relationships with GPs will remain the main lenders of subscription credit facilities,” says Aspioti. “Non-bank lenders are more active in NAV lending. Non-bank lenders, especially private credit funds, can offer sponsors flexibility and structure transactions tailored to the fund’s needs. We anticipate that banks and non-bank lenders will frequently operate in tandem to meet the industry’s expanding demands.”
Fund finance is gaining momentum in the private credit world, as investors and managers discover the liquidity and investment potential of these solutions. While the more established players seem set to take the lion’s share of this market, there are still plenty of opportunities for new entrants who have something new to offer.
Read more: Bayview launches fund finance strategy
